Stop me if you've heard this before – Alcatel-Lucent (NYSE: ALU) has a bold plan to cut costs, refocus the business, and return the company to profits and prosperity. To be fair, the new CEO does deserve a chance to show if his plan can/will work, and the broad strokes outlined today make sense. Even so, this is Alcatel-Lucent and the telecom equipment industry we're talking about, and success is far from guaranteed.
Cut Costs, Cut Businesses
The centerpieces to the new plan are deep cost cuts and a sharp focus on businesses where Alcatel-Lucent can compete effectively in the coming years.
While the company had been targeting about EUR 500 million in cost cuts by 2015, that target has been doubled. Management intends to achieve this by increasing its direct channel focus with sales and marketing and reducing the scope of its R&D. That's an interesting move, particularly given how many Alcatel-Lucent bulls try to point to the company's patent estate as a store of future value. While it makes ample sense to reduce the scope of R&D (translating those patents into real products and real revenue streams has not gone well), I wonder how it will go over with shareholders.
On the other side, management will still look to sell businesses where it does not believe it has a long-term competitive edge. In particular, management is retrenching around its IP networking and Access businesses, and hopes to raise upwards of EUR 1 billion by selling the rest.
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This is a smart move on balance. For all of my criticism of Alcatel-Lucent, the company is quite competitive in areas of networking like edge routing – where the company has consistently gained share from Cisco (Nasdaq:CSCO) and Juniper (Nasdaq:JNPR) over the years. Likewise, getting out of areas like wireless and optics is something I think management should do – Ericsson (Nasdaq:ERIC), Ciena (Nasdaq:CIEN), Huawei, and ZTE have steadily taken share away from the company in those markets, and I see no reason to believe that Alcatel-Lucent can reverse that trend.
Will This Be Enough?
If management can do what it says, there is the possibility that this business could generate close to $1 billion (or EUR 750M) in free cash flow in just a few years time. I say “possibility” and not “probability”, though, because I don't think management will reach those targets.
For starters, I think the company will be hard-pressed to find buyers willing to pay the contemplated amounts for its assets. Nokia Siemens Networks has looked a great deal better lately, and Siemens (NYSE:SI) can't seem to find a buyer for its stake on reasonable terms. So I don't see why buyers will be clamoring for Alcatel-Lucent's assets (they're not all bad, mind you, but the buyers just aren't there today).
I also believe that the company's networking growth and access margin improvement goals may be too ambitious. Cisco has effectively said “this far, and no more” with respect to losing share to the likes of Alcatel-Lucent in routing and I know whom I'd bet on between Cisco management and Alcatel-Lucent management.
The Bottom Line
If things go well, Alcatel-Lucent will emerge in two or three years as a slimmed-down, focused, competitive player in a much narrower segment of the telecom equipment market. On balance, that's fine – being a “soup to nuts” provider hasn't worked, so why not try the other way? I still believe, though, that there are fundamental cultural issues within this business and that senior management is going to find it difficult to meet those cost goals and/or refocus the business along these new, narrower lines.
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These shares ran up pretty well on investor hopes and expectations for this new plan, and I don't think they'll walk away disappointed. Even so, when companies like Cisco, Ciena, and Juniper all seem to be trading below fair value, taking the chance on Alcatel-Lucent seems like an unappealing risk-reward proposition.