We have been following Alcatel-Lucent (ALU) and its predecessor Lucent Technologies since the late 1990s. We first heard of Lucent in Charles Carlson's book No-Load Stocks, as Lucent had offered a direct stock purchase plan to investors. Lucent was a beneficiary of the telecom and technology boom-and-bust of the late 1990s. Lucent went from being a $250B telecom equipment darling at the dawn of 2000 to racking up four straight fiscal years of losses from 2000 to 2003. After generating a $2B profit in 2004, Lucent only generated $1.6B in profits from 2005 to 2006, before accepting a $13.4B buyout from Alcatel to form Alcatel-Lucent. Patricia Russo was in charge of Lucent when it bounced off its losses to regain profitability and she was tapped to run Alcatel-Lucent, with Alcatel's CEO Serge Tchuruk retiring as CEO and serving as Non-Executive Chairman. Russo and Tchuruk certainly did their best when running the company from 2006 to 2008. Unfortunately, their best wasn't good enough, as Alcatel-Lucent racked up $9B worth of losses under their leadership in 2006-2008.
Our Evaluation of the Alcatel-Lucent Merger Deal
The Alcatel-Lucent deal officially qualified as a "Deal From Hell" in that Alcatel-Lucent had to write down all the goodwill and intangibles associated with the deal - both Tchuruk and Russo were put out to grass in September 2008 and Alcatel-Lucent's market cap of $2.83B as of August 17, 2012, is 20% of what it paid to acquire Lucent in 2006.
Alcatel then picked Ben Verwaayen off the waiver wire and named him as its next CEO on September 2, 2008. As ALU's CEO, Verwaayen had at least minimized operating losses at Alcatel-Lucent and sold off non-core assets. However, Alcatel-Lucent is still seeing its cash and liquid asset balances steadily erode in order to support operations.
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Source: Morningstar Direct
Recent Highs And Lows At Alcatel-Lucent
Unfortunately for Alcatel and Ben Verwaayen, the stabilization that Alcatel-Lucent enjoyed from 2009-2011 has come to an end and the company has returned to generating operating losses. Alcatel-Lucent saw a 7.2% revenue decline in Q2 2012 versus Q2 2011 levels due to a 19% revenue decline (€202M) in its Wireless Networks business.
ALU's revenue was €3.55B in Q2 2012 versus $3.82B in the prior year period. ALU's Optics Networks business also saw weak results, declined by €103M in Q2 2012 versus Q2 2011 levels. This helped contribute to a €105M year-over-year decline in its Networks Division adjusted operating income, which pushed it from an adjusted operating profit of €48M in Q2 2011 to a loss of -€57M in Q2 2012.
ALU's Wireless Networks revenues had seen a continued decline from Q1 2011 to Q1 2012, before trending upward in Q2 2012. Alcatel-Lucent includes the old Bell Laboratories and as such it is a former affiliate of AT&T (T) and Verizon (VZ). Verizon and AT&T also represent 12% and 11%, respectively, of ALU's YTD 2012 revenues. Considering that Verizon had cut its YTD CapEx by $1.5B year-over-year and AT&T cut its YTD CapEx by $663M, it's no wonder why ALU's revenue and profits have been soft this period.
Alcatel-Lucent's Financial Position
Despite the fact that Alcatel-Lucent has been bleeding cash since its 2006 merger combining Alcatel and Lucent, we take note of the fact that it still has €5.4B in cash and other liquid financial assets as of Q2 2012. Unfortunately, it is nearly offset by its €4.86B in bonded debt outstanding as of Q2 2012. At least it is in a net cash and investments position of €540 right now.
However it still has to deal with €856M of financial debt due within the next year, as well as €585M due in 2014 and €1.027B in 2015. We don't know why it repurchased $115.5M of its 2.875% Series B Convertible debentures in H1 2012 for $110M. While this may save $3.3M in annual pre-tax interest, we think it is foolhardy to prematurely redeem low-cost long-term debt when the company has higher-cost debt with shorter maturities outstanding. Furthermore, if Alcatel-Lucent tries to refinance its $2.5B in upcoming debt maturities over the next 3.5 years, we expect it to be paying a lot more than the 5.5% weighted average cost of debt that it is paying right now, which will be another headwind to its already weakened profitability.
In conclusion, we believe that Alcatel-Lucent will continue to muddle through the morass of its mediocrity for at least two to four quarters before it begins to recover. When the biggest increase in telecom capital expenditures is coming from Sprint Nextel (S), we are not that optimistic on telecom equipment makers like Alcatel-Lucent. When you combine a decline in telecom equipment spending from leading telecom blue chips like AT&T and Verizon with a weak macroeconomic environment in Alcatel-Lucent's home market of Europe, you get an investment with high risk and volatility and little immediate upside.
We like the fact that the company is trading at a near 50% discount to gross cash and a near 50% discount to its book value. However, we are also mindful of the fact that Alcatel-Lucent has a negative tangible book value of $2.4B and has had free cash flow deficits since its 2006 merger combining Alcatel with Lucent. Morningstar expressed such concern with its performance that it decided to drop coverage of the company due to its weak competitive position and high risk associated with its operational restructuring and macroeconomic headwinds.
Source: Morningstar Direct
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