FOOL ON THE HILL: An Investment Opinion
Yep, Lucent announced an earnings warning again. This time it comes due to decreased sales in optical networking, which is noteworthy since this is one of the highest-demand technology fields in existence. Lucent's shareholders are shouting for the CEO's removal, and yet the company's management does not seem to get it. With a collapsing core market and a revenue stream under assault by nimble competitors, Lucent's only got a few more chances to make it right.
Even in the midst of a really "special" year for telecom companies, Lucent's fall from grace has been particularly steep. This is a company that, until January, really could do no wrong. Its shares had appreciated by more than 1,000% in the four years since it was spun off from AT&T Corp. (NYSE: T), its patent portfolio was unmatched in breadth and value, and its management team was the toast of the investing community.
Well, now it's just plain toast.
It would be nice to say that Chairman and CEO Rich McGinn's problems started when Carly Fiorina left Lucent to run the show at Hewlett-Packard (NYSE: HWP), but just as plumbing leaks tend to make themselves known by slowly causing other problems, decisions made long ago at Lucent are only now coming back to haunt them. And, just like a quantum effect, what made little difference then makes a huge difference now.
Lucent is by no means dead. It is a big, lumbering company, wounded by more-nimble competitors and fragged from within, but there's a lot of hunt left in this dog. Someone, though, has got to point it back toward the covey, and the management has created considerable doubt that among them is someone capable of doing so.
Our disdain for Lucent's operational and fiscal policies is longstanding and well-known, so there is not much need to rehash it. But, going back even two years, we see that the company had significant cash flow issues, with receivables and inventories significantly outstripping revenues.
Further, as has been reported, the company said its sales in optical networking equipment declined by 5% from the previous year. Businesses have products that show slowing growth all the time, but optical networking is currently the hottest sector of technology. Lucent probably could have used PVC piping and flashlights and increased sales.
Lucent also just spun off Avaya (NYSE: AV), its old enterprise communications division, and is shipping off its component business as well, in the name of concentrating on its highest-growth businesses. Great. But, how about actually growing those businesses. Lucent has also suffered since it got off to a late start in optical networking, and it had so much of its revenue streams coming from switched-network sources that it fell behind in the packet-switching that is increasingly dominating the next-generation networks.
And finally, there is the market segment that Lucent has sold heavily to: start-up Competitive Local Exchange Carriers (CLECs). Lucent has been very aggressive in marketing its equipment to these capital-thirsty companies, and used copious amounts of vendor-financing to do so.
Now many of these companies are in big trouble, as their investments have not turned into expected revenue or profit generation. They have neither the credit to purchase more equipment for still-incomplete networks, nor the operating capital positions to give creditors much comfort that they will be paid. This didn't matter when capital was plentiful, but now that the markets are tight, Lucent's having to increase its reserves for bad debt to combat its earlier largesse.
What To Do?
Lucent needs to act decisively on both the operational and financial fronts. But deeper, the company has got to regain some credibility with investors and with its customers. The fact that the company admits customer acceptance problems for some of its products shows how badly it has been outmaneuvered by Nortel Networks (NYSE: NT), Cisco Systems (Nasdaq: CSCO), and others in the most hotly competitive equipment sectors (not coincidentally, the same ones showing the fastest and most robust growth rates). Still, Lucent has some options.
1. Get credibility. When the new CFO comes out and says that Lucent is sitting on a pile of gold, investors are right to roll their eyes. The management team is cruising for a restructuring, but still no one is coming out and saying "we've got problems we've got to fix." It's the market, or currency, or production problems, or the competition. But it's never Lucent's fault. And so, for good reason, investors are steamed, and hungry to see McGinn's ouster. This will not help at all if Lucent's management, existing or new, does not profess determination to clean its own house first.
2. Enough with the pathetic financial position. When Tom Gardner, Matt Richey, and I first spoke about the problems at Lucent, we concentrated on the fact that the company did a poor job in managing its cash, receivables, or inventory. There is still no evidence that the company has changed. Regardless of the fact that almost none of the analysts covering Lucent pointed out its cash position when things were going well, now that the company is troubled, they'll be watching like hawks for improved fiscal management.
3. Speed up product cycles. Lucent is a behemoth working in an entrepreneurial neighborhood. Unfortunately, it is being beaten not by start-ups, but by fellow gargantuans Cisco and Nortel. Without an increased speed-to-market, Lucent will not gain the customer acceptance in its new product lines relative to these two companies, not to mention the truly nimble kids on the block such as Corvis (Nasdaq: CORV) and Juniper Networks (Nasdaq: JNPR).
4. Tighten up vendor financing. This is going to hurt, because in some ways Lucent's advantage with some of the CLECs was that it was willing to give them generous payment terms. Lucent will once again have to compete on product quality, interoperability, and service. Not an easy road, but one that the former Bell Labs is certainly capable of navigating.
I, for one, in no way believe that Lucent is dead, or a loser, or anything else. It is a company with a proud history and an enormous amount of capital value. But its management has done a miserable job of unlocking this value for its shareholders, and it has taken an overall downturn in telecommunications economics for most to notice. After three consecutive warnings, Lucent is running out of chances with investors. But if it performs, they'll be back, and all will be forgiven. If it doesn't, both its investors and customers will move on to more fertile ground, and that pile of gold of which the CFO spoke will go for naught.
Bill Mann, TMFOtter on the Fool discussion boards
There's a debate raging on the Lucent discussion board about what is to be done, with some capitulation going on. We're also interested in your thoughts on the Fool on the Hill board.