Alcatel Cuts Deeper: Is This the Magic Bullet?

When Alcatel Lucent (NYSE: ALU  ) first unveiled its cost-cutting plansm including 5,000 heads about to roll, the stock crashed through the floor. CEO Ben Verwaayen conceded that the time had come for drastic measures: "I've not said this before and I say it here for the first time, you have to admit that you can't be everything for everybody everywhere. And that means that you have to make those choices."

In all fairness, the news came with a side of terrible second-quarter results. But when a stock plunges 20% overnight, as Alcatel did on that balmy July day, it's safe to say that investors don't love where the company is going.

But the big news back then was just a plan to start slashing payrolls. The actual incision lines have been decided now, and Alcatel is cutting about 10% deeper than Verwaayen had planned. And this time, investors are loving it.

Shares jumped as much as 5.6% on Thursday as the cost-cutting plan was finally unveiled. A large portion of the reductions will happen in France, where the company is headquartered. French unions are all up in arms about it. In the Americas, 1,200 jobs will be lost.

The upside to all this is, Alcatel is cutting corners in the right places.

What do you mean, "the right places"?
Alcatel will move some of its research and development engineers around the map to save on expensive building leases, but will otherwise leave its beating heart alone. The damage done falls in supporting areas like human resources, sales, and finance.

All of these segments are important to Alcatel's operations, or indeed any large company, but this is where the corners have to be cut. Firing engineers will only accelerate Alcatel's demise, because the company lives and dies by innovation.

Chinese vendors Huawei and ZTE would be happy to take over all of Alcatel's accounts for telecom equipment, even if they have to undercut existing deals on price. Ericsson (Nasdaq: ERIC  ) and Siemens (NYSE: SI  ) stand ready closer to home, in case Western customers might prefer to buy from local suppliers.

Even American rivals Cisco Systems (Nasdaq: CSCO  ) or Juniper Networks (NYSE: JNPR  ) could ship drop-in replacements for almost anything Alcatel makes. They also hold home-field advantage over the French company when the end customer happens to be a large American network -- and Alcatel's two largest accounts are with AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) .

If all of these competitors continue to innovate but Alcatel gives up, well, it's game over. Innovate or die, because there's no shortage of alternatives when you fail.

Alcatel must execute these cost-cutting moves with surgical precision. Verwaayen needs to give financial breathing room to his operational core, but he also has to take care not to tear down the company's essential infrastructure. It's a delicate balancing act that many have tried and most have failed, and Alcatel is a tremendously risky stock right now.

Endgame?
But at least he's taking action, and a correct one at that. I wouldn't recommend backing up the truck with a second mortgage in hand, but Alcatel could be a speculative winner if everything works out according to plan.

That's why I'm ending my thumbs-down CAPScall on this stock today. I opened that position on the theory that Alcatel would take the supposedly easy way out by firing the R&D department. It's a very dangerous thing to do, but also very common. Verwaayen has proven me wrong. I might even turn that CAPS frown upside down one day, if and when Alcatel starts showing signs of life again.

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Fool contributor Anders Bylund holds no position in any company mentioned. Check out Anders' bio and holdings, or follow him on Twitter and Google+. The Motley Fool owns shares of Cisco Systems. The Motley Fool has a disclosure policy.
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  • Report this Comment On October 22, 2012, at 11:07 AM, mruyog wrote:

    Good point, Mr. Bylund! Engineering.technology R&D is the most crtical part of Alcatel-Lucent in this communication technology area where many formidable competitors have to be dealt with. Thanks for bringing up that point which an accounting guy writing about this company can barely get!!

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