Could This Telecom Equipment Stock be a Late Bloomer?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Since January 2012, Sprint Nextel (NYSE: S) has been one of the best performing midcap stocks, with a gain of 220%. While these gains are large, Sprint was a bit of a late bloomer, and now, Alcatel-Lucent (NYSE: ALU) looks to be following a similar path.

2012’s late bloomer of the market

In 2012, Sprint was my “Value Of The Year” selection. For many months, I wrote article after article explaining why I believed that Sprint was destined to produce great gains.

In fact, I even promoted the stock in the most public way possible. In my book, Chapter 9 “Behavioral Selling," I went out on a limb with my Sprint prediction by saying:

“Today, Sprint is trading at $2.29, and I promise that by the time this book is published the stock will be trading at least 75% higher.”

Just so you know, I wrote the book in the first four months of 2012. During that time, I was highly criticized for my selection of Sprint as 2012’s value of the year. Today, we all know how the stock has performed – but up until May 2012 – Sprint traded with gains of just 2% while the S&P 500 traded with gains of 11%.

In my opinion, Sprint is a true example of how a value investment works in the market. A value investment should be easily identified with common sense, but often takes longer to appreciate. When it finally does appreciate, the stock has a tendency to explode with abrupt gains.

In the case of Sprint, the market valued its worth at more than $5 per share in 2011 with falling subscribers and revenue -- without the iPhone -- and with a rising debt-to-assets ratio. When the company begun to sell the hottest phone in the world (iPhone), and was priced at $2.30, my thinking was that Sprint was worth a whole lot more than in the year prior at $5.

Following a similar pattern?

My outlook for Sprint was not complicated, it was hardly fundamental, but it was correct. In 2013, I made, what I thought, was a very similar call with Alcatel-Lucent.

Much like Sprint, I have continuously been told that I am wrong – in part because I made 2013 a joint selection between Alcatel-Lucent and Rite Aid. While Rite Aid has exploded with fundamental gains, Alcatel has lagged the broader market, having produced a YTD loss of 2% as of May 1.

What I find interesting about Alcatel-Lucent is that it appears to be following the same pattern as Sprint. In 2012, Sprint was dead money for the first four months, much like Alcatel this year. Then, afterwards gains were continuous, much like Alcatel’s 22% gain in the month of May.

Will the large gains continue?

Back when I chose Alcatel, it had seen a great deal of upside to end 2012 due to its plan to become a smaller but more efficient company. Alcatel secured financing from Goldman Sachs and then began the process of evaluating its assets and intellectual property in an attempt to sell its unprofitable segments and increase margins.

My thought process behind the choice was very similar to that of Sprint: common sense! Alcatel-Lucent is a massive company with a small cap valuation, thus its sum-of-parts equate to great upside for the stock.

Alcatel has a market cap of $3.8 billion and revenue of $18.7 billion. It operates in an industry that trades at 1.2 times sales. Thus, in a perfect world, its market cap would be near $22 billion, or its stock price near $10.

Unfortunately, price/sales is not universal, and companies have different multiples depending on various factors such as growth and efficiency. In the telecom equipment industry, higher multiples are awarded to those that are more efficient – stocks in the industry typically trade with operating margins between 10% and 17%.

However, If Alcatel can sell 30%-50% of its business and focus on the segments with operating margins between 10% and 17% then it will likely trade with the same multiples as other companies in its space. Furthermore, investors will be even more optimistic as Alcatel has high-growth segments and will use cash from divestments to pay off debt. Combined, this will create great upside throughout 2013.

Final thoughts

Late last year, the idea of Alcatel’s restructuring plan created significant upside – and now after four months it looks as though investors are buying once more. Strangely enough, it does follow the same pattern as with Sprint – but in order for it to continue – the company must execute on its restructuring plan.

With Sprint, I never feared whether gains would or would not be created. I made it my second largest holding at $2.35 and then sold around $6.50. With Alcatel, I don’t have the same level of confidence.

Back in January I was very confident – but with the hire of a new CEO it is imperative that all executives and board members are on the same page. The company has a massive IP portfolio to monetize and if the company can cut its operations by 30% and achieve margins on the low end of the industry average then it should warrant the same multiples as other telecom equipment stocks; which would represent a valuation that is two-four times greater than its current market cap.

In my opinion, this is easily attainable – but the company has to execute its original plan – and that is yet to be seen. 

Brian Nichols is long ALU. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus