This is a story that came out this moring from UBS talking about the pooling of interest vs. purchase methods that Lucent can use to make a substantial aquisition in the data networking arena. The two top companies are BAY and ASND. This is a good read.
(FIRST CALL) UBSS: LU: TO POOL OR NOT TO POOL?
UBSS: LU: TO POOL OR NOT TO POOL?
08:23am EST 16-Mar-98 UBS Securities (Nikos Theodosopoulos (212) 821-695) LU C
UBS Securities Equity Research March 16, 199
Nikos Theodosopoulos (212) 821-6951 Anton Wahlman (212) 821-367
LUCENT TECHNOLOGIES (LU-NYSE) - Buy
LU: TO POOL OR NOT TO POOL?
Business: Telecom equipment
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Price: 115.00 Div: 0.30 Mkt Cap: 74.8b Debt/TC:
Price Tgt: 120 Yld: 0.3% Shrs O/S: 650m ROE: 43%
52wk: 117.38-49.00 5yr Est: 20% BV/Shr: 6.79 LTM OCF:
Cvt Secs: No
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FY QUARTERLY ESTIMATES FISCAL YEAR ESTIMATES
1stQ 2ndQ 3rdQ 4thQ EPS P/E REV(M
09/97 1.35A .10A .33A .57A F97A 2.35 48.9 2636
09/98 1.72A .21E .51E .66E F98E 3.10 37.1 2897
09/99 1.72E .39E .70E .89E F99E 3.70 31.1 3279
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SUMMARY
Recent strength in Lucent stock has raised questions on whether the company
should make a large data networking acquisition prior to October, when Lucent
can use the pooling method of acquisition. Even with the recent stock rise,
Lucent would have to accept earnings dilution in order to buy a leading data
networking company such as Ascend or Bay Networks before October 1998. We
believe that this will most likely make Lucent wait to October 1998 before
making its move, hoping that its stock will stay up and that the acquisition
candidates will still be available.
HIGHLIGHTS
* Recent strength in Lucent stock has raised questions on whether the company
should make a large data networking acquisition prior to October, when Lucent
can use the pooling method of acquisition.
* Even with the recent stock rise, Lucent would have to accept earnings
dilution in order to buy a leading data networking company such as Ascend or
Bay Networks before October 1998.
* We believe that this will most likely make Lucent wait to October 1998 befor
making its move, hoping that its stock will stay up and that the acquisition
candidates will still be available.
ANALYSIS
Strong Stock Appreciation Spurs Questions on Potential Timing of Data
Networking Acquisition
Lucent stock was very strong last week, fueled by continued strong business
fundamentals. We, for example, recently raised our price target from $100 to
$120. As a result of this strength, we received several client calls asking
about the possibility of Lucent making a large data networking acquisition
before October 1998, which is the date that Lucent can use the pooling method.
Prior to October, Lucent must use the purchase method in any acquisition it
makes. We also have checked the accounting rules, and we believe these rules
also do not allow Lucent to announce an acquisition prior to October 1998,
close the deal after October 1998 and use the pooling method. Our assessment
of the rules require any announced acquisition prior to the October 1998 date
to utilize the purchase method.
Purchase Method Still Dilutive Even With Strong Stock Performance
Our analysis of the numbers indicates that even with the recent strong Lucent
stock price, doing a purchase method of accounting deal now would still dilute
Lucent's 1999 EPS by up to 15% depending on the data networking company
acquired. The companies considered are: Ascend (ASND-$35 =-Hold), Bay Network
(BAY-$27 3/8-Hold), Cabletron (CS-$14-Hold), 3COM (COMS-$35-Buy) Fore Systems
(FORE-$14 >-NR) and Newbridge Networks (NN-$28 <-Hold). Under the purchase
method of accounting, the goodwill (i.e., the difference between the purchase
price and the book value) must be amortized over a number of years - we assume
six years.
Our basic set of assumptions for analyzing the impact of a data networking
acquisition to Lucent's 1999 earnings are:
7 That there is a 25% takeover premium on the acquisition target's stock.
7 That 65% of the goodwill is written off immediately as in-process R&D (based
on the experience from prior Lucent acquisitions of Octel and Livingston).
7 That the balance of the goodwill is amortized over six years.
7 That the deal is financed completely by Lucent stock.
7 That we do not account for any outstanding options in the acquisition
targets.
We are presently estimating that Lucent will produce EPS of $4.19 in calendar
year 1999. If Lucent were to make an acquisition before October 1998, the
following companies would impact that number by the following amounts:
+-----
Company Dilution % Dilution
Bay Networks ($0.31) -7%
Fore Systems ($0.08) -2%
Cabletron $0.00 0%
Ascend Communications ($0.64) -15%
Newbridge Networks ($0.51) -12%
3Com ($0.77) -18%
-----+
This set of assumptions - particularly the ability to immediately write off as
much as 65% of the goodwill - make at least a couple of today's options look
very much digestible. To wait until October 1998, however, look all the more
appealing given the ability of Lucent to use the pooling of interests method o
accounting. The corresponding impacts on Lucent's estimated calendar year
$4.19 EPS would be as follows:
+-----
Company Accretion % Accretion
Bay Networks $0.19 +5%
Fore Systems $0.05 +1%
Cabletron $0.13 +3%
Ascend Communications (0.03) 0%
Newbridge Networks (0.03) 0%
3Com $0.22 +5%
-----+
In the final analysis, what counts is not the individual impact of doing one o
the other type of acquisition, but the difference between the two methods.
Netting the difference between the two methods yields the following
differences:
+-----
Company Net Difference Between Pooling and Purchasing Methods
Bay Networks $0.50
Fore Systems $0.13
Cabletron $0.13
Ascend Communications $0.61
Newbridge Networks $0.48
3Com $0.99
-----+
The numerical conclusion is that the difference between doing a purchase
acquisition now, and doing a pooling after September 1998, is that 3COM, Bay,
Ascend and Newbridge are roughly equally more dilutive to do now versus when
Lucent can pool. Fore and Cabletron are both relatively inexpensive that it
does not make much of a difference whether to buy now or after September 1998.
While the accounting favors buying Fore or Cabletron prior to October 1998, w
do not believe these are the top two fundamental choices. Numerical
considerations aside, there are fundamental issues involved. Specifically, wh
would Lucent want to buy any of these companies? We deal with them in the
following sections. In summary, we believe that the two most likely candidate
from a fundamental basis are Ascend and Bay. Given our view, we continue to
believe that Lucent will wait until after it can use the pooling method before
making any major data networking acquisition.
ASCEND
At first look, purchasing Ascend seems somewhat inconsistent with Lucent's
recent acquisition of Livingston and new internally developed ATM switches suc
as the MX-1000 edge switch. While Livingston was primarily a player in the
mid-tier remote access concentrator (RAC) market, however, Ascend has a broade
RAC product line. Specifically, Ascend is a market leader in the high-end of
the RAC spectrum - the so-called 'carrier class' segment - with its TNT
product. Livingston is set to launch its carrier-class RAC by mid-year called
PM4. The success of Lucent selling the PM4 into the high end of the RAC
market will be important to evaluate. The more successful Lucent is in
penetrating the high-end market with the PM4, the less likely Lucent will want
to acquire Ascend. The reverse also holds true. Lucent is also launching its
internally developed MX-1000 ATM edge switch, which will compete with Ascend's
CBX-500 and GX-550 platforms. Ascend already has a strong position in the WAN
ATM market with established customers including AT&T, WorldCom, GTE, Bell
Atlantic, Bell South and others. The ability for Lucent to win major carrier
customers with its MX-1000 and Globeview-2000 ATM switches will also make an
Ascend acquisition less likely. The reverse, however, is also true. Thus, we
will look at Lucent's success over the next several months in both the WAN ATM
market and carrier class RAC market to determine the likelihood of Lucent
acquiring Ascend.
BAY NETWORKS
There is an existing resale agreement between Bay and Lucent, where Lucent
resells Bay LAN equipment. The attractive feature of Bay from Lucent's
perspective, however, is Bay's installed base of LAN equipment. Lucent has
stated the goal of breaking into the LAN market, but as Newbridge showed in
1997, that is very difficult to do without a very large installed base.
(End of Part 1)
First Call Corporation - all rights reserved. 617/345-2500
END OF NOTE
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[IN TELECM.1 COMPUT.1 ELECTS.1 ENERGY.1 DATAPR.1]
*** end of story ***
(FIRST CALL) UBSS: LU: TO POOL OR NOT TO POOL?(Part 2)
UBSS: LU: TO POOL OR NOT TO POOL?(Part 2)
08:24am EST 16-Mar-98 UBS Securities (Nikos Theodosopoulos (212) 821-695) LU C
While Lucent has made acquisitions of Agile and Prominent to better compete
in new LAN product cycles (e.g., gigabit ethernet and layer 3 switching), a
lack of installed base and a full product portfolio in the LAN market will mak
this a challenge. Buying Bay would solve those potential challenges as Lucent
would have the installed base of both voice and LAN networks, as well as new
products that target new technology cycles.
NEWBRIDGE, 3COM, CABLETRON AND FORE - Not As Likely
We believe these companies are less attractive for Lucent for the following
reasons. Fore and Cabletron are smaller companies and would not give Lucent
much market share and installed base in the LAN market. Cabletron also has a
fairly strong relationship with NorTel, which makes it less desirable than Bay
3Com and Newbridge are closely tied to Siemens, which make them less of match
than Bay and Ascend respectively. 3Com also derives a large share of its
revenues from the low-end of the data networking market (e.g., modems and
NICs), and has comparatively more of a consumer exposure as compared to Bay an
Ascend.
Lack of Other Potential Buyers Also Favor Waiting Until Pooling Is Allowed
We should also point out that some of the other potential acquirers of these
data networking companies also have accounting difficulties, in the sense that
they cannot pool. That includes the foreign players, such as NorTel (NT-$57
3/8-Buy), Alcatel, Siemens, Ericsson and Nokia. None of these companies is
also known for making large and bold acquisitions. While Cisco (CSCO-$64
=-Buy) could certainly acquire any of the companies we discussed above from a
financial perspective, it is highly unlikely given a strong overlap of product
lines and potential antitrust issues. Tellabs (TLAB-$62-Buy) could be a
potential acquirer of Ascend, but we believe that Tellabs is not enthusiastic
about entering the RAC market. RAC revenues comprise about 40%-45% of Ascend
revenues, which may make an acquisition of Ascend less likely. Combinations
within the network industry are also possible - such as Bay/Ascend - but
mergers of equals have not faired well in the past in the networking industry.
Thus, Lucent may not feel a competitive threat to act before October given
that the most immediate competitors may not seek to acquire either Ascend or
Bay. Other candidates such as Intel and IBM are less likely to make large dat
networking acquisitions, but cannot be ruled out completely.
- - - - - - - - - - - - - - - - - - - - - - - - -
UBS Securities LLC makes a market in the securities of ASND, COMS, CSCO, and
TLAB.
First Call Corporation - all rights reserved. 617/345-2500
END OF NOTE
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[IN TELECM.1 COMPUT.1 ELECTS.1 ENERGY.1 DATAPR.1]
*** end of story *** |
