Alcatel-Lucent: Room to speculate?

by Paul McWilliams, editor Next Inning

While I wouldn't yet call Alcatel-Lucent (ALU) a "value" play, my outlook for the company has improved and I think in the mid one dollar range it merits consideration as a speculative investment.

The price of ALU has declined for several reasons. While ALU has reported earnings above the consensus of the covering analysts during the first three quarters of 2011, it has done so while reporting revenues below the consensus estimates.

It appears that analysts are looking at the wrong line on the income statement. Going into 2011 ALU was not suffering from a revenue problem - it was suffering from an absolutely horrendous operating structure.

By virtue of the fact ALU reported notable year-over-year profitability improvement in Q3 2011 off lower revenue is a sign the company is addressing this core problem.

However, as I see it, we should view this as only the start of the process and not assume the problem is fixed or even that the rest of the process will be successful. The short story here is there are still a lot of ghosts in Lucent's past haunting the company.

Beyond its revenue shortfalls this year, ALU has suffered with a weaker than expected demand environment in Radio Access Network (RAN) markets, and substantially higher competition.

In addition, ALU has also suffered from fiscal issues still plaguing Western Europe and the fact it operates with a highly leveraged balance sheet.

When we add all these together and consider ALU's still thin operating profit margin, the sharp decline we've seen in ALU's price in this risk-adverse market shouldn't be terribly surprising.

While there are still plenty of things that could go wrong for ALU, it appears to me most of the bad news is baked into the price and, with that, I think there is room to speculate things might go better than Wall Street is modeling.

While analysts have boosted earnings estimates for 2011, they have dropped earnings estimates for 2012. As I see it, the big wildcard in the ALU deck is whether or not we'll see an acceleration in RAN deployments in 2012; if the value of the Euro continues to fall (like I continue to believe it will) ALU's competitive positioning should improve.

If this proves to be the case, and ALU executes as well as it has in 2011 (not to imply 2011 execution was stellar, but that improvements were made), I think we will see analysts' estimates for 2012 improve, and if Europe is able to stabilize its fiscal mess, I think the price of ALU could move up considerably.

The other alternative for ALU would be to sell off some assets and become a smaller, but more focused and more profitable company. I think Wall Street would also react favorably to that strategy.

Learn more about this financial newsletter and get a risk-free trial subscription at Next Inning.

An investment service that delicately balances the investment ideals of Warren Buffett and the technology vision of George Gilder, Next Inning Technology Research provides subscribers with coverage on over 150 technology and semiconductor stocks.

Sign up for a free trial and start receiving real-time commentary and trade alerts, as well as access to monthly semiconductor sales analysis, regular Special Reports, and the Next Inning model portfolio. Click here to get a Risk-Free Trial to Next Inning Today!