LUCENT'S EARLY LEAD IN A TINY MARKET: WHY INVESTORS SHOULD CARE
Hoping to cash in on the launch of HDTV? You'll have to wait awhile. It may be the most significant innovation in television since color TV. But until broadcasters provide breathtaking new programming and couch potatoes start snapping up the expensive new sets -- years from now, perhaps -- there's precious little money to be made.
In fact, your best play might be the companies that will supply HDTV equipment to TV stations. The Federal Communications Commission has mandated that stations in the top 10 markets begin digital broadcasts by next May, which means they have little choice but to ante up for the necessary high-tech gear. That could provide a revenue bump for Lucent Technologies (LU), the telecommunications equipment giant spun out of AT&T Corp. (T) two years ago. It controls 50% of the market in digital "encoders," which are the boxes stations use to prepare an analog signal for a digital format, says Lucent spokesperson Chris Pfaff.
Of course, these sales represent a tiny part of Lucent's total business. Encoders range in price from about $40,000 to $450,000. That's peanuts for Lucent, which has a market capitalization of $83 billion and is expected to bring in $30 billion in revenues this year.
CUTTING EDGE. As negligible an impact as HDTV may have on overall sales, Pfaff says, the company's innovations should be important symbolically to Lucent investors. They show that Lucent has been able to turn 10 years of cutting-edge research done by its Bell Labs research and development arm into a marketable new product. Another sign that Bell Labs is in the vanguard of emerging technologies: On Oct. 13, a Bell Labs' director and two former Bell Labs scientists were awarded the Nobel Prize in physics (for discoveries unrelated to HDTV).
Both developments "show how smart they are and that they are coming up with inventions that make things work better," agrees David Toung, an analyst with Argus Research Corp., who seems especially impressed with the Nobel prize. "HDTV is not going to make or break Lucent," Toung adds.
The main theme analysts say investors should focus on when considering Lucent is surging worldwide demand for phone equipment. Service providers in the developed world need Lucent's gear to meet increasing demand from business and residential customers for more phone lines and faster service. "The need is to send more data, to send it faster," Toung says. "And Lucent equipment enables those types of transmissions."
In developing regions in Latin America and Asia, phone networks still need to be built as well as expanded and upgraded. Lucent is one of the world's largest suppliers of wireline and wireless infrastructure, as well as switching, transmission, and operation support systems. "Lucent's outperformance should continue as the company leverages its broad product portfolio and technological expertise to exploit the most dynamic market trends," Salomon Smith Barney analyst Alex M. Cena wrote in an Oct. 5 report entitled Lucent: Solid to the Core (Holding).
ON TARGET. Worries that global economic problems would lead to cuts in phone companies' capital budgets have driven down telecom-equipment stocks. But about 75% of Lucent's sales are in the U.S., "so Asia's problems haven't really affected them as much as global players in the industry," says Mark Cavallone, an analyst with Standard & Poors equity research group. Alcatel (ALA) and Northern Telecom Ltd. (NT), both of which warned of earnings shortfalls last month, have seen their share prices fall by half from their highs.
By contrast, Lucent Chief Executive Richard McGinn has said that the company is comfortable with analysts' earnings estimates for its fiscal fourth quarter. They expect Lucent to report 1998 earnings of $1.70 a share on Oct. 22, vs. $1.17 a year ago. Lucent's shares closed on Oct. 15 at 70 5/8, down 35% from its 52-week high of 108 1/2 on July 21.
While the stock is much cheaper than it was in July, it is still fairly high-priced relative to the rest of the market, analysts say. Cavallone currently rates it a hold, pointing out that its forward p-e of 30 is higher than the market's and also higher than is merited by its projected earnings growth rate of about 22% a year. (Growth stocks are often judged to be overvalued when their forward p-e is higher than their projected earnings growth rate.)
Another short-term uncertainty: Lucent is expected to make a major acquisition in the next year. As of Oct. 1, its two-year birthday, it became free to pursue a major acquisition (accounting rules prohibit new spin-offs from using a beneficial accounting method called "pooling of interest"). An acquisition could give Lucent greater access to the fast-growing data-networking market as well as more international exposure -- a long-term plus. But major acquisitions are usually a short-term negative for a company's stock, says Cavallone. Still, he says, "Lucent is still a great long-term story. If you own it, you should hold onto it."
Other analysts are more bullish than that. They believe the stock deserves an above-market multiple because of its premier position in a growing industry. Cena believes Lucent will hit 100 by the end of next year. Toung's 12-month target is 90. Lucent's early strength in the HDTV market is just a tiny part of that story, but it could be telling nonetheless.
By Amey Stone in New York
Updated Oct. 15, 1998 by bwwebmaster
Copyright 1998, Bloomberg L.P.