Lucent At Bat
Part 2

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By Phil Weiss (TMF Grape)
October 23, 2000

Poor Execution of the Fundamentals
Lucent also announced credit concerns related to its customers in the emerging service-provider market. The company has been aggressively offering financing terms to the emerging service-provider market. When generous credit terms are offered, there's a big difference between sales booked in the financial statements and those for which the company has actually been paid. Lucent is going to record additional bad debt reserves, as its original estimate of sales for which it won't be paid was underestimated.

This news really shouldn't be all that surprising. Lucent's revenues have been growing at a slower rate than its accounts receivable balance on a fairly regular basis. This can be a recipe for disaster, as it is often a sign that the company is so focused on managing earnings that it reports revenues that will ultimately become uncollectible. It wouldn't surprise me if the size of the actual problem is pretty substantial.

I expect these bad debts will be represented as a onetime charge in Lucent's third-quarter earnings announcement. Companies often use that technique to take investors' focus off the fact that they've messed up. The hope is essentially that investors will ignore onetime charges when evaluating the company. The problem is that the revenues related to these uncollectible receivables were considered to be part of operating earnings when the company first reported them.

On several occasions (particularly this one and this one), the Fool has published articles detailing Lucent's financial problems. I'll leave it to you to read those, rather than rehashing all of its problems yet again.

Lucent's failures this year serve as an excellent example of how valuable studying a company's financial statements can be in foreshadowing future difficulties. For example, Lucent's Foolish Flow Ratio is currently a very unhealthy 2.89. When the Flow Ratio gets to that level and is increasing on a regular basis, you should look to see why.

Poor Free-Agent Signings and Bad Personnel Moves
A baseball team can throw lots of money at star free agents, but if it signs players without considering how they'll fit in the clubhouse, it's typically not money well spent.

Like the high-spending but generally unsuccessful Baltimore Orioles, Lucent hasn't fared well in its forays into the acquisition market. After originally announcing that it would not make any acquisitions in the optical space, Lucent paid $4.5 billion to acquire Chromatis. Even worse, Lucent was working to develop similar products prior to making this acquisition. That means money was wasted someplace.

Worse yet, Lucent has had a terrible track record of retaining employees from the companies it acquires. One reason Cisco has been so successful with its acquisition-based strategy is that it integrates acquired companies into its own operations quite well. This is driven by the fact that, as detailed in reports on Cisco for Motley Fool Research, Cisco views the employees of acquired companies as the most important asset. It goes to great lengths to assimilate the employees into its existing operations.

The hit to Lucent's stock price is going to hurt its acquisition efforts as well. Lucent's stock is a much less valuable currency to any company it's looking to acquire. Financing future acquisitions won't be easy either, as Lucent already carries a lot of debt. The missteps of its management and the related impact on its stock price are likely to dampen Lucent's ability to make future acquisitions.

Lest you think that I'm alone in my distaste for Lucent's management team, I'd like to include an excerpt from a recent Red Herring article on Lucent:

"On top of these strategic disasters, the current management team has done a miserable job of accurately assessing and informing the public of its problems and managing its relationship with Wall Street investors. The scorn for [Chairman and CEO Richard] McGinn has reached epic proportions on Wall Street. One fund manager, asking not to be named, calls him a pathological liar."

The Manager Gets Fired
To this former shareholder, today's announcement of McGinn's ousting was easily justified. I think that this change is a necessary first step that the company had to take in order to recover. As long as Richard McGinn remained in place, the odds of more negative earnings pre-announcements were greater than the odds of hearing of an upside surprise. Interestingly, as part of today's announcement, Lucent also announced its fourth earnings revision of the year -- fourth quarter earnings were once again revised downwards.

Hiring an Interim Manager
It's been a tough year for Lucent. It hasn't done a good job of sizing up its competitive marketplace. It's done a poor job of integrating acquisitions. Its financial statements have sprung a number of leaks. In other words, Lucent just completed a losing year.

In the off-season, baseball teams that fail to make the playoffs look to make trades, sign free agents, and determine which minor league players may be able to move up to the big time and help the parent club. While Lucent doesn't have the advantage of an off-season to make improvements, the beginning of a new fiscal year does represent a good time for it to take a look at what's gone wrong and take some affirmative steps to improve things for the better.

Lucent has put Henry Schact into the chairman and CEO seat until a permanent replacement is found. This will enable Schact to assist with the day-to-day management of Lucent and also to take an active role in the search for McGinn's replacement. This move is certainly not a panacea by any means. Lucent has a lot of operational issues that need to be cleared up. At 66, Schact is not a permanent solution. The key to Lucent's future will be hiring a permanent chairman and CEO who will restructure the company to get it back on course.



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