Alcatel Not A Turnaround Story

| About: Nokia Corporation (NOK)

Alcatel Lucent (ALU), with major exposure to Europe, has continued to suffer from weaker spending by telecom businesses in the region. Moreover, the prevalent sovereign debt crisis in the continent has continued to adversely impact business spending, which is another negative for the company. ALU has high debt on its balance sheet and is not generating any positive operating cash flows, which has also led a credit rating agency to recently cut its company outlook from stable to negative. Other downgrades have come from the sell side. For instance, RBC Capital Markets downgraded ALU to underperform from sector perform. Even though the stock is trading near its 52-week low, we are bearish on the company based on its continued losses, declining revenues and cash flow losses.

Alcatel Lucent, headquartered in Paris, has operations in over 130 countries and engages in mobile, fixed, internet protocol, optics technologies, applications and services. ALU also includes Bell Labs, which is a center for research and innovation in communications technology. The company operates in three geographic regions, namely Americas, Asia Pacific and Europe, comprising one region, and the Middle East and Africa making up the other two. It is a $2.7 billion-worth company and its shares are currently trading at $1.15, 16% above its 52-week low of $0.99.

ALU functions through two operating segments, which are responsible for developing, delivering and supporting products, solutions and services for the company's service providers, enterprises, as well as industrial customers. The two operating segments are networks and software, and services and solutions, which together provide various products and services utilized by various telecom carriers, as well as governmental agencies. Products and services include broadband triple play for residential customers, 2G, 3G and LTE services to telecom companies. As mentioned previously, the company through its research center Bell Labs has provided major breakthroughs like Light Radio, which is a cube antenna. This radio antenna basically transmits signals from wireless stations to a wireless subscriber, using a wide range of devices like smartphones and laptops, improving energy efficiency and lowering manufacturing costs. Moreover, the company has recently announced that it will provide quick response emergency teams the ability to view and share multiple videos and data feeds simultaneously on mobile devices. The technology will utilize 4G LTE broadband networks to convey real time video. With the capacity of existing broadband networks reaching their limits, the company's first responder video optimizes bandwidth use and integrates multiple video feeds into a single stream, and then transmits it to the emergency teams. This will allow for the quick delivery of various videos that have a greater appetite for bandwidth.

However, despite the recent innovations and breakthroughs, the company is also going through some tough times. On August 13, S&P revised its outlook on ALU to negative from stable. The rationale given was the recent weak operational results and high cash flow losses in 2012, which, according to S&P, if not contained would hurt the company's current strong cash position. The company has total long term debt of EUR 4 billion as at the quarter ended June, 2012 and debt maturities of 600 million Euros scheduled for the financial year 2013. With the company using cash in operating activities rather than generating any, its liquidity position can worsen. Even though the company's management believes that the current cash balances and short term investments (approximately 5 billion Euros as at June 30, 2012) are sufficient to finance its cash needs, as well as capital expenditures, for another year, ALU has recently launched a "Performance Program," which among other issues will tackle the stiff competition that the company faces. by cutting 5,000 jobs. According to a Bernstein analyst, the layoffs are likely to make the situation worse for the company, as the layoffs themselves would cost a lot of cash. On the legal front, the company has been facing some pressure as well. Liberty Media Corp. (NASDAQ:LMCA) has proceeded with its lawsuit against companies like Ericsson and ALU, accusing them of keeping its phone position technology from being available to various telecom carriers that assist emergency response teams in locating a cell device in case an emergency call is originated. According to the latest update by Reuters, a U.S. judge has said the lawsuit can proceed, after dismissing the case in January.

Latest Financial Results

As mentioned previously, the company operates in three geographic regions, with major exposure to the U.S. and Europe. According to the company's latest filings, it derived almost 38% of its revenues from its business in the U.S. while generating 27% from the entire of Europe in the first half of FY2012. With the exception of "Other Americas," revenues from all other regions were down in the first half. The company posted total revenues of 6.7 billion Euros, down 10% from the first half of the previous year, largely due to a deterioration in its local operations and a double digit drop in revenues from its U.S. operations. The company's network segment, which contributes more than half of the company's total revenues, performed poorly in the first half of the year, with its revenues tumbling by almost 14%. This decrease was largely due to a poor performance by its Optics division. The division, which designs equipment for data transportation over fiber optic connections through land and sea, suffered a substantial decline in revenues. The company also designs SONET equipment, which defines optical signals for digital data traffic. Decreased spending by businesses for its equipment led to the revenue deterioration. Despite the deployments of 4G LTE wireless networks in the U.S., a major contributor to the company's revenue stream as mentioned previously, revenues from its wireless division dropped as well, largely due to a weakness in the second generation (2G) and third generation (3G) technologies, as well as CDMA, in the U.S. The wireline division slipped as well in the European and Americas regions, however, the decline was partially offset by strong growth in the Asia Pacific region, especially China, where the company found more demand for its fiber-based access equipment. The company's other segment, S3 (software, services and solutions), also reported a drop of 1.2% in revenues. From a bottom line perspective, the company reported a net loss of 254 million Euros, compared with a 43 million Euros profit in the second quarter of 2011.

Financial Position

ALU had a total of 5 billion Euros of cash and short term investments on its balance sheet as at June 30, 2012, which even though were sufficient, meant a drop from the previous quarter. Moreover, the company has been burning cash for the last few years (cash burn of 644 million Euros in the first half of the year), with the exception being FY2008, which is a cause for concern. In the first half, the net cash used in operating activities increased to 421 million Euros, up 16% from the six months ended 2011. As mentioned previously, this was the major reason behind S&P's recent decision to cut the company's outlook to negative from stable. If the company's cash flow losses continue going forward, it could lead to a possible downgrade by the credit rating agency in the next coming months. The company has a total debt of 4 billion Euros, and a very high debt-to-equity ratio of 118%, which is a concern, especially when the company is burning cash quite regularly. Moreover, with upcoming debt maturities, the company might find itself in financial troubles. Revenues over a four year period have declined by 4%, with its gross margins remaining stable around 33%; the company has posted operating losses from FY2007 to FY2010, which signals its deteriorating operational results.


The stock has performed poorly on a YTD basis, losing almost 30% of its value. This is a worse performance as compared to its peers Ericsson (NASDAQ:ERIC) and Cisco Systems Inc. (NASDAQ:CSCO), as evident in the graph below. Moreover, it has also underperformed the broad market benchmark.

ALU is trading at 16 times its trailing earnings, which is a premium of 18% to the industry as well as a significant premium to its 5-year historic average. Forward P/E of 14x for the company is also much higher than CSCO's forward P/E of 9x and ERIC'S 13.8x, indicating that the stock is expensive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Telecom Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article