Cisco vs. Lucent
By Phil Weiss (pweiss@homemail.com)
Towaco, NJ (Jan. 6, 1999) -- Tonight I thought that I'd visit a question
that comes up regularly on Cisco's Message Board: Which is the better
stock to own, Cisco (Nasdaq: CSCO) or Lucent (NYSE: LU), or
both?
Before I get to the analysis I should disclose that I own shares of both
of these companies in my portfolio; however, I don't treat them the
same. I remember back in April of last year Al wrote a report about his
thoughts on Lucent. He concluded that Lucent, which he had acquired
when it was spun off from AT&T, was not a Rule Maker, so he sold
his shares when he rotated his Foolish Four stocks. At the time I took
the other side of the argument as I believed then (and still do by the
way) that Lucent is a great company -- one that I thought could become
a Rule Maker over time. However, based upon its performance over the
last 9 months, I think that it is now much further away from Rule
Maker status than it was at that time.
Sometimes, even though several of our stocks fall short on one or
another of our criteria, it may seem that our approach can focus more
on the numbers than anything else. To me, the numbers are important
as a starting point in determining whether or not a company is a viable
Rule Maker candidate. However, the numbers themselves are less
important than their direction. This is where Lucent really falls short in
my view.
Warning! Warning! Danger! Those of you that don't like to go through
numbers too much may want to go through the next section of this
report real quickly. But, I think that if you do take the time to look
through it, you'll see some rather disturbing trends.
As of December 31, 1996, Lucent had $3.2 billion of cash on its
balance sheet. By the first quarter of 1997 this number had fallen to 2.0
billion. As a matter of fact, with one exception, this number has fallen
every quarter since then and as of September 30, 1998 cash represented
only $685 million of Lucent's assets. This also means that its ratio of
cash-to-debt has fallen from 1.92 to 0.28 - an 85% decrease. During
this timeframe, long-term debt has also increased from $1.7 billion to
$2.4 billion.
If you take a look at Lucent's flow ratio, you'll also see a similar trend.
From December 31, 1996 to September 30, 1998, it has increased from
0.97 to 1.28 (though it has been relatively steady over the last year) a
32% increase. The trend here is what's most disturbing to me as the
1.28 value is really right in line with our minimum threshold of 1.25.
Now, let's look at Cisco's numbers for the same period. At the end of
the quarter ended January 25, 1997 Cisco had $1.1 billion of cash and
no long-term debt. As of the end of its October 1998 quarter, Cisco had $1.9 billion of cash and still
had no long-term debt. During this same period our company's flow ratio has fallen from 1.59 to
1.13.
So, if we take an isolated look at the balance sheets of these two companies, Cisco looks much
stronger. Even more telling is the fact that Cisco's balance sheet has been getting stronger every
quarter while Lucent's has been getting consistently weaker. In my view, Lucent has not shown any
real evidence that it's been able to successfully pay off its long-term debt (or even wants to). Lucent
is currently incurring a little more than $300 million of annual interest expense on its debt. Cisco is
not paying a penny of interest expense.
You might ask what value this information has to me as an investor analyzing these two companies.
Well, I know that many view these companies as potential competitors. They are certainly industry
heavyweights. I'd expect that if Lucent continues trying to make inroads into the networking space
the battle between it and Cisco could get nasty. Since it doesn't have Lucent's heavy debt load, I think
Cisco is in much better shape to do battle than Lucent.
A look at the income statements of these two companies only serves to strengthen my conviction that
Cisco currently has a strong leg up in any competition with Lucent. Cisco's gross margins have been
around 65% during the period that I mentioned above; Lucent's have ranged from 41% to 48%.
Cisco's net margins are consistently above 20%. On the other hand, Lucent's are generally less than
10% (for more information on gross and net margins, you can check through our 6th Step).
These superior margins also leave Cisco in better position to survive a competitive situation. Cisco
could much more easily cut prices in order to win new business while still staying more profitable
than Lucent. And Cisco doesn't have to pay $300 million in interest expense either.
Can Lucent win a battle for supremacy with Cisco? Yes. Do I think that it's likely that it will? No.
Lucent has chosen to take on a large amount of debt in an attempt to grow its business. There is
nothing that says this strategy can't be successful. However, if given a choice between one company
with a heavy debt burden and another that is lean and mean, I'll take the lean, mean fighting machine
any day. The latter company has a lot more margin for error. But, this also doesn't mean that I can't
be wrong. After all, I'm simply a Fool.
I also like the fact that, while neither company is small, Cisco's revenues are less than a third of
Lucent's. This gives it a lot more room to grow. As a matter of fact, for what it's worth, according to
Zacks, the Wise currently estimate that Cisco will grow earnings per share by approximately 28%
over the next 5 years. The estimate for Lucent is only 22%.
I did say up front, though, that I own shares in both companies. You might ask why I would choose
to do so when I believe that one is much stronger than the other. There are really two reasons for
this. The first is that in my view there really isn't a reason to sell my Lucent stock right now. It's
been executing its business model well. I won't sell unless I think that's changing. The other is that
holding onto Lucent allows me to hedge my bet a little bit. But, whenever I invest new money in a
company in this industry it is much more likely that I will add more Cisco stock rather than Lucent
stock.
Do you agree or disagree with my views? Do you think that you can convince me otherwise? Do
you have any other questions? I'd be happy to continue the discussion on our Companies Board.
Phil Weiss, Fool
Cash-King Strategy Folder
Cash-King Companies Folder |
