Today, Alcatel-Lucent warned that it was likely to report a second quarter adjusted operating loss of €40 million with revenues above € 3.5 billion. It said that the revenue figures reflected good sequential growth in sales across all divisions and geographies, but profits did not improve as much as anticipated because of a slower than expected improvement in the business mix. The company made good progress in reducing fixed costs by about €100 million compared with the 2011 second quarter. Even so, with a net adjusted operating loss for the first half of the year, ALU said that it would not be able to achieve its previously announced adjusted operating margin guidance for the full-year 2012. That guidance had called for 2012's adjusted operating margin to be better than 2011's 3.9%.
Based upon the company's disclosure, 2012 second quarter revenue of more than €3.5 billion is up more than 9% from the first quarter, but down about 10% from the 2011 second quarter. The anticipated second quarter adjusted operating loss of €40 million is a big improvement over the first quarter's adjusted operating loss of € 221 million, but also much worse than the 2011 second quarter's adjusted operating income of €108 million. The operating loss figures imply an operating margin of minus 1.1%, compared with minus 6.9% in Q1 and plus 2.8% in 11Q2. It is evident that ALU made good progress from the very difficult first quarter, but it still has work to do to reach what would be considered a normalized operating margin in the mid-single digit range.
Today's press release did not address the second part of the company's 2012 guidance: to end the year in a strong net cash position. Based upon the figures reported today, ALU's second quarter cash flow performance will probably not raise additional concerns, but it may not alleviate concerns either, since the company may be required to increase working capital somewhat in anticipation of a modest increase in sales in the second half of the year.
It is possible, but hopefully not likely, that the disappointing second quarter results will renew speculation that Ben Verwaayen will be forced to step aside. If he does, I would view it as negative for the company. Most of ALU's problems are, I believe, market-related. Since the merger and under Verwaayen's leadership, ALU has made excellent progress in regaining its competitive edge, both in the wireless and the IP businesses. I believe that the company is uniquely positioned to benefit from the increased demand for product and services that integrate, streamline and optimize the data flow from both wireless and wireline broadband traffic from the network edge and through the backbone.
ALU is especially challenged by the slowdown in capital spending by European telecom carriers. That combined with global telecom equipment supplier overcapacity has put pressure on both revenues and margins for all competitors. A little over one week ago, the Financial Times reported that Brussels was considering launching an investigation into subsidies given by the Chinese government to Huawei and ZTE, the telecom equipment manufacturers. China has threatened to retaliate, but it is clear that the European authorities understand the pressures that the industry faces and may very well try to take some steps to alleviate them.
In this environment, it is also unclear whether Nokia-Siemens Networks can continue to operate as an independent entity. Nokia clearly has a lot on its plate. Although it incurred significant charges in the first quarter to restructure NSN, it is not clear whether NSN will continue to require support, which Nokia may not be able to afford. The industry would obviously be better off with one less competitor, but the European Commission may find it difficult to approve further consolidation among the remaining suppliers.
For now, the disappointing second quarter results will likely lead to lower earnings estimates for ALU for 2012. Analysts had anticipated earnings of $0.02 for the second quarter. Based upon today's disclosures, I pencil out a loss from continuing operations (including restructuring charges) of about $0.05. Current consensus estimates anticipate full-year 2012 earnings of $0.17 for ALU. With an estimated $0.14 in losses from continuing operations for the first half of 2012, a more realistic full-year estimate is probably now around $0.10.
ALU's shares fell 19% today to $1.11, which gives an implied P/E multiple against my 2012 estimate of about 11 times. Considering that this should be trough earnings, the stock looks very cheap. If the outlook for global economic growth improves, as I anticipate it will, led by a pick-up in the U.S. growth rate, then telecom carriers around the globe will begin putting more upgrade projects on the front burner. This is the upside scenario for ALU and most of its peers. In "normal" times, it is not unreasonable to think that ALU could earn $0.30 to $0.45 per share, which would probably translate into a stock price of $3.50 to $5.00.
With net cash (i.e. cash minus debt) of €753 million at the end of the first quarter, the company should have the financial wherewithal to muddle through this rough patch. It cannot afford to be complacent, however, since it potentially faces significant debt maturities beginning in 2013. Ideally, I am sure that the company hopes to see some meaningful improvement in its financial performance in the second half of 2012 to put it in a stronger position to issue new debt perhaps early in 2013.
Disclosure: I am long ALU.