This Tech Stock Will Hurt Your Portfolio

| About: Nokia Corporation (NOK)
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Alcatel-Lucent (ALU) is throwing different tricks out of its strategic bag to survive. This comes after reported its third quarter 2012 results. It reported revenues of 3.599 billion Euros, or equivalent to $4.62 billion. This translates to an increase of 1.5% sequentially and 2.8% compared to the same period last year. Meanwhile, it incurred an operating loss of $1.29 billion. For the last 10 years, revenues have declined by 4.92%. It also incurred operating income of $117 million in 2011, a turnaround of operating loss $728 million. But, it reported its second consecutive quarterly net loss.

With this net loss, Alcatel-Lucent experienced a cash burn of around $466 million for the quarter. At this cash burn rate, the company would run out of cash for the next quarter. After deducting its debt of $6.29 billion, it would have only $200 million left. For the last 10 years, free cash flow experienced significant decline. It posted free cash flow of $2.2 billion in 2002 to negative free cash flow of $445 million in 2011. The lower free cash flow is due to the lower operating cash flow the company experienced despite capital spending remaining flat of around $400 to $500 million a year.

Its business segments have mixed results. Its network segments experienced double digit decline for the period. Separately, both its IP business and wireless business affirmed their strong competitive positions with strong gains. Meanwhile, its software and solutions segments posted flat growth. Finally, the enterprise business also posted double decline rates. In terms of geographical segment, both North America and Asia Pacific posted declines. Europe declined despite the strong growth experienced in Russia. Overall, it has not been a quarterly result that the company expected as it struggles to deal with tough operating environment.

Asset Sales Necessary

Chief Executive Ben Verwaayen said that the company will pursue various avenues to improve its financial position. These decisions will include asset sales, job cuts, and 1.25 billion worth of cost-effective measures. While these actions will strengthen the company's balance sheet in the near term, this would not lead to profitability in the coming years.

First, the industry is experiencing different changes. It won't do any good to cut jobs and dispose business segments. The company would have to incur one-off charges, and there is a big risk that it could fire good people in the process. Second, there is always a limit to cost-effective measures as it provides immediate cash source for the company. On a longer run, this appears a defensive move for the company and will have impact on its long term profitability. Finally, turnarounds usually take time. There is also a likely chance that turnaround would take longer than planned. In fact, it would translate to losing competitive position in key markets it operates. For example, Hewlett-Packard (NYSE:HPQ) has failed to convince investors that its turnaround plan is working. A lot of HPQ's woes stem from the overall bearishness in the PC industry. Other PC heavyweights, like Dell (DELL), have also traded at multi-year lows, implying that the bottom has not been reached. There are still lots of uncertainties surrounding the future of the PC industry.

On the other hand, its peers have mixed results. Nokia (NYSE:NOK) reported quarterly loss of $0.33 per share. Excluding special items, the loss came in at $0.09, narrower than the estimated loss of $0.12 per share. The better than expected result is attributed to the strong launch of its Nokia Lumia product line. But, management is pessimistic about the company's upcoming quarter results despite the holiday season. Cisco (NASDAQ:CSCO) reported a robust full year 2012 earnings per share of $1.49, an increase of 27% year on year. Its management is confident of its long-term outperformance given its transition to cloud, mobile, virtual and social services. The industry is currently in the middle of transformation as industry has spent significant cash to invest in these businesses.

The silver lining is that Alcatel-Lucent will be a leaner company after its restructuring efforts. This would mean smaller headcount and few managed service engagements. Ultimately, Alcatel will be a more focused company than ever. I believe this will involve cutting businesses that cannot deliver modest operating margins. It also plans to partners in key countries than full-scale operations.

Meanwhile, the company will focus on certain markets in its wireless and mobile. It cited the LTE TDD Deal with China Mobile (NYSE:CHL) as one of its significant deal that will improve its revenue visibility. Separately, its IP division is posting tremendous success with double digit gains for the quarter.

Valuations - Market Betting on ALU's Failure

The stock is currently trading at 10 times forward earnings and 40% of its current book value. At these levels, the market is betting that the company is likely to fail. In terms of price over growth, the stock trades at 1 time. In contrast, Cisco is valued 8.3 times earnings and 1.8 times. On a price over growth, Cisco trades higher at 1.9 times. Even Nokia trades at book value, although its price earnings ratio is negative. It seems that the market is far more enthusiastic over Nokia's prospect than Alcatel. This is probably due to the recent success of Nokia in convincing consumers to take a second look at its Lumia product lines.

At these valuations, it is hard to imagine Alcatel expanding its earnings multiple in the near term. I believe that the company's management will have a hard task on convincing investors that it is here to stay for the next few years. Before considering its growth plans, it would have to raise enough cash to survive. Time is not with Alcatel's side. It probably would have to take drastic measures even raising money to survive in this tough environment.

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