LUCENT UNBOUND
Untethered from AT&T and free to flex its financial muscle, Lucent Technologies is poised to define communications in the next decade.
By Brian E. Taptich
The Red Herring magazine
August 1998
Despite Lucent's stature as the leading communications equipment company in the world, much of its headquarters is oddly reminiscent of a '50s high school science room--replete with linoleum tile, eyewash stations, and fire extinguishers. But Lucent's outdated industrial appearance belies the 21st-century strategies under consideration in the posher executive offices. When AT&T decided simultaneously to divorce itself from its computer division, NCR, and to unleash the potential of its communications equipment business, Lucent Technologies was born. Raising over $3 billion, Lucent's April 1996 initial public offering was the largest in U.S. history; the company officially became an independent entity in September 1996. Lucent's genesis coincided with a fundamental shift in communications. Growth in Lucent's traditional market, circuit-switching equipment for voice communications, was beginning to wane as the demand for data networking and wireless infrastructure sprinted ahead: according to Dataquest, the market for telecom equipment has grown a paltry 8 percent over the last two years, while the markets for data networking and wireless equipment have risen 23 and 28 percent. And these separate networks are beginning to merge into a single, packet-switched communications channel. No one is exactly sure how the networks will converge--how, for example, service providers will connect to residences, where the telephone companies will fit in, and what role wireless communications will play. But all of the communications equipment providers consider the migration to a universal network inevitable, and competition to provide the equipment, software, and services that will serve as the infrastructure of this universal network is growing ever more fierce.
Undoubtedly, the existing telecommunications infrastructure will be an important element in the universal network, and to ensure that Lucent secures the largest market share possible, the company has been organizing all of the components--from silicon to software--that will be needed. In addition to its domination of circuit-switching equipment, Lucent is ranked among the leaders in such unexpected categories as digital signal processors for wireless communications; communications software (see table, below); and dense wavelength division multiplexing (or DWDM), a technique that splits optical fibers into multiple lanes for increased capacity. Lucent has also set about filling gaps in its product line: the company has begun acquiring and developing technologies in areas from broadband wireless communications and data networking, as well as building overseas sales channels.
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Switch-hitting
Lucent's market ranking in different sectors
WORLDWIDE TELECOM EQUIPMENT
1. Lucent 2. Ericsson Telephone 3. Motorola
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DENSE WAVELENGTH DIVISION MULTIPLEXING
1. Lucent 2. Ciena 3. Northern Telecom
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FIBER-OPTICS MANUFACTURING
1. Corning 2. Lucent 3. Siecor
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COMMUNICATIONS INTEGRATED CIRCUITS
1. Lucent 2. Motorola 3. Texas Instruments
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DIGITAL SIGNAL PROCESSORS
1. Texas Instruments 2. Lucent 3. Analog Devices
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U.S. WIRELESS INFRASTRUCTURE
1. Lucent 2. Ericsson Telephone 3. Motorola
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SOURCES: DATAQUEST, DECISION RESOURCES, KESSLER MARKETING INTELLIGENCE
Lucent is universally lauded for its accomplishments in its first two years, especially given that the company's progress has come with most of its equity tied behind its back--esoteric tax law, coupled with the structure of AT&T's divestiture, has prohibited Lucent from using the low-tax pooling of equity as a strategy for acquisition. But as of this October, two years after officially becoming an independent company, Lucent will be free to flex all of its financial muscle. And CEO Rich McGinn has big plans to reinforce Lucent's position as the leading equipment provider for the universal network.
Pulling up the roots
The invention of the 130,000-employee company, which is among the world's 20 largest corporations, has been handled as nimbly as any good startup. According to Mr. McGinn, such rapid growth was an exhausting endeavor. "In our first 24 months, we were able to create a company, figure out a name, choose people, build an organization, get customers, and energize this place," he reflects. "Lucent certainly didn't start as a 98-pound weakling, but we were not ready to go full speed ahead."
As part of the former AT&T monopoly, and even after the 1984 creation of the regional Bell operating companies (RBOCs), the division that became Lucent worried little about either marketing or market share. In 1996, however, Lucent faced a very different marketplace. To keep up with the legion of competitors vying for a stake in building the universal network, the company has had to part definitively from the industrial and laggardly traditions of its parent (a heritage so abysmal that the Herring once labeled AT&T "The Worst Tech Company Ever").
Fortified with the part of AT&T that was innovative--the R&D arm, Bell Laboratories--Lucent set about achieving top speed. After forming a joint venture with Philips Electronics to shed its ancillary consumer products division, Lucent trimmed other slow-growth divisions, including its circuit board and capacitor businesses. The company also has transformed the hierarchical legacy of AT&T into a horizontal structure, reorganizing business units to promote innovation. "Quite frankly, we missed the last generation of data networking while a part of AT&T," admits Bill O'Shea, president of Lucent's business communications group. "We had all the technology to compete, but it was buried under a huge organization."
This dedication to creating a more market-driven culture has trickled down even to Bell Labs. Long dismissed as chin-stroking theorists, Bell Labs' scientists are now working closely with Lucent's business units and focusing as much on development as on research (see "Bell on the Ball"). Lucent even went so far as to set up a new-ventures group to give researchers a stake in the commercial success of their inventions. "Lucent re‰nergized this whole place," gushes Bell Labs president Dan Stanzione. "Inventors want to see their ideas make it to market."
To beat or not to beat
As competition increases to provide the equipment for the universal network, Mr. McGinn considers the move into the data networking market the first priority and Cisco, therefore, the obvious competitor. But the battle will be waged by several competitors, and data networking will be one of many fronts. Because the equipment for carrying voice, data, and wireless traffic will have to interoperate, Lucent faces the prospect of butting heads not only with the agile data networking community but also with traditional voice competitors like Northern Telecom (which in mid-June announced it would acquire Bay Networks for $9.1 billion), wireless communications giants like Ericsson Telephone, hardware behemoths like Texas Instruments, and overseas titans like Siemens. Furthermore, the immensity of the communications equipment market--estimated by Dataquest to be worth over $500 billion by 2001--will require multiple infrastructure providers. "There's no way that one, or even just two, companies will be able to serve such a huge market," admits Mr. McGinn.
One of the greatest advantages that Lucent and the rest of the voice equipment providers have is their extensive experience supplying worldwide networks. An integrated universal network will have to be as reliable as existing telecommunications systems, and the instability of today's data networks is notorious. "Before any universal network is up and running," asserts Mr. O'Shea, "someone will have to resolve the incredible reliability, operations, and management issues."
Analysts agree that voice equipment companies will find it much easier to migrate from building voice to building data equipment than the reverse will be for data networking companies, which "are great at connecting LANs and getting companies onto the network," says Dataquest analyst Don Miller, "but their equipment is not yet equal to standards set by voice equipment."
Witching hour
According to Mr. McGinn, Lucent's biggest advantage "kicks in at midnight EST on September 30"--the date when the company can finally use its massive market capitalization to make significant acquisitions. If Lucent intends to compete with Cisco or 3Com, the company must strengthen its abilities in the enterprise data networking space. Mr. McGinn suggests that one possible strategy will be to use huge equity packages to lure away the best engineers from the data networking companies.
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Building the new empire
Lucent's acquisitions since AT&T's divestiture.
DATE COMPANY BUSINESS DEAL
SIZE ($M)
10/96 Agile Networks Data switching N/A
5/97 Triple C Comm. Systems Integration N/A
9/97 Octel Comm. Voice messaging 1,800
10/97 Livingston
Enterprises Remote access 650
1/98 Prominet Gigabit Ethernet
switching 200
2/98 Hewlett-Packard's
LMDS division Broadband wireless N/A
3/98 TKM Comm. Call-center
integration N/A
4/98 Optimay GSM wireless
Software N/A
5/98 Yurie Systems Asynchronous Transfer
Mode access 1,000
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Though raiding competitors would secure top talent, and Lucent's acquisitions to date have secured great technology, the company is in dire straits without an installed base of enterprise customers. A strategic acquisition would let Lucent instantly create a customer base for future products. Eager neither to drive up the price of a potential acquisition nor to violate the law, Lucent's management is predictably evasive. "We haven't taken the possibility of a large acquisition in the data networking space off the table, and we're certainly not going to make any declarations, but we'll take a long look at all of the usual suspects," says Mr. O'Shea.
Analysts believe that the most likely suspect is Ascend Communications. "The company has great technology with a large installed base, and the two have worked together for a long time," argues Chris Crespi of BT Alex. Brown. "Ascend would give Lucent exactly what it needs." Another name that has come up is Newbridge Networks, whose close ties to Siemens would provide important overseas channels.
A second, and less apparent, need is for Lucent to increase its presence in the comparatively untapped international market. To date, Lucent's ongoing international sales force development, partnership with Philips, and acquisition of German wireless-communications-software developer Optimay have established an overseas beachhead. "We exited the international business in 1925," Mr. McGinn explains. "Since the divestiture, we have built up our international market share to 25 percent, exactly what it was 73 years ago." As with the data networking market, Lucent may have no choice but to make a sizable acquisition if it desires international clout: Alcatel Alsthom and Siemens would be the largest, and most daunting, candidates.
In the meantime, Lucent has been busy patching more urgent, less capital-intensive holes: the company has acquired four data networking companies (for remote access, Gigabit Ethernet switching, and Asynchronous Transfer Mode access), Hewlett-Packard's broadband wireless division, and voice messaging giant Octel Communications. The company has also instituted practices that would have been anathema back in the AT&T days, when it relied completely on Bell Labs for bleeding-edge R&D: besides adapting to the prevailing data networking practice of acquiring companies for their technology, Lucent has established the $100 million Lucent Venture Partners to invest in promising communications equipment startups.
Everybody likes a winner
Lucent still has areas that need to be addressed, and it acknowledges that mistakes have been made along the way. In addition to missing the early boat in data networking during the AT&T days, the company has lost business in niche markets that it should have cornered--to Ciena in DWDM, to Tellabs (which announced in June that it would acquire Ciena) in digital transmission systems, and to Advanced Fibre Communications in digital connections between telephone service users and public telephone networks. But because Lucent has moved to plug so many of its gaps so quickly, finding somebody other than competitors to disparage the company is nearly impossible; Lucent's stock was recently downgraded by analysts only because it had run up so dramatically in the past year. "Of course there are things Lucent needs to work on, but there's nothing wrong with the company," says Mr. Crespi, who downgraded Lucent in April. "And Mr. McGinn recognizes the spaces they need to fill."
Mr. McGinn's savvy has been rewarded by Wall Street: Lucent has the largest market cap of all the communications equipment competitors (see chart, below), and, even more impressively, its stock has become a required holding among institutional investors--an exalted bellwether status reserved for the likes of IBM, Microsoft, and Cisco.
And just as IBM was to the '70s, Microsoft to the '80s, and Cisco to the '90s, Lucent is poised to be the technology company that defines a decade--and, quite dramatically, the beginning of a millennium. Lucent has positioned itself to capture a significant share of a seemingly limitless market, and Mr. McGinn says Lucent's real triumphs are still to come: "It may be a result of good planning or just serendipity, but it's absolutely phenomenal to be in this business right now." Not to mention in the 21st century.
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LUCENT TECHNOLOGIES AT A GLANCE
CEO: Rich McGinn
LOCATION: Murray Hill, New Jersey
PHONE: 908/582-3000
WEB: www.lucent.com
OWNERSHIP: Public (NYSE: LU)
FOUNDED: 1996
EMPLOYEES: 130,000
PRODUCT: Communications equipment
PARTNERS: Ascend Communications, Bay Networks, Cirrus Logic, NEC
COMPETITORS: 3Com, Alcatel Alsthom, Cisco Systems, Corning, Ericsson Telephone, Motorola, Nokia, Northern Telecom, Siemens, Texas Instruments, Toshiba
REVENUES FY97: $26.4 billion
REVENUES 1Q98: $6.2 billion
MARKET VALUE: $95.8 billion
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