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This Telecom Giant Faces Tough Challenges Ahead

Thursday - 5/23/2013, 4:20pm  ET

Alcatel-Lucent  is going through a rough period. The company faces tough challenges ahead. Its cash flows and income are declining. The last fiscal year was a very bad one for the company. Its net income tremendously dropped from net positive earnings to net losses. Its debt is rising whereas cash flow from operations turned negative.

On top of that, it is also facing tough challenges in the market due to stiff competition. Alcatel is facing a tough time competing with Ericsson  and Cisco . The telecommunication equipment war is focused on quality and price. To stay competitive in the price war, companies must have a low-cost structure. Alcatel already has a major issue on this aspect, particularly compared to low-cost Chinese competitors.

While Alcatel has a global footprint, majority of its revenue, about 72%, comes from the European and the U.S. markets. Unfortunately, it is facing tough times in Europe, significantly affecting its overall revenue growth.

Its best bet now lies in the U.S. market. The company has to strengthen its stronghold in the U.S. At the same time, it needs to improve its market share in Europe and South America.

Alcatel-Lucent financials

A major highlight of Alcatel's financials is the sharp decline in net income. It posted a staggering drop, from $1.49 billion in net income in 2011 to a net loss of $1.91 billion. That's more than a $3 billion decline in earnings within a year.

For the first quarter, Alcatel-Lucent beat estimates. But the cash flow remains weak. In fact, the company has never posted positive free cash flow since the merger of Alcatel and Lucent in 2006. At present, the cash cycle of Alcatel-Lucent is 59 days. This is quite high, leading to growing concerns on the relatively poor liquidity ratios of the company.

Alcatel also faces a near-term debt concern of close to $3 billion, which is due within three years. Total liabilities amount to $24.62 billion. Therefore, the company needs to trim down its expenses in order to shore up enough cash flow. This is crucial for the refinancing and roll-over of its debts.

The huge debt exposure forced the company to contemplate on laying down its last cards. Alcatel is now eyeing on using its patents as collateral to raise a billion dollars at least. The value of its patent portfolio could be as high as $9 billion. Alternately, Alcatel-Lucent plans to use its routing business as collateral, in lieu of the patents.

Putting all these valuable assets on the table as collateral is a relatively risky bet. But, it seems this is the last resort to fuel a major breakthrough. However, it may also be a good strategy for a complete turnaround. But, the success heavily relies on the company's cash management. With a new CEO in place, there are high hopes for Alcatel to survive the financial turbulence.

What about Ericsson and Cisco?

Alcatel is not the only company that is suffering from intense competition in the industry. Both Ericsson and Cisco also experienced low prices. Due to the financial crisis, most companies opted for low-cost manufacturers, which slashed the market shares of brand names such as Alcatel-Lucent, Ericsson and Cisco. As a result, the investors in these companies have faced substantial capital losses in the last five years.

Nevertheless, Ericsson and Cisco are in much better financial condition than Alcatel-Lucent. They have negligible debt issues compared to the French giant. In fact, Cisco’s third-quarter earnings report was very much appreciated by the market. The company experienced substantial growth in emerging markets and boosted its dividend by 20%.

Ericsson recently made a bold move to acquire Microsoft’s Mediaroom business. For a company that is known as a global telecommunications service provider, this acquisition was a step outside the box. The acquisition of Mediaroom will put Ericsson into the IPTV business, which is growing pretty fast. It can also provide a safety cushion against declining prices in the networking & communication industry.

Summary

It seems that Alcatel needs a miracle to make a complete turnaround. As a matter of fact, the board is doing something about the generally weak financials by installing a new CEO, Michael Combes. He used to be the head of Vodafone's European operations. He took over the top management position in April. He is expected to announce the company's turnaround strategy plan by June.

With his experience in the European market, he is expected to improve the market share of Alcatel in Europe. Michael Combes is a veteran in the telecom industry. He also has a reputation of being an excellent cost-cutter. He is just what the company needs at this point amid year-over-year negative free cash flow and rising debt. However, cost-cutting is just one piece of the puzzle. There are other tough challenges that must be dealt with such as the declining market share.

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