These are still very early days, but if the second quarter is any sign, Alcatel-Lucent's (NYSE:ALU) latest restructuring efforts may bring this company (and stock) back into relevancy. There is still plenty than can go wrong, but the carrier spending environment is looking better by the month, and will likely put some significant tailwinds into Alcatel's sales. While I definitely missed out on the early jump in these shares, a pathway to $3.50 (or higher) for the shares is at least worth talking about today.

Solid Second Quarter Earnings, On A Relative Basis At Least
Alcatel-Lucent's second quarter results wouldn't have passed muster for a company like Cisco (Nasdaq:CSCO) or Huawei, but they weren't bad for a company that badly needs to re-establish its credibility with the Street.

Revenue rose 2% as reported (or 4% in constant currency) from last year, or 12% versus the first quarter. That was good for a 3% beat, as the company saw surprising strength in edge routing (leading to IP revenue growth above 20%) and better than expected results in LTE (leading wireless to 5% sequential growth. 

Margins likewise improved. Gross margin increased only slightly from last year, but improved 250bp sequentially. More importantly, gross margin beat the average estimate by more than 150bp. Adjusted operating income was positive (unlike the year-ago and quarter-ago results), and Alcatel's slim positive operating margin was almost 300bp higher than expected.

SEE: A Look At Corporate Profit Margins

A New Focus On Growth Products, Just As The Cycle Turns Positive Again
There have been a lot of false dawns with predictions of better telecom carrier spending, but it looks like conditions are finally, legitimately, getting better. Other equipment providers like Ciena (Nasdaq: CIEN) and Infinera (Nasdaq: INFN) have been seeing demand improving, as have Juniper (Nasdaq:JNPR) and Cisco. Results haven't been quite as strong as Ericsson (Nasdaq:ERIC) or Nokia Siemens, but then there too are some margin/mix improvement stories at work.

SEE: How To Pick The Best Telecom Stocks

As seen with Ciena and Infinera (and in recent announced wins), 100G is pretty strong for Alcatel-Lucent right now, and I would expect this market to get better over the next year or two. I still have my doubts about Alcatel's ability to compete, but I also don't believe that the company has to gain share to still benefit from this growing market. Edge routing, too, is looking quite a bit stronger for Alcatel as data traffic grows. As with 100G, I have my doubts that Alcatel-Lucent can grow share against its rivals (in this case, Cisco, Juniper, and Huawei), but once again Alcatel-Lucent doesn't have to “win” edge routing to still benefit from it.

We'll see what happens in wireless. Although Alcatel gets a lot of flack from bears (myself included in the past) for its share losses in LTE, a global share of around 15% to 17% is still good enough to allow the company to benefit from upcoming rollouts. The real question here may be margin, though, and Alcatel management could well face some difficult decisions with respect to how it bids on business.

On a somewhat related note, I thought it was rather interesting that Qualcomm (Nasdaq: QCOM) chose to partner with, and invest in, Alcatel for 3G/4G small cells. Qualcomm seems to be turning into something of an angel investor these days (at least between investments in struggling companies with good IP like Sharp and now Alcatel), and these small cell products won't roll right away, but it's hard not to see this move as something of an affirmation of Alcatel's IP and ability to endure.

The Bottom Line
I have long been very critical and skeptical towards Alcatel-Lucent, in large part because prior management line-ups couldn't execute their way out of a broom closet. And again, this is only one quarter and one where most of Alcatel-Lucent's comparables have sounded pretty positive on the market trends. So there's still a great deal of work left to do (and much to prove), but it's a good start.

I now expect Alcatel to return to positive free cash flow in 2015, and although liquidity is going to be tight for some time, improving financial performance over the next two years ought to create additional refinancing opportunities (though likely with higher base interest rates).

I'm still looking for long-term revenue growth in the neighborhood of 3% from Alcatel, well below Ciena and Infinera, but only a bit below Cisco. I'm more optimistic, though, that Alcatel can pull long-term free cash flow margins back into the mid-to-high single digits, though, and that leads to a discounted fair value (even with an elevated discount rate) of about $3.50. That's enough to make these shares worthy of consideration (something I wasn't sure I'd say again) even after this big run, and if the company continues to execute, those targets could head higher as the turnaround continues.
Disclosure – At the time of writing, the author had no positions in any stocks mentioned.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  10. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!