Notes and observations

1.    Lucent has once again become a technological competitor. During the late 1990’s and early 2000’s, they did lose their technological edge. This loss was caused by  internal fraud, engineer defection, increased competition and technological disruption. Lucent is known as the leader in supplying Wireless Service Providers with CDMA infrastructure. Verizon Wireless is their largest wireless customer. Lucent strategically decided to abandon GSM network builds in 2001/2002. This was a controversial decision, since GSM was the prevalent system in Europe. CDMA is the alternative to GSM.  The mass penetration and growth of CDMA is occurring. Over the last year or so, GSM companies, such as ATT Wireless and Cingular, have given serious consideration in upgrading their networks to UMTS. UMTS gives GSM systems, the benefits of 3G and CDMA operations. UMTS uses WCDMA technology.


2.    Competition and disruption is always a concern for any developer of communications infrastructure. Lucent has unusual and company specific, competitive concerns due to their retired labor force and associated retirement benefits. Lucent has what is called “legacy costs”.  These legacy costs are primarily benefits that need to be paid to retirees.  These costs need to be built into their projects and "Requests For Proposals" (RFP).  Competitors do not have such legacy costs, and hence can bid on jobs in a less expensive manner, at the same time still retain greater profitability.  Lucent also is contending with several companies from China. These companies, have lower costs and certainly a qualified “brain trust”. Up until a year or so ago, China was regarded as telecom copy-cats.  These companies were known to have technology copied from the likes of Lucent, yet without the technological quality. Many argue that these companies from China currently now have leading technology, and of course their costs are much lower. Two of the leading Asian competitors of Lucent are Huawei and ZTE.


3.    In F2003 ATT, BellSouth, SBC, Verizon and Verizon Wireless contributed 22% of Lucent revenues. Customer concentration does produce greater risks.


4.    There has been a historical general rule of thumb that Service providers spend 10% - 20% of their revenues on capital expenditures. These capital expenditures include line maintenance, warehousing, rental or purchase of real estate, and infrastructure upgrades (switches, routers, routes, etc). Data and voice networkers, such as Lucent claim that they receive about 50% of that allocation. Of that remaining 50%, being very liberal in rounding off the allocation, you can say that ½ goes to wireless and ½ goes to wireline (both voice and data, but that is now being converged into one). When trying to monitor capex from service providers, I generally use 10% - 15% of revenues. Of course it is difficult to monitor, but it helps to have an understanding of this historic trend.

5.    Corporate insiders have not been selling many shares for the last couple of years. Pat Russo , CB owns 2,017,963 shares, Henry Schacht owns 1,088,014. Frank D’amelio CFO owns 346,518. Assorted other officers own in the area of 3,000,000 shares. In general, insiders own less than 2% of the available common stock.


6.    The telecom market entered a depression during mid 2000, which continued through 2003. It appears as though the decline in spending has ceased. Unlike the mid 1990’s of high double digit spending growth, most companies are forecasting mid single digit growth.  CFO, D’amelio,  recently claimed that Lucent is  quite happy with single digit growth, whereas in the past they would have been extremely disappointed with such lackluster growth. Lucent once had revenues in excess of $30B. They now do on average around $2.2B per quarter. Lucent’s breakeven seems to now be in the area of $2.1B.  Nortel (a competitor) issued a revenue warning on September 16, 2004.  In that warning they discussed the expected growth of mid single digits.


7.    Service Providers are expected to spend as little as possible in their infrastructure over the next few years.  One type of spending will be to save money over the long term.  This can be done in network upgrades, be it wireless or wireline.  The other type of spending  will be done, to avoid losing customers to their competition. In the past, Service Providers would spend for the sake of claiming to have the most efficient network.


8.    Certain industry segments are growing faster than others. Voice and circuit switching is a dying breed, as the telecom is moving to converge both voice and data over IP (internet protocol) systems. The largest growth is expected to be in VoIP gateways. I have seen projections of 30 – 50% CAGR in that area. Lucent has been a weak force in VoIP. They recently purchased a company called Telica.  Supposedly is strong in the VoIP area. There has yet to be any contract announcements from the Telica acquisition.  There is speculation that Telica already existed in Verizon’s network. Lucent hinted at analyst day a few weeks ago, that a contract with a major carrier would be announced at some point. Lucent claims that the RFP process of a VoIP network is slow, and hence investors need patience.


9.    Lucent does offer an end to end service. They develop the software, the equipment (generally via OEMs, outsourcing or via Joint Ventures), offer the services, and have compatibility with other vendors. This end to end service is becoming more valuable as the Service Provider networks are downsized, more complicated and cost controls and profitability of providers are looked at much closer today, as opposed to the late and mid 1990’s.

Positives:

1.    Industry leader in CDMA. This is important as wireless companies around the world begin to build or upgrade their networks.

2.    They have excellent position in China, India and Eastern Europe.

3.    Strong strategic partners such as Juniper.

4.    Balance sheet is getting stronger. Lucent debt was recently upgraded by Moody’s. Debt is still lower grade, nevertheless the picture is improving. Debt has been upgraded to B2 (highly speculative) from Caa1 (Substantial risk).  Here is a link on our site, which has a table on debt ratings.

5.    Cost reductions, debt buybacks and stabilizing revenues have helped make Lucent a stronger company. Unlike mid 2002, they do not appear to be an immediate or imminent bankruptcy contender.  Here is a link on our site, where we discussed the deterioration of Lucent bonds during 2002.  Lucent short term bonds were selling for nearly $0.30 per share.  The same bonds are now trading over par.

6.    Lucent has been consistent with their strategies over the last 3 years. They recognized and openly discussed their solvency issues. They laid out a game plan of restructuring and goal of liquidity. So far they have achieved those goals. More recently they have laid out a framework for continued profitability.  Here is a link of ours, which details much of Lucent's financial history since 2001.

7.    Lucent is one of many companies that were harmed in the telecom depression. I can’t think of one competitor that has not gone through the same magnitude of pain. Even Cisco lost nearly 75% of her market cap during the slowdown. Cisco is not a fair example, as they are not really providers of end to end networks, nor do they have a great presence with the Service Providers.

8.    Cash flow from operations, not only exists, it also seems to be improving.

9.    Lucent bought back or recapitalized over $2.2B in debt since the fiscal fourth quarter of 2002. Fixed charges will be reduced by about $150M due to this.

10.    Lucent Worldwide Services (LWS) is a rather new division of Lucent. Margins are less than Mobility Solutions and INS. Nevertheless, Lucent claims that LWS gives Lucent the ability to enter a network, which Lucent does not currently have a presence in , and in turn over time, gives Lucent the ability to enter that network in other areas. Some of these areas could be optical switches, bay stations, multiplexers, DSL deployments, etc.

11.    Lucent took a charge to their deferred tax asset  during 3Q02. This was done in accordance with SFAS 109.  There has been recent industry talk that Lucent will be able to bring this asset on the balance sheet again.  The prior write off was in excess of $5B. If the valuation allowance  was materially reduced, Lucent would once again have a positive tangible book value.


12. Lucent recently announced that they have been approved for a tax refund in the area of $1B (including interest).  Lucent previously recorded a receivable of $139M. A $1B unanticipated inflow, will be quite positive for Lucent.