Analyst: Alcatel Should Rethink Things

As Alcatel (NYSE: ALA; Paris: CGEP:PA) shareholders prepare to vote on the proposed merger with Lucent Technologies Inc. (NYSE: LU), one analyst says Alcatel needs to negotiate new terms.

In a series of notes issued this week, Dresdner Kleinwort analyst Per Lindberg lines up what he considers to be the shortcomings of Lucent -- the "American laggard," as he calls it at one point -- and analyzes how much they could damage Alcatel after a merger.

His points revolve around the issues of Lucent's pension overhang and the military work done by Bell Labs . Both issues have drawn questions since the April announcement of the merger, but Lindberg feels they're strong enough to warrant concern.

"It must be a foregone conclusion that Alcatel's shareholders have become increasingly alarmed by the prospect of swallowing Lucent's precarious operations and hollow balance sheet," Lindberg writes. "The financial setbacks of Lucent, prompted by a free-fall in its wireless operations, not only escalate the integration risks but also make the agreed terms increasingly unpalatable to holders of the French supplier's stock."

Whether Alcatel investors share Lindberg's worry will be revealed on Sept. 7, the day they vote on the proposed deal.

Signs of trouble? Well, maybe not. The pension and Bell Labs situations aren't exactly secrets; in fact, both drew questions back in April, when the merger was announced. (See Alcatel, Lucent Seal Deal.) That leads some analysts to believe there isn't much chance of the deal getting derailed or repriced.

"The big [Alcatel] shareholders I've spoken to understand the deal," says Tim Daubenspeck, an analyst with Pacific Crest Securities Inc. "I fully expect that on Sept. 7, they'll get enough votes, and the deal will close this fall, with the current terms."

Alcatel shareholders might not "scupper" the deal, as Lindberg puts it, but he muses that they could at least dispute the exchange ratio. One reason is that Lucent's pension overhang could be more serious than the numbers say.

In evaluating its pension figures, Lucent estimates an 8.5 percent return on assets and a 5.5 percent discount rate. Alcatel uses more conservative numbers of 4.7 percent and 4.5 percent, respectively, Lindberg points out.

Put Lucent's pension fund through the Alcatel numbers, Lindberg writes, and a gap of $4 billion to $5 billion appears. "Lucent would suddenly appear 40 to 50 percent more expensive than the financial markets currently believe," he writes.

Alcatel officials weren't immediately available for comment -- but given that Lucent's pension figures aren't exactly secret, one might assume Alcatel and its institutional investors already knew all this. In fact, going with that "not a secret" theme, analyst George Notter of Jefferies & Co. Inc. has openly suggested Lucent's declining pension returns provide one more reason for the company to sell itself off.

(Lucent's pension numbers are tightening up anyway. The company is shifting its return-on-assets figure, probably to 7.5 percent, Jeffries noted last month. )

Then there's the Bell Labs question, as many have pointed out that the U.S. government may balk at putting any military-related work under control of a French company. Lucent has already said it's forming a subsidiary, led by a board of U.S. citizens, to deal with sensitive government work. "They've put the infrastructure in place to cordon that off," Daubenspeck says. (See Lucent Creates Subsidiary.)

But Lindberg suggests that might not be enough. "U.S. lawmakers' concern may escalate as the real consequences of the proposed merger are explored. If so, later in the autumn, the assigned committee, known as CFIUS (Committee on Foreign Investment in the U.S.), may reach the conclusion that serious concessions have to be made," he writes. "A forced sale of Bell Labs, we surmise, would most certainly invalidate the vote on 7 September."

Substantial concerns, or just fear mongering amid a slow trading month? At the least, it gives the rest of us something to talk about while much of the Western world is on holiday.

Lindberg does have one point that most analysts agree on: Lucent's CDMA business isn't all that attractive. There's been some concern there, "because it's not a particularly high-growth market for the next several years," Daubenspeck says.

Should the deal somehow fall through, Lindberg expects Lucent's stock would fall 20 percent. Lucent traded up 2 cents (0.9%) at $2.29 midday today. Alcatel shares were up 19 cents (1.5%) at $12.51.

— Craig Matsumoto, Senior Editor, Light Reading