Lucent Isn't Biting a Big-Enough Bullet


If bad news had a name, it would be Lucent. The beleaguered company is dealing with a flurry of shareholder lawsuits and has restated last year's fourth-quarter revenues from $9.4 billion to $8.7 billion. Its stock has plummeted more than 70% off its highs last spring. As an encore, the company couldn't come close to analyst estimates with its Jan. 24 announcment of a huge loss per share of 30 cents for its first quarter of 2001, ended Dec. 31. The quarterly loss of $1 billion from continuing operations marked the third consecutive decline for the Murray Hill (N.J.) outfit.

To turn Lucent (LU) around, executives unveiled a $2 billion cost-cutting plan, double the size hinted at a month earlier. As part of the restructuring, the company will eliminate 16,000 jobs and some product lines. It will take a one-time charge of $1.2 billion in the second fiscal quarter to cover severance pay, consolidate facilities, and write down assets.

SHALLOW CURE. Will this comeback attempt work? Most analysts don't think so. They fear that cost-cutting won't solve Lucent's fundamental problems. The company needs to focus on delivering hot products to customers in a timely fashion, says Derrick Queen of U.S. Trust, a communications-equipment consultancy.

Moreover, Lucent still lacks a basic plan for future sales growth, says Robertson Stephens senior analyst Paul Silverstein. Already, more nimble competitors such as Ciena and Nortel Networks have stolen market share from Lucent in the key optical-networking sector. In 2000, Lucent failed to capitalize on the fast-growing wireless phone network sector. And at the Jan. 24 earnings conference, Lucent interim-CEO Henry Schacht talked all about the company's restructuring efforts, but he failed to outline Lucent's improvement plan.

Conversely, the conference call raised as many questions for market watchers as it answered. By refusing to share any sales targets, break down revenue by sector, or discuss the health of the company's flagging optical-systems segment, Schacht left many analysts still trying to get a handle on how badly the company's business has deteriorated -- and whether the process is over yet.

Clearly, the problems at Lucent run even deeper than anyone had thought. From September to December, its inventories grew 21.2%, to $6.9 billion. While some blame component shortages for the company having to store up "nuts and bolts" to be prepared for customers' orders, Queen says parts have been more readily available in recent months. That could mean a low volume of orders, he says. Or Lucent might have suffered from poor communication with its customers, which hindered its ability to anticipate demand for specific products. So far, the company has refused to divulge inventory details to analysts.

SLOW-MOTION PAYMENTS. When Lucent does make sales, it often gets the money only after an unacceptably long wait. That's because some of its customers, especially small telecoms, are in financial trouble, explains Lucent CFO Deborah Hopkins. The company's accounts receivables actually decreased in the first quarter of 2000 compared with the same period of 1999. Though normally a good sign, some speculate that this decline could have resulted from falling sales as small telecoms' purchasing power sagged and competition intensified. And the gap between making a sale and Lucent receiving payment increased 13 days, to 112 days, compared to the same quarter the year before. Other calculation methods show that the quarter's payment lag climbed 28 days.

Schacht is sanguine about the perception. He has pledged to exercise a "more careful approach in the [small-telecom] market." But that pledge could be hard to uphold. Lucent, like many companies in the industry, has financed purchases by small customers to gain crucial market share. And the fallout from small telcos' payment defaults could be far from over.

Merrill Lynch analyst Michael Ching believes Lucent might write off some of its defaulted accounts receivables and redundant inventories as part of the one-time, second-quarter special charge. Company officials say the charge will be used for severance pay and closing product lines. Also, Ching says he wouldn't be surprised if the company decided to do more inventory and accounts receivable write-offs in a later quarter. Trouble is, the slowing economy drags small telcos down, that could further exacerbate Lucent's payment problems.

ON THE HOOK. For now, Lucent's financing exposure is considerable. As of Dec. 31, the company had $5.7 billion in customer financing. It had also guaranteed $1.8 billion in customer debt. Nortel, a company of comparable size, had customer financing commitments of only $4.1 billion as of Dec. 31. Lucent's financing burden could increase when it completes an imminent $1.6 billion credit deal with Telefónica, the world's leading telecom operator in Spanish- and Portuguese-speaking countries.

Under that financial weight, Lucent would have "the least flexibility" in the wireless-infrastructure industry and lose some opportunities to increase its market share through financing its customers, says Queen. And the latter is something Lucent can't afford. The company has seen its market share deteriorate even in fast-growing markets like optical systems. The company's share in the optical-transport field slipped from 24% in 1999 to 14% last year, according to telecom consultancy RHK.

Competition intensified this year with a push from Ericsson, Nokia, and Nortel. Ciena also came out with a new optical-switching product. Revenues from Lucent's fiber-optic-cable segment grew 50% in the past quarter, but its market position in optical systems continues to weaken, according to analysts.

CUTTING ITS LOSSES. Despite these concerns, most analysts say the restructuring effort takes tiny steps in the right direction. Schacht hopes to sell two plants and eliminate 10,000 jobs this year and 6,000 more in 2002. The company won't yet pinpoint which unprofitable product lines will be cut. But analysts speculate that they'll come from its ATM (asynchrous transfer mode) switch business and the internetworking products from its acquisition, Ascend Communcations. The measures, which should help Lucent's bottom line, represents a huge cut for a company that had only $3.1 billion in net income from continuing operations in fiscal 2000.

At the earnings conference call, Schacht tried to soothe investors. He said Lucent would cease offering special discounts to move products quickly. Sales, which plunged 26.1% for the first quarter of 2001 compared with the same period in 1999, would pick up in the second fiscal quarter of 2001, he added. So Lucent's financial performance should start to improve in the second half of 2001. And the stock price has essentially held steady around $18.50 since Schacht's call.

Analysts claim -- with a nervous laugh -- that it's unlikely the stock price can slide any further. It has been inching up of late from a 52-week low of $12.19 and closed on Jan. 30 at $18.57. Make no mistake: Lucent still has a deep financial base. While its cash kitty has been severely depleted, Lucent has arranged for a $4.5 billion credit line from J.P. Morgan and Salomon Smith Barney to replace a $2 billion line of credit coming up for renewal in February. Lucent is also expected to raise $8 billion with the initial public offering of its microelectronics subsidiary, Agere Systems, in March. As part of the float, Agere will assume $2.5 billion in Lucent debt.

NO "DYING BEAST." And the company retains some significant strengths. It's still the third-largest patent holder in the world, and its research arm remains an intellectual powerhouse. Lucent has also generated a few hot new products, including the WaveStar OLS 1.6 T optical system, which is attracting its first buyers. The company hasn't denied rumors of pending contracts with WorldCom and another big international carrier. Gartner analyst John Gonsalves says: "I don't think it's a dying beast."

Still, as the restructuring kicks in, Lucent's second fiscal quarter will likely be another tough one, warns ABN Amro analyst Ken Leon. He says productivity will likely decline because of workers' lay-off concerns. Lehman Brothers analyst Steven Levy believes that the core Lucent divisions (businesses excluding Agere) will become profitable only in June, 2002. That's an awfully long wait, and many investors have basically hung up on the company.

Even Schacht admits: "This is a period of great uncertainty." For a fallen bellwether struggling to regain its footing in a nervous market, that's not a reassuring recipe for quick recovery. By Olga Kharif in New York


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