To get a sense of just how badly wrong the Alcatel-Lucent (NYSE:ALU) story has gone, consider that the combined company has never produced a full year of positive free cash flow since the 2006 merger. What's more, while the company still has very relevant share in areas like edge routing, rivals like Ciena (Nasdaq:CIEN), Huawei, and ZTE have been taking share, while companies like Nokia Siemens Networks get their acts together.
That's all pretty well known, though, and part of the reason the stock sits below $1.50 today. With a new CEO, new products, and new market opportunities, perhaps Alcatel-Lucent has new life to offer shareholders.
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First Quarter Results Show Good And Bad News
All told, Alcatel-Lucent basically met expectations for first quarter results. Unfortunately, the expectations weren't terribly demanding and the company continues to post weak cash flow numbers.
Revenue rose under 1% as reported this quarter, or nearly 2% on a constant currency basis. That was good for a roughly 1% outperformance relative to the average sell-side estimate. There were some areas of decent performance, as IP and wireless were up 5% and 6%, and wireline access was up 9%. Although optics as a whole was weak (down almost 16%), the company saw solid 100G performance.
Alcatel-Lucent's profit performance was likewise on target, albeit not terrifically strong. Adjusted gross margin declined almost a point from the year-ago and quarter-ago levels, but did slightly beat expectations. The company spent a bit more on opex, however, and the operating margin (negative 5.5%) was basically on target.
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There's Still Opportunity, But It Will Take Share Loss Reversal
Alcatel-Lucent did post a book-to-bill of 1.03 for the quarter, which isn't bad given Alcatel's problems and the general weakness of the telco equipment sector. As previously mentioned the good result in 100G is encouraging, given that Ciena is looking to this market for growth and companies like Huawei and Nokia Siemens Networks (a joint venture of Nokia (NYSE:NOK) and Siemens (NYSE:SI)) have been stepping up their efforts.
Alcatel-Lucent also seems to be doing at least okay in routing. The company still has about one-quarter of the edge routing market and has been trying to leverage that position to grow its core routing business at the expense of Cisco (Nasdaq: CSCO) and Juniper (Nasdaq:JNPR).
All of that said, some perspective is in order. Over the last few years, Ciena has gained almost as much share in optical as Alcatel-Lucent has lost, while also gaining WDM share. Samsung has been getting more aggressive in trying to grow its telco equipment business, while Ericsson (Nasdaq:ERIC) has been taking share from Alcatel-Lucent in the U.S.
Will The New CEO Bring What Alcatel-Lucent Really Needs?
It wasn't too long ago that the company announced that Michel Combes as the new CEO for the company. Combes is a telecom industry veteran, and most analysts expect to hear a detailed run down on the new strategic plan sometime this summer. That said, many have already pointed out that he has a solid reputation as a good cost-cutter.
That's all well and good, but I'm not entirely sure it's exactly what Alcatel-Lucent needs. The problem at the company has long been execution, and expense control is only a part of that. Alcatel-Lucent has good technology (even if investors often overstate the quality and value of Alcatel's patent estate), but good technology isn't worth much without the ability to turn that technology into desirable products that can be manufactured and sold profitably. So slimming down is all well and good, and should help reduce the company's cash breakeven point, but Alcatel-Lucent isn't going to regain share from Ciena or its Chinese rivals by under-spending them.
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The Bottom Line
Given the moves that Alcatel-Lucent has made to shore up its balance sheet, I think the question of whether the company survives is tabled for now. But what is still very much up for debate is how the efforts to rebuild share and revenue growth at Juniper, Ericsson, Nokia Siemens Networks, and Ciena all play out, as newer entrants like Huawei, ZTE, and Samsung grab for business as well. There's room for more than one winner, but they won't all win.
Right now I think Alcatel-Lucent is pretty much fairly valued, as I do believe that rivals like Ciena are going to grow at their expense. That said, I see do upside of at least double the current share price if Alcatel can hold its market share and eventually generate a mid-to-high single-digit free cash flow margin.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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