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Technology Stocks : Lucent Technologies (LU) -- Ignore unavailable to you. Want to Upgrade?

To: Mark Duper who wrote (5562)	1/14/1999 8:43:00 PM
From: Ibexx	Read Replies (3) \| Respond to of 21876

Mark and thread, The following is from the Prudential Research, dated 1/14/99. Recommendation: STRONG BUY (table deleted because of formatting problems) _____ -------------------------------------------------------------------------------- * Our model suggests the acquisition of Ascend can be EPS neutral in both fiscal 1999 and 2000. Lucent sees potential for 2% to 4% EPS accretion ($0.05 to $0.10) in fiscal 2000, but we are not increasing estimates at this time because achieving these levels would require substantial incremental revenues. * Ascend's penetration of major carriers around the world, should mean for Lucent incremental business with existing U.S. carrier customers and provide it an opening to penetrate major carriers outside the U.S. * The acquisition makes Lucent a stronger competitor in carrier data and to Cisco. However, we believe the major opportunity is for both Cisco and Lucent to increase their market share at the expense of weaker companies in the telecom equipment/data networking market. -------------------------------------------------------------------------------- The acquisition of Ascend solidifies Lucent's data networking efforts for the carrier market. Progress has been slow for Lucent in developing the competitive ATM WAN switching products that have been missing from its data networking portfolio. To address the strong demand by the carriers for these products Lucent had formed an OEM relationship with Ascend which should enable Lucent to market Ascend's products until the merger closes in April/May. Following the acquisition, Lucent can shift its focus away from developing its own ATM products, to integrating Ascend's products with other Lucent technologies. Ascend strengthens Lucent's hand in its traditional customers and gives it an important foothold in other carriers. Most of the major carriers in the U.S. are using Ascend's ATM WAN switches and we anticipate that Lucent should see incremental sales of products, such as wave division multiplexing (WDM) gear, software, or services as a result of owning Ascend. In addition, Ascend has a position in several major carriers in which Lucent does not have a meaningful presence such as Worldcom and Qwest. Approximately 30% of Ascend's sales come from abroad, including NTT in Japan and several major PTT's in Europe. Ascend's presence at the core of these major networks represents a significant opportunity for Lucent to increase its penetration of these accounts. We are estimating the acquisition is EPS neutral in FY-1999 and FY-2000 despite the rich price that Lucent paid. Our model suggests an EPS neutral result in both years, assuming minor SG&A reductions at Ascend. To achieve the 2% to 4% earnings accretion in FY-2000 (an incremental $0.05 - $0.10 to EPS) that Lucent expects would require between $500M and $1B in incremental sales of the combined entity. To us this seems aggressive given the more than 50% revenue growth required to achieve the 1999 consensus EPS estimate of $1.67 for Ascend and the more than 30% revenue growth needed to get to the $2.19 EPS consensus for 2000. Ascend's revenue growth in 2000 would have to be 75% to get an added $1 billion in sales, yielding year 2000 sales of $4 billion for Ascend (The current 2000 consensus would assume a $3 billion revenue level, for about 30% growth). We estimate that Ascend should increase Lucent's gross margins by about 90 basis points on an annual basis. Lucent's strong financial position eliminates the issues Ascend had with vendor financing. Ascend's market share positions Lucent as a major player in data networking. The merger gives Lucent a 20% to 25% share of the ATM WAN market. Competitors Cisco (CSCO--$95 7/8; rated Strong Buy/Select)and Nortel (NT--$53; rated Accumulate) each have similar shares, while Newbridge's is slightly less. In remote access concentrators, Ascend, Cisco, and 3Com each have somewhere between a 25% and 35% share. Despite their market shares in these segments, Newbridge (NN--$36 3/16; Not Rated) and 3Com (COMS--$45 7/16; rated Accumulate) are each relatively small players compared to their rivals in these spaces, and their market shares could come under pressure as their larger competitors increasingly use bundling and aggressive financing to win business. Ascend's penetration of the carrier market is better than these numbers suggest, because as much as 40% to 50% of the competitors' sales in these markets are to the enterprise segment (with the exception of Newbridge), whereas virtually all of Ascend's sales are from carriers. The issue is not Lucent versus Cisco, but rather the threat Cisco and Lucent pose to other competitors. Cisco has already learned how to compete against Ascend and therefore the acquisition does not present any addition threat to Cisco's ATM business or its dominance of IP and routing for the next six to nine months. Beyond that point, Lucent's muscle is likely to be felt by Cisco, however we think the opportunity for them is to focus on other competitors. Combined, Lucent and Cisco have less than 15% of the global carrier market. It makes more sense for them to go after the lower hanging fruit, the 85% market share held by the competition around the globe, rather than to be at each other's throats. Lucent has to deal with some product overlap. It has its own MX-1000 ATM switch as well as Ascend's CBX-500 switch which overlap in the edge ATM switch space. In remote access, Ascend's MAX TNT product is well-adopted with larger ISPs and carriers and overlaps with Lucent's PortMaster products from the Livingston acquisition. In the IP space, both companies have routing products, but neither have had a product that competes effectively with Cisco's. Carrier-class IP routers are, in our view, a remaining hole in Lucent's data portfolio. Lucent is creating a new broadband unit that Ascend will join. The priority that Lucent is putting on this business is underscored by the selection of Lucent's well-respected COO, Dan Stanzione to lead the new broadband unit. The business unit includes Lucent's existing data networking business (which will be rolled into Ascend), Lucent's optical networking products, the communications software business, and Ascend. Lucent still has to contend with important issues. 1) Retaining talent is critical. It is unclear whether Ascend's employee stock options will vest immediately or whether they will convert to Lucent options. 2) It is critical for Ascend to achieve its earnings targets over the coming two quarters, or else the deal could become dilutive. 3) Lucent has to define its vision for the future and generate a migration plan for the current Lucent and Ascend products to converge, eventually, within that vision. Ascend's sales are nearly evenly split between remote access and WAN switching. ATM WAN switching (including frame relay) represents about 40% of Ascend's business, or about $600 million in 1998. About 43% of revenues are from sales of remote access concentrators, or $630 million by our estimate. Stratus was acquired in the fall, and its carrier signaling business has a $200M annual runrate, beginning in the December quarter. Consensus revenue expectations for 1999 are in the $2.3 billion range, about a 50% increase from 1998 revenue levels, excluding the impacts of the Stratus acquisition. _____ Ibexx