Lucent Technologies (plus mentions of Nortel, Apple, Cisco and Intel.)
By Robert Hunter
NEW YORK (Dow Jones)--My ada likes to say that it's easy to make a killing on the Super Bowl. Just plunk down some money on the team he's rooting against, and you're all but guaranteed a big payday. His absolute certainty that such things never go his way is the main reason he doesn't invest in individual stocks.
I wish my friend Vlad (not his real name) felt the same way. Vlad has been endowed with just enough luck - winning a $500 Super Bowl pool once and routinely hitting improbable billiards shots - to expect that good things will happen to him more often than not. Sadly, good fortune hasn't visited his stock portfolio since, well, forever.
In January, he embarked on a Bataan Death March of stock-picking. So far, he has built positions in Lucent Technologies (LU), Apple Computer (AAPL), Cisco Systems (CSCO) and Intel (INTC). Besides Cisco, which has lost just 8% in this horrendous year, Vlad's portfolio is stuffed with more downers than the pocket of Keith Richards's nightshirt.
Each of those companies has had unforeseen problems, but Lucent's woes have been the toughest for Vlad to take. The very week he bought the stock at around $70, it plummeted to $53, after Lucent warned that earnings for its December quarter would fall short. Since then, it's been spiraling downward at an alarming rate.
On Wednesday, Lucent got pounded yet again, falling 32% to $21.25. After Tuesday's close, the company warned investors - for the third time in four quarters - that it would not meet earnings estimates. (It wasn't the first time, either, that those too-rosy estimates were based on guidance that had already been lowered.) While the Street was expecting 27 cents in earnings for the fiscal fourth quarter ending Sept. 30, Lucent warned that it would be more like 17 or 18 cents.
Losing Ground
Lucent offered three reasons for the shortfall. The most troubling: Amid the most robust market for telecom equipment ever, the company's optical systems unit saw total sales fall 5% from the same period in 1999 - even though the unit includes Lucent's thriving optical-fiber business. The problem is Lucent's new 10-gigabit optical system, which was released in February. Lucent insists its sales have sagged because of a lengthy "certification" process required before customers can implement the system. But many analysts think certifications are taking so long because the product has serious technical problems. They point to the success of Nortel Networks (NT) and others as evidence of a still healthy, if slowing, optical-equipment market.
Between the first and second quarters of this year, Lucent's share of the optical-systems market fell from 19% to 15%, according to the Dell'Oro Group, a networking-industry consultancy. Nortel's share, meanwhile, grew from 37% to 43% . (Third-quarter figures aren't out yet.) While Lucent is expected to lower its revenue guidance yet again when it reports on Oct. 24, Nortel is increasing its calendar-year 2000 revenue guidance for optical systems to $12 billion from $10 billion - up from $4.5 billion last year. "This is a massive market-share shift, " says B. Alexander Henderson of Salomon Smith Barney, "and we think it will be extremely difficult for Lucent to claw back to respectability."
Another reason for Lucent's earnings slump is lower sales of its circuit- switching products. These traditional telephone gizmos set up and keep distinct voice or data connections open between two or more users. Lucent began its fiscal year by projecting 15% sales growth in circuit switchers. After it lowered its guidance twice during the year, we found out on Tuesday that sales dropped 13% in the last quarter.
While the company didn't elaborate on the reasons, analysts think the troubles in the competitive-local-exchange-carrier, or CLEC, market are taking a toll. That market is so crowded, and profits are still so far away, that investors have begun to sour on the sector. As a result, capital-markets funding is drying up - and, with it, demand for such things as voice-circuit-switching products. While Lucent predicts that the sales decreases will moderate, some analysts foresee another double-digit drop in the next quarter.
Perhaps the strongest evidence that there is trouble in CLEC-land is that Lucent says it has had to set aside bigger reserves to cover the bad debts of some of its CLEC customers. Lucent practices what's known as "vendor financing," meaning it delivers its products to customers before it has received full payment. Now that many CLECs are either going under or scraping to pay their bills, those receivables are less of a sure thing. Lucent will charge $115 million against doubtful accounts and completely write off another $159 million in its fiscal fourth quarter. And most analysts expect more in the future. ( Nortel, Cisco and others are also exposed to the CLEC market's problems, to varying degrees. But Lucent has been far busier in that market than any other company, analysts say, and therefore is the most susceptible to downturns.)
Silver Lining?
On Tuesday, Lucent outlined a vague restructuring plan to combat its woes. Among the changes: It'll set a return-on-capital target for each business group, compensate its personnel on a team basis as opposed to a companywide basis, create a central engineering group to focus on its core strengths, and use the Internet more to cut costs. To foot the bill for this still-nebulous plan, the company will probably take a one-time charge next quarter - which would guarantee another subpar earnings report.
There was, however, a moment of optimism during Tuesday's otherwise bleak conference call with analysts. Lucent's microelectronics unit, which makes the semiconductors used in its communications equipment, increased its revenues by 50% last quarter to $4 billion - and Lucent is finalizing plans to spin it off to shareholders early next year. That'll surely unlock some value, since most analysts value the unit at $19 to $22 a share. It'll also allow Lucent to focus all of its resources on its struggling core businesses, rather than the highly capital-intensive chip business.
In that sense, now could be a good time to consider bottom-fishing. Think about it: At Thursday's close of $21.50, the entire company, which will pull in close to $40 billion in revenues this year, traded for around what analysts believe its $4 billion microelectronics unit alone is worth. On a sum-of-parts basis, Lucent seems to be a screaming Buy.
But stocks don't always perform the way quantitative analysts think they should. For all of Lucent's supposed locked-up value, nine analysts pounded the stock with downgrades on Wednesday. Analysts' ratings in themselves don't mean much, but widespread changes in ratings often mean a lot - especially on the downside.
At the core, investors have lost confidence in Chief Executive Rich McGinn, a company man for 22 years (previously at AT&T (T)). Who has been at Lucent's helm since 1997. Since its stock hit an all-time high of $84.19 last December, the company has lost more than $200 billion in market cap. McGinn has had 10 months to improve things, but they appear to be getting worse. Salomon's Henderson, for one, argues that Lucent's problems "are not only continuing but are actually accelerating." Rumors are flying that McGinn is about to step down or be fired, and that Lucent has already hired executive recruiting firm Korn/Ferry International to find his replacement. Nothing would make shareholders happier.
Analysts are particularly miffed at management's poor earnings guidance this year. Moreover, the fact that its latest preannouncement came a full 10 days after the quarter ended suggests that new Chief Financial Officer Deborah Hopkins, who joined Lucent from Boeing (BA) in April, doesn't have a firm grip on the company's books. To be fair, Hopkins walked into a tough situation. I'd rather be the chief grooming officer for the Sultan of Brunei than the CFO at Lucent.
No Time to Sell
Lehman Brothers' Stephen Levy summed things up nicely on Wednesday: "Owning Lucent shares for the next few months, even at what we are expecting to be near- fire-sale prices, is not likely to be rewarding in any way."
As for the long run, it's difficult to have much confidence in a company that has fumbled things so badly. Lucent is going to have to make good on its restructuring plan quickly to regain investors' confidence. I'm skeptical that it will, at least under McGinn.
On the other hand, the stock is too low to sell right now. My friend Vlad has held on, as a good long-term investor should. In fact, he's shown more patience than Dennis Rodman's acting coach. I have to believe that this $40 billion company will get its act together at some point, and that Vlad will be rewarded for his steadfastness.
But in the meantime, for some quick profits, I'm advising him to ask my dad who he's picking to win next year's Super Bowl. For more information and analysis of companies and mutual funds, visit SmartMoney.com at http:// www.smartmoney.com/ |
