Is This Contract a Game-Changer for Alcatel-Lucent?

Is This Contract a Game-Changer for Alcatel-Lucent?

Over the past couple of years, Paris-based Alcatel-Lucent has been going down a rocky road, struggling to put its finances in the black while reeling under the burden of cutthroat competition.

The telecommunications-gear maker just won a contract to help build Telefonica's next-generation wireless network in Spain. Will Alcatel give its peers a run for their money, after all?

Why this deal is so important
Alcatel will deploy 8,000 4G LTE, stand-alone base stations overlaying Telefonica's existing 3G network. That's a drop in the bucket compared to T-Mobile's LTE rollout in the U.S., which involves 37,000 next-generation base stations. In addition, Alcatel is not the only one having a hand in Telefonica's LTE buildout. Market leader Ericsson will provide the Spanish provider with 1,000 nodes in 2013 alone, including the ones in Barcelona and Madrid.

Even so, that's the biggest 4G LTE contract Alcatel has ever landed in Western Europe. Amid macroeconomic headwinds and plummeting service revenues, European telecom operators have been dragging their feet on deploying 4G networks. On top of that, Alcatel's decision to focus on the "overlay" technology solution, which is more popular in the U.S. market and not so much in Europe, weighed on its European wireless business. That's all about to change. This contract could be a shot in the arm for Alcatel, enabling it to get a firm grip on the European LTE market.

As far as Telefonica is concerned, it's about time it got the ball rolling on its own nationwide network. Vodafone, Orange and TeliaSonera-owned Yoigo have already launched their 4G services in Spain.

In order to keep up with its peers, Telefonica signed a network-sharing agreement with Yoigo last month. Under the terms of the agreement, which will run until 2016, Yoigo gave Telefonica access to its LTE network. In return, Yoigo will use Telefonica's fiber network, meaning that it will be able to offer fixed broadband services along with mobile services.

Competition is obviously heating up in a market that's crucial for Telefonica, since the company's Spanish division manages the access of around 37% of its total clients in Europe. The sooner Telefonica wraps up its 4G build-out, the better.

Wait a minute...
This contract is a feather in Alcatel's cap, but it doesn't necessarily mean that the company's wireless problems in Europe are a thing of the past. EU regulators' plans to ban roaming charges for incoming calls and to put a lid on other tariffs next year raise a red flag.

As soon as regulators go through with their plans, Telefonica will be faced with skimpy profit margins, leaving Alcatel, as well as other equipment makers, sort of up the creek.

However, over the medium term, a possible consolidation of the telecom services industry in Europe could benefit Alcatel. It's highly likely that big telecom operators will jump at the chance to take over smaller, less profitable rivals in hopes of achieving economies of scale. Eventually, they will have to ramp up spending on network infrastructure.

Moreover, Nokia's latest business moves have created quite a stir.

Nokia sold its handset-manufacturing unit to Microsoft for $7.2 billion and bought Siemens' stake in Nokia Solutions and Networks, or NSN, a specialist in mobile broadband formerly called Nokia Siemens Networks. This unit will account for almost 90% of Nokia's revenues.

Following the Microsoft deal, analysts have been buzzing with speculation that the Finnish telecom will bid for Alcatel's wireless unit -- a move that would make NSN a much stronger player. Nokia is clearly chasing networking-equipment profits, making waves in the entire network infrastructure industry.

Will Alcatel make it?
In response to years of poor performance, Alcatel introduced a three-year turnaround plan, which includes cutting costs and focusing mainly on its core networking business, among other initiatives. This strategy makes sense, since Alcatel already has a strong foothold in the edge router market.

On the LTE front, besides the contract with Telefonica, the equipment vendor recently grabbed a 13% share of China Mobile's $3.26 billion of base-station supply contracts. That's higher than what Ericsson and NSN got.

Also, it's teaming up with chipmaker Qualcomm to develop mobile, "small-cell" technology, aiming at cashing in on operators' growing appetite for mobile data capacity.

These deals help paint a brighter picture for its future.

The takeaway
A turnaround doesn't happen overnight. Alcatel still has a long way before it can exit its doldrums.

Investors should stand pat on the stock and wait until Alcatel shows signs of margin gains and positive free cash flow.

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