With Shares Tanking 24%, Is Alcatel-Lucent SA a Buy?
In the past month, shares of Alcatel-Lucent have declined more than 24% after rising steadily in 2013. Given Alcatel-Lucent's cheap valuation and significant asset sales, the stock might just be presenting a good long-term investment opportunity.
Why the sell-off?
According to research from Delloro, telecom capital expenditures are expected to fall 2% in 2015 worldwide. Companies like AT&T expect to reduce capital investments in 2015, as large expenses like AT&T's Project VIP come to an end. While 2% may seem relatively small, Delloro notes that it could mean $6 billion less in spending.
Alcatel-Lucent's stock has been one of the hardest hit as a result of these feared capital expenditure cuts. The problem with selling shares of Alcatel-Lucent ahead of such cuts is that the company has made drastic changes to better its business, focusing on growth segments. After such steep stock losses, it is cheap.
The good, bad, and shift
Alcatel-Lucent is a large, diversified telecom equipment provider that has generated revenue of nearly $18 billion during the last 12 months, 44% of which came from North America. The problem with a company of this size, which has an operational presence in hundreds of countries, is that there are a lot of bad segments that weigh down its good segments.
As a result, management made moves to sell assets that underperformed and didn't fit in the company's stronger-performing segments. Alcatel-Lucent sold its LGS unit earlier this year, which provides secure networking, satellite communications, and VoIP, among other services. The unit generated more than $250 million in sales last year, and has a selling price that could reach $200 million depending on performance.
Most recently, Alcatel-Lucent's 85% sale of its Enterprise business, which sells telecommunication equipment and services to other companies, will remove about $1 billion in annual revenue, and provide Alcatel-Lucent with cash of more than $250 million. These two asset sales alone account for 35% of the $1.27 billion in asset sales the company has planned with the Shift plan.
Alcatel-Lucent's area of strength
In removing assets that are either underperforming or are not essential to Alcatel-Lucent's core segments, the company can become more focused on growth opportunities. This refers to routers and switches, specifically the former, which are rolled into Alcatel-Lucent's core networking segment.
During Alcatel-Lucent's most recent quarter, core networking as a segment saw sales fall 10%, to $1.74 billion, which accounted for 41% of total revenue. This performance was a stark contrast to the 7% growth it produced in the first quarter. Furthermore, IP routing saw a decline of 7% in the second quarter after a 16.4% increase in sales during the first quarter. IP routing accounts for nearly half of the core networking segment, or 20% of Alcatel's total sales.
Alcatel-Lucent's growth in core networking and routing in recent years has been much more comparable to the first quarter than its performance during the second. According to research firm Delloro, Alcatel-Lucent's router business has grown at a 12.5% compound annual growth rate during the last decade. As a result, Alcatel-Lucent's excuse of delayed orders and tougher comparable sales are likely an indication that the poor performance in core networking is not long term.
In fact, JPMorgan analyst Sandeep Deshpande recently said that Alcatel-Lucent's core networking business could account for nearly $9 billion of revenue next year, with an operating margin that eventually reaches 12.5%, up from 9% in the second quarter. This would be quite impressive considering Alcatel-Lucent has created less than $4 billion in sales during the first two quarters of 2014 from core networking.
The reason for this expected growth lies in Alcatel's competitive positioning. The company is ranked No. 2 in edge routers, behind Cisco. These routers are used for speed and performance to route lower quantities of traffic. However, Alcatel has also recently entered the core router business, which are more powerful routers used with heavy traffic. This is a market controlled by Cisco and Juniper.
While routing accounts for 20% of Cisco's total sales, it has been a point of weakness for the company. During Cisco's last two quarters, routing sales have fallen 11% and 7% respectively. In other words, Alcatel-Lucent has outperformed Cisco in the high-margin routing business by a significant margin.
All things considered, Alcatel-Lucent's large stock losses in 2014 seem a bit premature. While the company will look significantly different -- and leaner -- following the completion of its asset sales, the company's core networking segment is a high margin, strong performing segment that should increase the value of Alcatel-Lucent's stock.
In fact, Cisco and Juniper trade at 2.6 and 1.9 times 12-month sales, respectively. Meanwhile, Alcatel-Lucent trades at just 0.4 times sales. As core networking becomes a larger percentage of total revenue, and Alcatel-Lucent pays off debt with cash from asset sales, its operating margin should rise to a level that's comparable with Juniper -- if, in fact, Deshpande is right with his analysis. Therefore, with the same 1.9 times sales multiple awarded to Juniper, Alcatel-Lucent's core networking segment alone might be worth more than its entire market capitalization, assuming growth and margin expansion occurs.
Investors have clearly focused on the poor revenue growth performance in Alcatel-Lucent's second quarter, and a disappointing outlook for telecom investments. What's being overlooked is the future impact of a high-margin growth segment in core networking, making Alcatel-Lucent a good investment long term.
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The article With Shares Tanking 24%, Is Alcatel-Lucent SA a Buy? originally appeared on Fool.com.Brian Nichols owns shares of Alcatel-Lucent (ADR). The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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