The telecom industry is one of the most promising in the market mainly due to the rapid growth in sales and usage of smart devices.
Network equipment providers such as Alcatel Lucent SA (ADR) (NYSE:ALU), Ericsson (ADR) (NASDAQ:ERIC) and Cisco Systems, Inc. (NASDAQ:CSCO) are bound to profit from this paradigm shift, along with the smartphone developers.
However in order to fully capitalize on the shift from feature phones and traditional mobile devices to smart devices, network equipment providers will need massive investment in research and development (R&D), as Internet access speed becomes a key factor for smartphones and tablets users.
Some of these companies’ balance sheets are in poor shape and cash flows are wanting. Alcatel Lucent SA (ADR) (NYSE:ALU)’s burgeoning debt of $8.67 billion and a debt to equity ratio of 228.23, is just but the tip of the iceberg, for the Paris-based company’s unimpressive fundamentals.
The shift plan
According to reports, Alcatel Lucent SA (ADR) (NYSE:ALU)’s new CEO, Michel Combes believes that he has found the solution to the company’s problems. Combes has come up with a strategy, which he referred to as “The Shift Plan” that is aimed to streamline the company’s operations by diverting attention from some of its multiple projects to a few key business units. According to the plan, Alcatel-Lucent will focus on cutting costs and sale of assets in a restructuring program slated for completion in 2015.
The new strategy turns certain key businesses in wireless, fixed access and other areas into cash cows, as the company seeks to generate income for investment in LTE technologies, Vectoring and FTTx (Fibre to the x). These technologies will help Alcatel Lucent SA (ADR) (NYSE:ALU) participate competitively in the networking business during the paradigm shift to smart devices.
According to the plan, the company expects 85% of its R&D expenses to be concentrated on developing these core units. This shift will also increase the core networking activities by more than 15% by 2015, while the company expects revenues to grow from EUR 6.1B in 2012 to about EUR 7B.
Consequently, the company expects to increase its operating margins from 2.4% to about 12.5% by 2015. Additionally, the cost cutting program is expected to save the company at least EUR 1 billion, while the sale of assets should generate a similar amount. The CEO expects to reduce the current debt by refinancing EUR 2 billion in the near term, and is optimistic that the company will be able to reduce the debt by a similar amount once the shift plan begins to pay-off.
The Shift Plan seems to solve some key problems for Alcatel Lucent SA (ADR) (NYSE:ALU) including cash problems and the reduction of debt. This should improve the company’s financial position going forward. On the other hand, the company’s idea to shift focus to core networking units aimed at participating competitively in the smart devices era will improve revenues, while the cost cutting measures should boost margins. Overall, this will result in self-sustainability and consequently growth prospects.
Competition
Cisco Systems, Inc. (NASDAQ:CSCO) is by far Alcatel-Lucent’s biggest rival, while Ericsson (ADR) (NASDAQ:ERIC) is still a constant threat as the companies continue to adapt to the rapid developments in smart devices. Growth in the usage of smart devices presents a huge opportunity with some of the rivals, with Ericsson predicting that mobile PCs, tablets and smartphones subscriptions with cellular connection could triple 2012’s subscriptions by 2018. According to its June 2013 report,Ericsson expects smartphone subscriptions to grow from about 1.2 billion in 2012 to about 4.5 billion by 2018.
Cisco Systems on the other hand, has embarked on acquiring small companies, with a focus on those that develop 4G LTE (Fourth Generation Long-term evolution) networks in a bid to boost its competitive advantage over its rivals. 4G LTE is a high speed data and broadband connectivity network for mobile phones and data terminals. broadband and network companies are developing these high speed connectivity networks to match the increasing demand for smartphone users. Cisco Systems acquired Broadhop last year December 18 aimed at boosting its competitive advantage in the 4G LTE networks. The company aims to integrate Broadhop’s widely deployed policy control solutions for mobile and fixed networks.
Performance and valuation
Alcatel-Lucent is the smallest in terms of market cap, among the three companies, with just $4.25 billion, compared to Cisco System’s $132.65 billion and Ericsson’s 39.25 billion. The company also trails the rest in terms of gross margins with 30%, just two percentage points below Ericsson’s and miles behind Cisco Network’s 61%.
Alcatel-Lucent’s trailing 12-month operating margin is flat at 0%, compared to Cisco’s 22%, and Ericsson’s 8%. Cisco is the only profitable company with EPS of $1.80 for the trailing twelve months (TTM), which is the annualized financial results for the company’s last four fiscal quarters. On the other hand, Alcatel-Lucent and Ericsson losses stand at $1.21 per share and $0.09 per share respectively.
However, in terms of earnings growth-based valuation, Alcatel seems to be the cheapest stock. At $1.87 per share, Alcatel-Lucent trades at 0.27 times in PEG ratio, as compared to Cisco’s 1.49 and Ericsson’s 0.53.
The bottom line
Alcatel-Lucent’s fundamentals go straight at the bottom if I were to rate the three companies.
However, based on the company’s growth prospects, and “The Shift Plan”, there is a huge upside for stock.The upside will depend on how effectively the company implements the shift plan. It needs to cut costs and reduce the huge amount of debt attached to its balance sheet. The concentration in high growth business units will also guarantee increased revenues and margins.
Nicholas Kitonyi has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems.
The article Alcatel-Lucent: Is “The Shift Plan” the Answer? originally appeared on Fool.com and is written by Nicholas Kitonyi.
Nicholas is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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