US to Watch Alcatel Lucent

Alcatel (NYSE: ALA; Paris: CGEP:PA) and Lucent Technologies Inc. (NYSE: LU) have agreed to leave their merger open to further review by the Committee on Foreign Investment in the United States (CFIUS) after their merger is complete, as part of a security deal struck with various U.S. government agencies.

The two companies announced late Friday that the office of U.S. President George W. Bush had approved recommendations from CFIUS, and that they were set to complete their merger by November 30. (See Bush Approves Alcatel Lucent.)

But that approval was conditional on the creation of two security agreements that could leave the terms of the merger open to amendment in the future, according to a filing made today by Lucent with the Securities and Exchange Commission (SEC) .

The first is the National Security Agreement, which will be concluded with the U.S. Department of Justice, the Department of Homeland Security, the Department of Defense, and the Department of Commerce. This agreement "provides for certain undertakings with respect to the U.S. businesses of Lucent and Alcatel relating to the work done by Bell Labs and to the communications infrastructure in the United States."

Under the terms of that agreement, should Alcatel Lucent "materially fail to comply with any of its terms, and the failure to comply threatens to impair the national security of the United States," the CFIUS could "reopen review of the merger transaction and revise any recommendations submitted to the President."

The second is the Special Security Agreement, related to the separate subsidiary that Alcatel Lucent is creating "to perform certain work for the U.S. government, and hold government contracts and certain sensitive assets associated with Bell Labs." The creation of such a subsidiary has been part of the merger plan since the deal was first announced in April. (See Lucent Creates Subsidiary.)

This agreement "contains provisions with respect to the separation of certain employees, operations and facilities, as well as restrictions on control by the parent company and on the flow of certain information." That means there may be parts of the Alcatel Lucent empire to which even the company's senior management won't have access.

That subsidiary is to have its own board of directors, including at least three independent directors "who are resident citizens of the United States who have or are eligible to possess personnel security clearances from the Department of Defense." As previously announced, three of these directors are: William J. Perry, former U.S. Secretary of Defense; R. James Woolsey, former director of the CIA and former Under Secretary of the U.S. Navy; and Lt. Gen. Kenneth A. Minihan, U.S. Air Force (Ret.), former director of the National Security Agency.

Alcatel and Lucent say that, as agreed upon with the various U.S. government agencies, these agreements will be executed "within the specified time periods."

The specified time periods have not been made public, though, and it's unclear what sort of impact the reopening of any CFIUS review and recommendation process might have on Alcatel Lucent in the future, or whether any separation of Bell Labs staff, facilities, and operations might affect R&D processes.

Both Alcatel and Lucent spokespeople say the terms of the agreements are confidential, and that they can't elaborate on the SEC filing.

But while questions surrounding those security agreements remain, the merger of Alcatel and Lucent is still on course to close by next Thursday, November 30. If that deadline is met, says Prudential Equity Group LLC analyst Inder Singh in a research note issued this morning, one month's worth of Lucent financials would be recognized in Alcatel's fourth quarter of 2006.

Singh also says he expects Alcatel Lucent to reduce its combined 88,000-strong workforce by "closer to 12,000, above the 9,000 publicly identified. This would help the combined company accelerate the realization of merger savings into 2008, the time when we expect the strongest EPS growth" for the combined company.

When the two companies first announced the deal they said they expected the merger to create $1.7 billion in cost savings within three years of the deal closing, which looks to be November 2009. Those savings, the two firms said, would come from consolidation processes that would result in a workforce reduction of about 10 percent, or 8,800 jobs. (See Alcatel, Lucent Seal Deal.)

Under the terms of the deal, each Lucent share will be exchanged for 19.52 percent of an ADS (American Depositary Share), representing ordinary shares of Alcatel. With 4.48 billion Lucent shares in circulation, the deal is currently valued at $11.8 billion. Based on 2005 reports, the combined company will have annual revenues of more than $25 billion, making it the largest single supplier of telecom equipment and support services.

— Ray Le Maistre, International News Editor, Light Reading