Lehman: Worst Over for LU and NT

The telecom downturn has stabilized, and restructuring efforts by two key vendors, Lucent Technologies Inc. (NYSE: LU) and Nortel Networks Corp. (NYSE/Toronto: NT), could lead to a breakeven point for both by fall 2003, according to a "Lucent and Nortel Update" report from Lehman Brothers.

The report focuses on both vendors as bellwethers of the telecom industry with roughly equivalent outlooks. With costs being reduced, profitability is imminent, says the report, but Nortel's showing more progress.

"Nortel is on track for breakeven in the June quarter, ahead of Lucent... [which will] break even in the September quarter," Steven D. Levy, managing director of wireline equipment equity research, said on a conference call with investors today.

Nortel's pulled ahead for several reasons, Levy says: First, it relies less heavily than Lucent on sales to the troubled U.S. market. In the quarter ended December 2002, for instance, 49 percent of Nortel's sales were in the U.S., versus 62 percent of Lucent's, according to the Lehman report. Nortel also started earlier on efforts to replace in-house manufacturing with more outsourcing. And presently, Nortel is enjoying the benefit of a higher gross margin, about 50 percent by Lehman's estimate, on sales to enterprise customers. Lucent's emphasis on providing services to telcos brings them a gross margin of about 14 percent, the report says.

The discrepancy won't last long. Operating margins -- sales minus cost of goods sold and operating expense -- will close the gap between the two companies later this year, Levy says, thanks to the nature of the enterprise and services businesses.

Both companies will show revenues of about $9.5 billion for 2003, he predicts, with 5 percent growth for both in 2004. Interestingly, nearly 40 percent of both companies' revenues for the foreseeable future will come from wireless infrastructure sales, the firm forecasts.

Table 1: Lehman Calendar Year 2003 Estimates
  Lucent Nortel
Sales $9.55 billion $9.65 billion
Percent change Y/Y -12% -9%
Gross margin 31.30% 39.80%
Operating margin -1.60% 1.90%
EPS -$0.14 -$0.03
Source: Lehman Brothers

Table 2: Lehman Calendar Year 2004 Estimates
  Lucent Nortel
Sales $10 billion $10.15 billion
Percent change Y/Y +5% +5%
Gross margin 35.50% 41.10%
Operating margin 5.70% 5.10%
EPS +$0.04 +$0.05
Source: Lehman Brothers

Changes like these are pleasant to contemplate. But Levy acknowledges some risks could throw Lehman's forecasts off. When it comes to Nortel, Levy says management's projection of "single digit" reductions in carrier spending for 2003 is "a bit too optimistic." That could mean Nortel's expense models are still too high.

Lehman originally predicted an overall capex drop of 20 percent this year, but now says 13 percent is likely.

Nortel also is counting on deployments of 3G/UMTS wireless installations getting activated in various international deals, but there are signs that interoperability issues could hamper these plans. And Nortel's banking heavily on voice over packet, but it's not clear carriers will respond as desired.

Meanwhile, Lucent has its share of caveats. Management's outlook on the capex conundrum seems reasonable, Levy says -- it calls for a 15 percent market decline this year. But the company's counting heavily on three or four major wireless infrastructure deals in the first half of the year, such as that with Indian carrier Tata Teleservices Ltd. (see Lucent Grabs Tata). With these deals done, it's not clear how Lucent intends to reach the revenues implicit in its guidance, which Levy said would call for equivalent $2.5 billion in sales for the remaining two quarters of this year. "Maybe there are contracts they haven't announced," Levy says.

There are industry-wide risks, too. "We believe that the industry fundamentals have stopped deteriorating and that much of the uncertainty... is either behind us or materially diminished," writes Levy and partners in the report. "To be clear, we are not yet, however, forecasting an improvement in the fundamentals. We also remain cautious that the pending geopolitical concerns, as well as the continued soft economy, create risks that could lead to further fundamental deterioration." [emphasis added]

On today's call, Levy reiterated these factors could throw a wrench into the works. Also, he concedes that his firm could be wrong on its outlook for either Lucent or Nortel. And, he said, "If we're wrong on one of them, we're wrong on both of them."

— Mary Jander, Senior Editor, Light Reading

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Lightlight 12/5/2012 | 12:32:57 AM
re: Lehman: Worst Over for LU and NT It's nice to hear that the worst of Telecomm downturn is over. I hope this is true and hope NT and LU do well in 2H 2003.
pipesoflight 12/5/2012 | 12:32:53 AM
re: Lehman: Worst Over for LU and NT I have made some money on short term trades with NT. I really like this stock and expect to make some good returns. I think the comapny is still a good company. Canada isn't going to let this puppy vanish. I am thinking that NT might be one of the first to double or triple in value this year alone.
walter_100 12/5/2012 | 12:32:48 AM
re: Lehman: Worst Over for LU and NT Me too. I hope we see some steady growth in Telecom this year....
BobbyMax 12/5/2012 | 12:32:46 AM
re: Lehman: Worst Over for LU and NT Both, Lucent and Nortel, have been battered due to sharp decline in stock prices. For example, Norel has come down to less thsn two dollars per share. Similarly the Lucent has cme dowm has come down from $75 pershare to less than $2.00 per share.

In case of Lucent, the diversity of product line has almost vanished. Lucent will have very tough time to maintain its product lines. There is no focus at Lucebt.

excitedPhoton 12/5/2012 | 12:32:42 AM
re: Lehman: Worst Over for LU and NT Oh, come ON!

BM wrote:
>> For example, Norel has come down to less thsn ...


>> There is no focus at Lucebt.

You can't focus long enough to write a six-sentence posting.

Fhunton 12/5/2012 | 12:32:41 AM
re: Lehman: Worst Over for LU and NT I agree, hopefully things will pick up. It would be nice to see some positives for a change, lets just hope though that Lucent can keep up. Alot of cuts have been made.....check out the message board.
captain kennedy 12/5/2012 | 12:32:39 AM
re: Lehman: Worst Over for LU and NT Which is stronger in this article, a statement about growth or a statement about making the downsized industry profitable? If the latter is the main point, anyone that has been part of a RIF should not expect to get their badge reissued anytime soon. The good news is those who are working can relax and get back to work.
sevenbrooks 12/5/2012 | 12:32:37 AM
re: Lehman: Worst Over for LU and NT
Don't you guys wonder why there is turnaround next year with signs we will see in 6 - 9 months? Go back a year and look. Go back 2 years and look.

piltdownman 12/5/2012 | 12:32:29 AM
re: Lehman: Worst Over for LU and NT The macro analysis presented is probably accurate at a high level, but drilling down to Nortel's optical business, it is dying month-by-month. Some facts:

- Nortel's main reason for its recent revenue success in Asia is that it is dumping excess inventory of long-haul gear at whatever price will win them the business. Not a recipe for long-term success or healthy margins.

- Nortel's optical share in Europe is still piss-poor, with no new optical wins in any of the major PTTs. They will not win FT's optical overbuild, and are in process of losing the BT business to either Ciena or Lucent. European leadership in the form of Peter Newcombe is clueless on how to win in this market.

- Nortel's US customer base that made them a giant in 2000 is a disaster. Nortel was supplier to all the carriers that today are in the worse of financial shape (ie: WCOM, 360, Level3, Qwest, Wiltel, Broadwing), and not present at all in the ones that are planning network builds in 2003 (Sprint and AT&T). So they lack the incumbancy in the market that is active.

- Nortel's HDX has yet to be adopted by ANY major carrier. So far all N. American carriers have deployed CoreDirector (Level3, AT&T, Qwest, Sprint, Wiltel) and Ciena is now positioning that product into the RBOCs. And Ciena and Alcatel have all the momentum in the next-gen OXC space.

- They have axed all development of next-gen long-haul platforms: LH4000 ULH is discontinued, LH5000 R&D is stopped, and LH1600 is a 4-year old product and nothing is being done to enhance it. So far Nortel has failed to short-list for both the AT&T and Sprint ULH projects, and their previous major customers MCI and Qwest have so much excess capacity in their networks they will not buy for a long time. The Metro WDM platform from Cambrian is now 4 years old and basically the same, and will get killed in the market by solutions from Movaz, Photuris and Tropic as soon as these players get a partnership with a major vendor.

- They have decimated their sales and marketing organizations (the US marketing team in Atlanta has been cut by 90% and only does chartware now), and retrenched around the "good old boys" of optical that continue designing products to their vision and not to customer specifications, and where the culture of NIH is thriving.

On the plus side Nortel has a great next-gen SONET portfolio that sells into some of the RBOCs. However the SDH product portfolio is high priced and obsolete, and is practically not selling anymore.

Nortel's overall optical business is a mess and the only thing saving them right now is that people like Lucent and Marconi are in even worse shape. When the market picks back up companies like Ciena and start-ups will destroy Nortel in the market.
Kumite 12/5/2012 | 12:32:20 AM
re: Lehman: Worst Over for LU and NT You make some valid points but I would not be quite so negative about Nortel optical.

- According to the latest Dell'Oro Group report Nortel maintained or gained market share in all optical segments and is still number one in many optical categories including Global optical.

- Yes they are unloading all the written off equipment, but so is everyone else in the industry (Ciena, Lucent, Alcatel, etc)

- Traction in Europe is weak, I agree. They need a new SDH platform to compete in that space. Maybe they'll come out with one soon. There is not a lot of spending going on right now no matter how you lok at it so they are not missing out on major revenue.

- The HDX has one 3 contracts I know of anyway: Touch America, Optus, and the China deal. Tough market for OXCs at the moment for everyone.

- I don't think Nortel has abandoned LH optical R&D altogether. The LH 1600 is done at Release 9 I think, but carriers will continue to buy more cards to deliver services across those underfilled pipes eventually. Beats installing a new network.

- The Metro 5200 isn't so bad for a 4 year old box and it has changed quite a bit as far as improved density, OC-192 capability, etc. It also still has a 40% market share with the closest competitor being Ciena & ONI with 16% combined. It is a feature rich platform that is OSMINE and TIRKS compliant so it is being used by most of the RBOCS for wavelength services, especially SBC.

- If Nortel has some next gen toys in their back pocket that they have not introduced due to slow market demand then they may be waiting for an uptick in the spending so they can ride the next wave of spending while their competitor's are trying to sell 4 year old toys.

All you can do is wait and see i suppose. Being late with a new product set may actually benefit them for a change since they are still doing well in most areas with what they have and there is not a lot of spending going on to warrant new toys when the old ones are holding their own.

Besides that they will return to profitability before the other major players which also bolsters their business position in the industry.

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