August 14, 2002 SUMMARY
* Yesterday, Lucent certified their financial results.
TELECOMMUNICATIONS This includes the FY2001 10-K, proxy filing, and 10-Q's
EQUIPMENT for FY2002.
Alex Henderson * We were encouraged that the company made its
certification on time as we had been concerned about the
potential impact to the shares if, for whatever reason,
Daryl Armstrong it was late.
* Within the 10-Q filing, LU reported it had off-balance
sheet financing that if consolidated, would increase the
Gregory Cipolaro debt listed on their balance sheet by up to $450MM.
Roughly $100MM of the total was attributable to a
synthetic lease.
* Lucent is cooperating with the U.S. Attorney's office
concerning an accounting error related to a deal with
Winstar in FY2000. LU was informed that they were not
the target of the U.S. Attorney's investigation.
* Lucent is in discussions to negotiate is agreement
with Solectron associated with its optical manufacturing
plant sale.
FUNDAMENTALS
P/E (9/02E) NA
P/E (9/03E) NA
TEV/EBITDA (9/02E) NA
TEV/EBITDA (9/03E) 9.8x
Book Value/Share (9/02E) $0.31
Price/Book Value 4.8x
Dividend/Yield (9/02E) NA/NA
Revenue (9/02E) $12,850.0 mil.
Proj. Long-Term EPS Growth 5%
ROE (9/02E) NA
Long-Term Debt to Capital(a) 90.9%
LU is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA RECOMMENDATION
Price (8/13/02) $1.50 Current Rating 3S
52-Week Range $8.59-$1.46 Prior Rating 3S
Shares Outstanding(a) 3,440.0 mil. Current Target Price $2.00
Convertible No Previous Target Price $2.00
EARNINGS PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
9/01A Actual ($0.39)A ($0.37)A ($0.35)A ($0.27)A ($1.39)A
9/02E Current ($0.23)A ($0.14)A ($0.16)A ($0.21)E ($0.74)E
Previous ($0.23)A ($0.14)A ($0.16)A ($0.21)E ($0.74)E
9/03E Current ($0.12)E ($0.10)E ($0.05)E ($0.02)E ($0.28)E
Previous ($0.12)E ($0.10)E ($0.05)E ($0.02)E ($0.28)E
9/04E Current ($0.01)E NA NA NA NA
Previous ($0.01)E NA NA NA NA
First Call Consensus EPS: 9/02E ($0.74); 9/03E ($0.31); 9/04E NA
Calendar Year EPS: 12/01A NA; 12/02E ($0.62); 12/03E ($0.18); 12/04E NA
OPINION
Yesterday after the market close, Lucent filed its 10-Q for the June quarter,
F3Q02, and certified its financial results. We were pleased to see that
Lucent certified its results given the August 14 deadline was looming. We
were encouraged that the company made its certification within the timeframe
set forth by the regulators. Previously, we had been concerned about the
potential impact to the shares if, for whatever reason, they were late.
Lucent's 10-Q for the June quarter was released which included additional
disclosures. We were pleased Lucent is offering additional transparency with
its business and have noted some of the more interesting filings within the
document.
Lucent Certifies Results. Last night, Lucent filed an 8-K last to certify
its financial documents pursuant to Section 960 of the Sarbanes-Oxley Act of
2002. The certification covers the FY2001 10-K, proxy filings, and 10-Q's
for FY2002. We were pleased to see that Lucent filed its certification and
cleared up any uncertainty about its willingness to certify. The first round
of certifications, which Lucent is a part of, are required to be filed with
the SEC by 5:30 pm today.
Lucent Increases The Transparency In Its 10-Q. In its most recent 10-Q,
Lucent seems to have increased the amount of financial disclosure. While it
is difficult to ascertain the impact of potential accounting changes on
Lucent's financials, we were pleased with the increased transparency in this
filing. We suspect the increase in transparency has to do with Lucent's
willingness to accommodate investor requests but acknowledge that it is also
probably a function of the required financial certification. The following
are points of interest we found in the 10-Q:
* Synthetic Lease. Lucent is a lessee under a $100 million synthetic lease
agreement for real estate. The synthetic lease does not appear on the
balance sheet. If accounting rules were to change in the future whereby a
non-consolidated special purpose entity may require consolidation, the
result would be to add $100 million of PP&E and debt obligations to
Lucent's balance sheet. It is unlikely that this would affect the
company's cash position, unless Lucent were to unwind the synthetic lease.
Lucent does not have any restricted cash associated with its synthetic
lease.
* Special Purpose Trust. Lucent's non-consolidated Special Purpose Trust
holds about $350 million of customer finance loans and receivables. The
loans were sold on a limited recourse basis; however, given Lucent's credit
rating the company has not been able to sell additional vendor finance
receivables to the trust since February of 2001. Given the negative credit
ratings outlook on Lucent by S&P, Moody's and Fitch, we believe it is
unlikely that Lucent will be able to use the Trust to sell receivables in
the near future.
* Accounts Receivable Securitization. Lucent also has a more traditional A/R
securitization facility. At the end of the June quarter, $20 million was
outstanding under its $500 million facility, which is due in June 2004.
The small amount was somewhat surprising given the Lucent's AR balance of
$2,245 million. We believe the use of the securitization program will
likely remain low unless the company runs into a cash crunch.
* Solectron Agreement Changes. Lucent is currently in discussions to
possibly alter its agreement for the sale of its optical systems
manufacturing facility in North Andover, MA with Solectron (SLR, 2H rated
by M. Morris--$3.20). On May 31, Lucent closed the sale facility and the
transfer of about 540 employees. The original agreement called for
Solectron to pay Lucent $100 million in cash in exchange for a 3-year
purchase agreement. However, we don't find it surprising the agreement is
up for renegotiation given the heavily subdued demand for optical systems.
Although it is unclear of the outcome of the discussions, we suspect a
longer-term contract with lower minimum purchase commitments may be in the
works.
* Financial Covenants. In June, Lucent amended the covenants covering its
$1.5 billion credit facility. The minimum EBITDA covenants loss covenants
are now $325 million and $300 million for the next two quarters as the
facility expires in February of 2003. According to our estimates, Lucent
should be in full compliance with the covenants although we acknowledge
EBITDA calculations by banks are slightly different than our calculations.
As of the end of the June quarter, Lucent had no outstanding balance drawn
on its credit facility and the company is currently engaged in discussions
to obtain a new credit facility.
* Litigation. In the filing Lucent also revealed that it was cooperating
with the U.S. Attorney's office concerning an accounting error related to a
deal with Winstar in FY2000. The company had previously reported this
transaction to both the public and the SEC. Furthermore, according to the
filing, Lucent was informed that they were not the target of the U.S.
Attorney's investigation.
* Goodwill Writedown. During the quarter, Lucent wrote down $837 million in
goodwill, mostly due to the $1.3 billion acquisition of Spring Tide in
September 2000. The remaining $367 million in intangibles on the balance
sheet is primarily related to the remaining goodwill and other acquired
intangibles for Spring Tide and Yurie Systems.
VALUATION
We have established a 12-18 month price target of $2. This is based on 0.4x
our calendar 2003 revenue estimate, in line with its nearest comp, Nortel,
but a discount to its communication equipment peer set, by our analysis.
Lucent has historically, and continues, to garner a discount valuation
compared with its peer set due to the falloff in sales and the struggle to
stem losses. In valuing Lucent, we have attempted to compare it to its
nearest competitors as well as the telecom sector as a whole. We use four
primary metrics for valuation: price/earnings, price/revenue, enterprise
value/revenue, and a PEG ratio. On a price to revenue basis, Lucent trades
at 0.5 times, at the low end of its valuation peer set, as we see it. On an
EV/R basis, we find Lucent trades at a multiple of 0.3x, once again at the
low end of its peer set. An analysis of the P/E or PEG ratio reveals little
information, as our EPS estimates are below breakeven.
RISKS
We think the most significant near-term risks include weak demand from
wireline telecom service providers, the expected rollover of Lucent's
profitable wireless upgrades, share losses to data networking competitors,
and the struggle to right size the business to get back to breakeven. While
the slowdown in service provider spending has been widely documented for a
number of quarters, Lucent's wireline business continues to decline, as
evidenced by its recent financial results. Furthermore, while its wireline
business continues to erode, we have become increasingly worried that high
margin wireless upgrades occurring in the first half of 2002 could roll over
as contracts are completed. These issues continue to pressure results and
hamper Lucent's ability to hit breakeven.
COMPANY DESCRIPTION
Lucent designs, develops, and manufactures communications systems and
software for use in telecommunication service provider networks. The company
has be realigned along two business segments: Mobility and Integrated Network
Solutions (INS). Lucent's primary Mobility, or wireless, product offerings
are based on 3G CDMA2000 solutions. In the INS, or wireline, segment,
Lucent's product offerings include optical, circuit to packet, broadband
access, edge access, and multiservice switches. |
