ML:details on AV,Opt&data NW are strong,wireless rebounding
Excerpts fr Merrill Lynch 9/29/00
Investment Highlights:
There are a lot of things going on at Lucent
right now, and it’s hard to focus on what’s
important. We have a spin off in progress, an
announced spin off, management turmoil, and
oh, weak fundamentals.
Lucent is planning an initial public offering
(IPO) for up to 20% of its communications
semiconductor and optoelectronic components
business. The actual terms of this spin-off are
still unclear.
On September 30, Lucent Technologies will
complete its spin-off Avaya, its enterprise
communications business, in a tax-free
distribution. Lucent shareholders will receive
one share of Avaya for every 12 shares of
Lucent held. Currently, we believe the Avaya
spin-off creates limited additional value.
The more important question is “what’s
left?”. In the near term, there are lingering
concerns about the company’s core businesses,
including optical systems, central office
switching and wireless infrastructure. The
company expects to report September quarter
and fiscal 2000 earnings the week of October
23 rd, and we are currently forecasting 15%
revenue growth and EPS of $0.27 versus $0.24.
Facts and Figures
On July 20 th , Lucent announced plans to spin off its
optoelectronic components and communications
semiconductor businesses into a separate unit by selling up
to 20% of the unit to the public in early 2001, with the
remaining ownership distributed on a tax-free basis to
Lucent shareholders in mid-2001.
This new unit is expected to generate about $4.3 billion in
sales in fiscal 2000. Currently, about 25% of revenues are
attributed to optoelectronic components and 75% to
communications semiconductors. We expect the
optoelectronic component sales to increase by 80%, while
communications semiconductor segment grows 15-20%
over the next year. This leads to a revenue forecast of
about $5.7 billion in fiscal 2001.
As we have stated previously, this spinoff has some
positive financial implications. At a high level (i.e.,
looking at just revenue to sales multiples of comparable
companies) we can frame an analysis that suggests the sum
of the parts is greater than the whole.
Lucent is currently trading at about 2.3 times 2001
revenues, which we will maintain for core Lucent. We
assume that Lucent’s communications semiconductor
business trades at a price to sales multiple consistent with
other large communications IC companies (Texas
Instruments, EPCOS, Fairchild, LSI, Conexant and
National Semiconductor). We also assume the company’s
optoelectronics components business trades at the same
multiple as other high growth optical component
companies (JDS Uniphase, Stratos Lightwave, Finisar,
Corning and Agilent). Our sum of the parts analysis
appears in Table 1.
Table 1: Lucent Sum of Parts
($ in millions except per share)
Rev.
FY01 Multiple Mkt cap shares $ per
Core LU 35,455 2.3 81,547 3331 24.48
Comm Semi 3,920 3.4 13,423 3331 4.03
Optoelectronics 1,800 23.7 42,671 3331 12.81
Total 41,175 41.32
Current Mkt Price 31.13
Unlocked addition 10.20
Source: Merrill Lynch
Based on this analysis, we estimate that the financial value
by unlocking the optoelectronic components business
translates to about $10 per share, or a 33% increase in
Lucent’s current share price. However, the terms of this
spin-off are still unclear, so it is difficult to accurately
analyze and evaluate the spin off. We do not yet know the
structure of the transaction, charges that will be incurred or
balance sheet implications.
[This unlocked value is very low compared to that of MSDW, SSB, CSFB who think the fair price for allof LU is $65 - 75/shr]
Avaya
The terms of the Avaya spin are much more evident.
Avaya is a leading supplier of enterprise voice
communications systems and attendant products and
services. It primarily caters to enterprise customers, such
as businesses, government agencies and other
organizations. The company is structured in three business
segments: Communications Solutions, Services and
Connectivity Solutions.
Communications Solutions represents Avaya’s core
business including enterprise voice/data communications
systems, software, professional services, networking
products and installation services.
Enterprise communications systems are the bulk of this
segment, representing 41% revenues. Products range from
large private branch exchanges (PBXs) to Cajun switches,
IP routers and business telephones. Notable products
include DEFINITY Server. The voice segment, which
represents the most segment revenue, is a mature market,
with industry sources projecting a 1999–2003 CAGR of
1.2-% (rising from $28 billion to $29 billion). The newer
data/voice integration products are linked under the
ECLIPS (Enterprise Class IP Solutions) family.
Software products represented 16% of FY99 revenues.
This includes customer relationship management (CRM)
for call and customer contract center systems, which
industry sources estimate are growing at a 1999 –2003
CAGR of over 30% (to $33.2 billion). Smaller segments
include voice messaging (estimated 12.6% CAGR to $6.1
billion) and enterprise unified messaging (estimated 71.5%
CAGR to $490 million). According to industry sources,
Avaya has a strong position in this segment.
Services represent maintenance and value-added services.
The entire segment represented about 23% of FY99
revenues, with the large majority of that amount coming
from maintenance contracts. This segment is a source of
recurring revenues as maintenance contracts typically run
for one to five years, while value-added service contracts
can last for up to seven years.
Connectivity Solutions includes Avaya’s structured
cabling and electronic cabinets units. In FY99, the two
segments represented about 15% of company revenues. A
structured cabling system connects phones, computers, and
other communications devices through a building or across
one or more campuses. Avaya believes it is the global
leader in sales of structured cabling systems to enterprises.
Avaya Transaction
On September 30, Lucent Technologies will spin-off
Avaya, its enterprise communications business, in a tax-free
distribution to shareholders of record as of September
20. Lucent shareholders will receive one Avaya share for
every 12 Lucent shares. Lucent will not have continuing
stock ownership in Avaya after the distribution. Avaya will
begin regular trading on October 2 under the symbol AV.
Avaya Financials
In FY99, Avaya generated approximately $8.3 billion in
revenues, or about 21% of Lucent’s total revenues and 6%
of its net income. Avaya’s FY99 as reported EPS was
$1.05. However, over the last year, Avaya has restructured
its business such that FY99 includes some discontinued
operations. Detailed pro forma data is not yet available, but
we have estimates that incorporate the pro forma revenue
and net income numbers provided by Avaya. We estimate
that the discontinued operations represented about $750
million in revenues and $231 million in net income. For
ongoing operations, we estimate FY99 revenues at $7.6
billion and operating EPS at $0.19.
We also expect the company to announce additional
restructuring activities that will lead to an improvement in
operating margins. For just continuing operations, our
preliminary estimates call for revenues of $7.4 billion in
FY00 and $8.0 billion in FY01. Our EPS estimates for the
same periods are $0.45 and $1.14, respectively (see Table
2). Using the current trading price of Avaya-when issued
(AV-W, $28.63) suggests that investors are valuing Avaya
at about 25-times fiscal 2001 EPS estimates.
What’s Left?
We are not changing our Lucent estimates as our model
already excluded the Avaya business. We continue to
estimate 15% revenue growth to $9.4 billion and EPS of
$0.27 vs. $0.24 for the September quarter. But the model
may later need changes based on current business trends,
especially in the following assumptions:
Optical systems sales growth, especially of OC-192
(10G) product. Current expectations are for at least
$750 million in 10G sales in the September quarter;
Continued growth in the carrier access & data
segment. This business has been surprisingly strong,
but recent market share data suggests that Lucent’s
momentum may be slowing;
Rebound in wireless infrastructure sales. After two
consecutive quarters of disappointing wireless
performance, we have yet to see evidence of a
rebound in Lucent’s new contract win rate.
Modest growth in the traditional central office switch
business. With recent concerns about a decline in
capital expenditures, we believe that spending on CO
switches could be vulnerable to further cuts.
Lastly, we expect Lucent to announce more restructuring
activities that will include several hundred million dollars
in charges. Lucent could use this as an opportunity to
readjust its expectations for revenue and earnings growth
in fiscal 2001. With this as a backdrop, we would expect
Lucent to remain under pressure over the near term, and
we maintain our intermediate-term Neutral rating on
the stock. |
