This Stock Is No Longer Dead, It Might Even Double
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The expected returns to be produced when two well-respected telecom equipment vendors merged to form Alcatel-Lucent (NYSE: ALU) has never materialized. In fact it has been a disaster. Instead, the company has struggled to compete against more agile rivals such as Ciena (NASDAQ: CIEN) and Acme Packet (NASDAQ: APKT).
However, after six years of battles to drive efficiencies, Alcatel-Lucent is beginning to show meaningful signs of progress. What’s more, the company now seems poised to render its good market share into shareholder value. But after the stock gained over 80% in the last quarter 2012, investors have begun to wonder whether it's too late for them to benefit.
Is There More Value Ahead?
There are a couple of ways to answer that question. It all centers on which metric is used and the assumptions that are made. On a relative basis, the answer is yes. This is despite (as noted) the stock’s 80% surge in three months. But I’ll get back to this in a moment.
However, of late the situation has been about liquidity – recently securing a $2.1 billion financing pact. On the news the stock shot up 10%. Then again, that it received the financing deal was not a surprise. After all, the majority of the company's struggles have been cash-induced.
What shocked the Street though was the amount, which arrived much higher than expected and much sooner than analysts projected. Aside from the flexibility that the company now has, Alcatel-Lucent will use the cash to extend its maturity profile over the next several years.
Too, the company now has the latitude it needs to finalize its previously-announced restructuring program, which includes cost-cutting measures. Now in terms of value, although the stock surged up 80% in the last three months of 2012, shares actually lost 40% on the year.
Today the stock is at $1.64. And with liquidity no longer a concern, there is room for the stock to move upward by 50% and perhaps even double. The Street seems to agree. The company received two upgrades last week. On Friday, Credit Suisse applauded the company’s efforts with a neutral rating. This followed another raise to neutral by financial services company UBS. But the company is not out of the woods yet.
It’s All About Carrier Spending, But Competition Weighs
In 2012, the amount of capital spent among prominent carriers such as AT&T and Verizon were abysmal. As a consequence, telecom equipment companies were not able to produce the level of growth that industry experts had anticipated. However, a rebound in 2013 is expected.
While the extent of the recovery remains unclear, for Alcatel-Lucent, even a modest spike upward can yield meaningful gains. Also, the company's new financing can help buy its way into some of that business. But with the company playing catch-up to rivals like Acme Packet, it won’t be easy since Acme Packet remains the leader in session delivery network solutions.
Acme Packet is intriguing because analysts seem to not always agree on the underlying value of its business. Consequently, the stock ended 2012 at $22.12 - representing a loss of almost 30%. However, as with Alcatel-Lucent, after Acme Packet reached a 52-week low of $13.26, the market woke up. And despite ending the year with gains of 67%, there is still cause for optimism.
Acme Packet has new technologies such as the Net-Net 6300 that should help stimulate growth over the next couple of years. Features of the Net-Net 6300, which includes its ability to provide high-capacity network interconnect between service providers should help the company steal market share from rivals like Alcatel-Lucent.
What’s more, the device offers large-scale subscriber access environment such as VoLTE. The extent to which Alcatel-Lucent can launch a competing product remains to be seen. And even if Alcatel-Lucent is able to hold its own against Acme Packet, there is still Ciena it has to contend with. However, unlike Acme Packet, the Street is in love with Ciena’s recovery. This is despite a recent miss-and-lower quarter.
Understandably, when fundamentals are as solid as Ciena’s, benefit of the doubt is deserved. Likewise, management deserves credit for navigating through a dark spending period to improve profitability. Too, the company continues to do a great job squeezing out every possible dollar that it can. Impressively, it was able to do this while also growing its R&D budget. In other words, the best is yet to come.
When All Else Fails, There’s M&A
Can Alcatel-Lucent hold off two rivals with growing momentum? Whether or not it can, I’m also willing to consider that the worst is over. Plus it is not farfetched to expect that if ALU can show any meaningful signs of life, the company might become an attractive acquisition candidate. At the top of my list of acquires would be Cisco (NASDAQ: CSCO).
The network giant’s Q2 guidance for fiscal year 2013 suggests year-over-year growth of only 3.5% to 5.5%. With the top range of the outlook coming in a full point below Cisco’s historical average, this tells me that the company is not done doing deals. And with $45 billion in cash, the company has plenty of resources at its disposal.
Plus Cisco’s recent acquisition, which includes paying $141 million in cash for Cariden and another $1.2 billion for Meraki suggests that Cisco aspires to give the market the growth it craves – regardless of cost. With the cloud market expected to grow to $177 billion over the next three years, it would be foolish for Cisco not to consider acquiring Alcatel-Lucent, whose CloudBand strategy can become a major threat to Cisco’s own cloud ambitions.
Aside from possible headwinds, investors have to consider that Alcatel-Lucent is also a story about valuation. The company will lose money this year – no surprise there. But with a market cap of $3.72 billion, the stock is trading at 0.76 times book value. And future net losses will only decrease that metric future.
What’s more, that shares are trading at low enterprise value-to-sales multiple of less than 0.4 times, which is 0.6 lower than rival Ericsson, Alcatel-Lucent might surprise risk adverse investors by doubling its stock price this year. To do that, the company has to drive better margins. It will be difficult, but not impossible.
Recoveries are never easy in the stock market. But Alcatel-Lucent has just been given an extra life. Where it goes from here – depends on its level of execution. The good news though, is that the expected recovery in communications spending will parallel its cash infusion. Also, things can’t possibly get any worse.
rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Acme Packet and Cisco Systems, Inc.. 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!