Alcatel-Lucent: Strong Buy On Turnaround Concept, Rights Issue And Potential Dog Sale

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Alcatel Lucent's (ALU) Q3 results were fairly decent: Total group revenues increased to EUR 3,668 million ($4,926 million) in Q3 2013 vs. EUR 3,600 million ($4,834 million) in Q3 2012 and EUR 3,612 million ($4,851 million) in Q2 2013. Adjusted operating income increased to EUR 116 million ($156 million) vs. a loss of EUR 126 million ($169 million) in Q3 2012 and vs. positive income of EUR 46 million ($62 million) in Q2 2013. Total segment operating cash flow also turned around and came in at EUR 51 million ($68 million) vs. (EUR 117) million ($157 million) in Q3 2012 and (EUR 52) million ($70 million) in Q2 2013. Alcatel's gross margin showed marginal improvement and stood at 32.6% in Q3 2013 compared to 27.8% in Q3 2012 and 31.9% in Q2 2013.

High volume after Alcatel-Lucent's Q3 results pushed the shares up above $4 at the beginning of the month. Shares are holding up quite well even after announcement of a EUR 955 million ($1.3 billion) rights offering. The market clearly supports Alcatel-Lucent's financing package (see further below). Many of the restructuring- and post-reorganization investments I have pursued over the years have marked their low point just before or during their rights offering. J.C. Penney (NYSE:JCP) is another notable equity investment that is now going through the same process. Holding up above the $4 level is a big positive for shareholders.

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A focus on cost savings is paramount

Alcatel-Lucent has achieved cost savings of EUR 259 million ($348 million) YTD and plans to cut costs by a total of EUR 250-300 million ($336-403 million) this year. Alcatel also targets EUR 1.0 billion ($1.34 billion) in fixed cost savings until 2015 and EUR 1.0 billion ($1.34 billion) in non-core asset sales. The company also announced a 10,000 headcount reduction program in order to get a grip on fixed costs. Higher revenues and a lower-cost structure generally hint in the right direction.

Strengthening balance sheet

Alcatel-Lucent announced several financing measures in November in order to improve its balance sheet. The proposed financing package includes EUR 955 million ($1.3 billion) in a rights offering, a EUR 750 million ($1.0 billion) senior unsecured notes offering and the signing of a syndicated unsecured revolving credit facility of EUR 500 million ($671 million). Net proceeds are expected to be used to push out debt maturities, reduce debt, provide financial flexibility and for other corporate purposes (read: overhead costs).

Asset disposals

As part of Alcatel's Shift plan the company intends to sell non-core assets in the amount of EUR 1.0 billion ($1.34 billion). Reuters reported on November 8, 2013 that Alcatel-Lucent's enterprise unit apparently is up for sale:

Alcatel-Lucent is exploring the sale of a division that sells switches and communications gear to corporate clients, part of the French company's efforts to shed 1 billion euros worth of assets by 2015, according to people familiar with the matter.

Alcatel-Lucent SA, which is in the midst of a turnaround and debt-reduction plan under Chief Executive Michel Combes, has brought in Lazard Ltd to help find a buyer for its enterprise business, the sources said this week.

Combes recently said the group was "actively working" on asset sales, and also announced a capital increase and high-yield bond to raise $2 billion.

That prompted credit rating agencies Moody's and Standard & Poor's on Thursday to upgrade their outlooks on Alcatel-Lucent.

The moves are intended to strengthen the money-losing French group's finances and keep it competitive against larger rivals including Ericsson, Huawei Technologies and Nokia's equipment unit NSN.

Alcatel does not disclose the revenue from its enterprise activity. It said sales to corporate clients and government brought in 959 million euros last year, while analysts say the enterprise business is likely losing money.

A sale of a loss-making division would psychologically be well-received in the investment community and it could act as a major, near-term catalyst to drive the share price higher. While the implementation of the Shift Plan is well under way and the financing package provides Alcatel with the means to transform its business model, success from those measure will only be visible gradually and over the course of multiple quarters. Selling-off a loss making division could take a burden off the company and provide the company with a substantial cash inflow. Alcatel-Lucent did the right thing for shareholders by putting this dog up for sale as it does not play a vital role for the 'new Alcatel-Lucent' to begin with. I regard a sale of the enterprise business as a substantial near-term catalyst.

Strategic partnership with Qualcomm

Alcatel-Lucent recently struck up a strategic partnership with Qualcomm (NASDAQ:QCOM) in its wireless line of business to develop small-cell base stations. Alcatel intends to position itself in the Ultra-Broadband and IP Networking markets and a strong strategic partnership with Qualcomm should lead to better quality and service to its customers. Qualcomm also owns a minority stake in Alcatel-Lucent.


Alcatel-Lucent is a strong contrarian BUY based on the implementation of the Shift Plan and the great progress the company has already made in terms of cost reductions this year. The rights offering and debt issuance also allow the company to recapture its financial flexibility and concentrate its R&D expenditures in ultra-broadband and IP networking. My experience with distressed securities also leads me to believe that Alcatel-Lucent has further substantial upside potential once its rights offering is completed and the company has had some time to reposition itself with a stronger balance sheet and a streamlined organization (Moody's and Standard & Poor's apparently share those views since they upgraded Alcatel-Lucent's outlook). Strong long-term Buy on Alcatel's turnaround concept, its rights issue and the potential sale of a loss-making business unit.

Disclosure: I am long ALU, JCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.