Lehman: Worst Over for LU and NT
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The telecom downturn has stabilized, and restructuring efforts by two key vendors, Lucent Technologies Inc. (NYSE: LU - message board) and Nortel Networks Corp. (NYSE/Toronto: NT - message board), could lead to a breakeven point for both by fall 2003, according to a "Lucent and Nortel Update" report from Lehman Brothers.
The report focuses on both vendors as bellwethers of the telecom industry with roughly equivalent outlooks. With costs being reduced, profitability is imminent, says the report, but Nortel's showing more progress.
"Nortel is on track for breakeven in the June quarter, ahead of Lucent... [which will] break even in the September quarter," Steven D. Levy, managing director of wireline equipment equity research, said on a conference call with investors today.
Nortel's pulled ahead for several reasons, Levy says: First, it relies less heavily than Lucent on sales to the troubled U.S. market. In the quarter ended December 2002, for instance, 49 percent of Nortel's sales were in the U.S., versus 62 percent of Lucent's, according to the Lehman report. Nortel also started earlier on efforts to replace in-house manufacturing with more outsourcing. And presently, Nortel is enjoying the benefit of a higher gross margin, about 50 percent by Lehman's estimate, on sales to enterprise customers. Lucent's emphasis on providing services to telcos brings them a gross margin of about 14 percent, the report says.
The discrepancy won't last long. Operating margins -- sales minus cost of goods sold and operating expense -- will close the gap between the two companies later this year, Levy says, thanks to the nature of the enterprise and services businesses.
Both companies will show revenues of about $9.5 billion for 2003, he predicts, with 5 percent growth for both in 2004. Interestingly, nearly 40 percent of both companies' revenues for the foreseeable future will come from wireless infrastructure sales, the firm forecasts.
Table 1: Lehman Calendar Year 2003 Estimates
Lucent Nortel
Sales $9.55 billion $9.65 billion
Percent change Y/Y -12% -9%
Gross margin 31.30% 39.80%
Operating margin -1.60% 1.90%
EPS -$0.14 -$0.03
Source: Lehman Brothers
Table 2: Lehman Calendar Year 2004 Estimates
Lucent Nortel
Sales $10 billion $10.15 billion
Percent change Y/Y +5% +5%
Gross margin 35.50% 41.10%
Operating margin 5.70% 5.10%
EPS +$0.04 +$0.05
Source: Lehman Brothers
Changes like these are pleasant to contemplate. But Levy acknowledges some risks could throw Lehman's forecasts off. When it comes to Nortel, Levy says management's projection of "single digit" reductions in carrier spending for 2003 is "a bit too optimistic." That could mean Nortel's expense models are still too high.
Lehman originally predicted an overall capex drop of 20 percent this year, but now says 13 percent is likely.
Nortel also is counting on deployments of 3G/UMTS wireless installations getting activated in various international deals, but there are signs that interoperability issues could hamper these plans. And Nortel's banking heavily on voice over packet, but it's not clear carriers will respond as desired.
Meanwhile, Lucent has its share of caveats. Management's outlook on the capex conundrum seems reasonable, Levy says -- it calls for a 15 percent market decline this year. But the company's counting heavily on three or four major wireless infrastructure deals in the first half of the year, such as that with Indian carrier Tata Teleservices Ltd. (see Lucent Grabs Tata ). With these deals done, it's not clear how Lucent intends to reach the revenues implicit in its guidance, which Levy said would call for equivalent $2.5 billion in sales for the remaining two quarters of this year. "Maybe there are contracts they haven't announced," Levy says.
There are industry-wide risks, too. "We believe that the industry fundamentals have stopped deteriorating and that much of the uncertainty... is either behind us or materially diminished," writes Levy and partners in the report. "To be clear, we are not yet, however, forecasting an improvement in the fundamentals. We also remain cautious that the pending geopolitical concerns, as well as the continued soft economy, create risks that could lead to further fundamental deterioration." [emphasis added]
On today's call, Levy reiterated these factors could throw a wrench into the works. Also, he concedes that his firm could be wrong on its outlook for either Lucent or Nortel. And, he said, "If we're wrong on one of them, we're wrong on both of them."
— Mary Jander, Senior Editor, Light Reading
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