HQ:Maintain BUY; LU near a trough; Service Provider BU undervalued
Excerpts from Chase HQ 10/2/00
1 of 2 Avaya and Microelectronics Spin-offs Allow LU to Refocus; Maintain
Buy Rating* Spin-offs should allow Lucent to focus on its core business
* New product development is key to a reversal of fortune
* Microelectronics accounts for most of LU's valuation, Service Provider
business undervalued
* Maintain BUY based on valuation
1999 A 2000 E 2001 E Q1 EPS $0.49 $0.33A $NE
Q2 EPS 0.17 0.20A NE Q3 EPS 0.23 030A NE
Q4 EPS 0.24 0.27 NE FY EPS 1.12 1.11 1.30
FY REVS (M) 29,911 34,317 41,180 CY EPS 0.96 1.05 1.40
CY P/E 32 29 22
FY Ends Sep Current Price $30.69
52-Week Range $28-84 Market Cap (M) $102,220
Shares Out (M) 3,331 Book Value $7.84
Net Cash/Share $0.21 Growth Rate 20%
CY01 P/E-to-Growth 110%
We are maintaining our BUY rating on Lucent shares, based on the a sum-of-the
parts analysis of the company's three businesses: Avaya (NYSE: AV-$20.06, Not
Rated), Microelectronics and Service Provider. We believe most of the value
in Lucent's current share price of $30.69 reflects the contribution of the
Microelectronics segment, with the Service Provider business being
substantially discounted and the Avaya portion contributing minimally. As a
result, we believe that Lucent shares are near a trough, and should begin to
rebound as investors focus on the spin-offs of Avaya and Microelectronics.
Near-term pressure on the shares of LU is expected, as we are expecting the
company's fiscal fourth quarter to be weaker than current estimates. We
believe the troubles in the Service Provider business are related to an
inability to quickly develop or acquire new products, but can be solved over
the long-term, given Bell Labs' enormous stable of engineering talent. We
believe ongoing product development and new products should continue to ramp,
and gain traction in the marketplace over the next few quarters.
Avaya spin-off should be a positive for Lucent
Effective October 2, 2000, the company has spun-off its enterprise networking
business, creating a newly independent company called Avaya Inc. The spin-off
was carried out as a stock dividend, with shareholders of Lucent receiving one
share of Avaya for every twelve shares of Lucent. Based on Avaya's when-
issued price of $19.75, the unit is valued at approximately $5.5 billion, or
$1.65 per Lucent share. The spin-off allows Lucent to focus on faster-growing
segments of the telecommunications equipment market, including optics,
wireless and data-networking. Over the past few years, the enterprise
business has grown in the mid-single digits, while Lucent's other businesses
have been growing in excess of 20%. Furthermore, Avaya's customer base, which
consists of enterprise subscribers, is very different than the Service
Provider business, which serves the regional Bell operating companies (RBOCs),
long distance carriers and competitive local exchange carriers (CLECs). We
believe the spin-off should allow Lucent to focus on the needs of its service
provider customers.Microelectronics business carries most of the LU valuation
Lucent has already announced its intention to spin-off 20% of its
Microelectronics business via an IPO in the March quarter, followed by a spin-
off of the remaining 80% in mid-2001. The Microelectronics division is
already a leading supplier of communications integrated circuits (75% of
revenues) and optical components (25% of revenues). We believe the
Microelectronics business will contribute $6.1 billion and $7.8 billion in
revenues in calendar 2000 and 2001. We believe the Microelectronics business
currently accounts for approximately $58 to $74 billion of Lucent's $102
billion valuation. This is based on a multiple derived by taking the blended
average of comparable companies, including JDS Uniphase (OTC: $91.81-JDSU) for
the optoelectronics portion of the business and an average of Broadcom (OTC:
$244.19-BRCM, Buy), Texas Instruments (NYSE: $50.00-TXN, Buy) and Conexant
(OTC: $41.69-CNXT, Buy) for the Integrated Circuit business. The low end of
the range on our Microelectronics valuation assumes that the unit is being
evaluated solely on its integrated circuit business, while the high end of the
range reflects the 75%/25% split between integrated circuits and optical
components.Source: Chase H&Q estimates
Based on our assumptions for Microelectronics and Avaya, we can back into the
current valuation for the core Service Provider business. As shown above, the
best case scenario values the Service Provider business at approximately $39
billion, similar to the combined valuation of ADC Telecommunications and
Tellabs. Looked at another way, the business is trading at approximately half
the valuation of Juniper Networks. We include a chart of the market
capitalizations of other companies we follow to get a picture of where
Lucent's businesses would fit.
Short-term pressure exists, but problems can be resolved in the long run,
maintain Buy rating
We believe that the company's problems are based on its inability to develop
and acquire products in high-growth areas. Nortel has extended its lead in
optics, while newer companies, such as Juniper, leave Lucent behind in the
rapidly expanding market for core IP routing. In addition, we believe the
company's fiscal fourth quarter could fall short of our expectations for $9.4
billion in revenues and $0.27 in EPS.
[LU didn't warn. IMHO, It would meet the consensus EPS]
However, in the long-run, we believe
that the company's tremendous customer relationships and the capabilities of
Bellabs should help the company turn its fortunes around. While the concerns
surrounding the stock are warranted, we believe the stock is near a trough and
is poised to rebound, once evidence of new product development and management
execution surfaces. We maintain our Buy rating on Lucent shares. |
