Alcatel-Lucent’s new CEO, Michel Combes, certainly got his timing right. Since taking the reins from Ben Verwaayen last year, the ‘Shift Plan’ ‘ Combes’ brainchild, but heavily based on initiatives of his predecessor ‘ has been delivering its results. Perhaps for the first time since its troubled merger in 2006, the company is looking viable ‘ even if its improvements are also reigniting rumors that Nokia might make a bid.
That would create a far bigger force to challenge Ericsson and Huawei, of course, but would plunge the firms into another disastrous round of merger pains, just after each had started to be functional again ‘ Nokia, having divested its handsets, firmly focused on a mobile broadband strategy, while ALU builds its growth around IP, whether wired or wireless.
The fundamental difference in the foundations which each firm has chosen for its turnaround plan should be reason enough to stay separate. NSN has focused entirely on mobile broadband, whereas ALU’s wireline business, particularly its carrier routers, has been its most valuable weapon in recent quarters. Some still believe it should sell off the wireless operations altogether and concentrate on taking on Cisco and Juniper in the core and the cloud. That may be the deal it finally strikes with Nokia, and would have the advantage of offloading all the merger traumas to its rival, while perhaps retaining a sales alliance, between what would effectively be a wireless-only and a wireline-only company.
But the risks would be high, and ALU would be left reliant on a partner going through yet another reorganization, or alternatively, offering only half of the converged IP platform ‘ even as direct rivals like Cisco get into wireless (these landscape shifts would make Juniper a far better buy for Nokia, allowing it to provide the wireline portion again, but with a strong readymade offering).
Both ALU and Nokia face a fundamental industry shift towards software networking, and new economics in their core businesses as those commoditize. Both would navigate these waters better without the storm of a new merger.
Especially as, for both companies, the return to growth and profit remains in the earliest stages, and most of the improvements have come from drastic cost-cutting and sell-offs. The next challenge will be to generate organic, profitable growth based on the new business strategies, and the jury remains out on that one, for both manufacturers.
This was clear in ALU’s latest quarterly results, which saw a sharp reduction in Q114 losses but a fall in sales. Worryingly, ALU said 39% of its revenues in the quarter came from just three carriers in one country ‘ the US’s Verizon, Sprint and AT&T. Ericsson has also talked about the need to compensate for a slowdown in the US LTE build-out, which has dominated global LTE revenues and benefited these two European vendors above all. It will now be vital to see network upgrades and modernizations gathering steam in other major markets such as China.
For the first quarter, ALU reported a net loss of $101m, down almost 80% on the year-ago figure of $486.2m, and its adjusted operating income of $45.5m was better than Wall Street had expected, and just one-fifth the size of the previous year’s $246.5m figure.
But total sales fell by 3.3% year-on-year to $4.07bn. In the US, the largest region by revenue, sales were down to $1.89bn, from $1.98bn a year earlier, although another factor was a slip in the managed services unit. That is actually less concerning since it was mainly down to a deliberate policy of exiting unprofitable contracts in order to improve margins. The Access division, in which most wireless activity is housed, saw just a slight downturn, to $2.17bn, indicating that the effects of the US carriers starting to complete their build-outs are not being felt just yet.
But when they are, ALU needs to have a good Plan B. It said Verizon accounted for 17% of revenue in Q1, AT&T for 14% and Sprint for 8% (up from 13%, 11% and 11% the year before).
That will be a big hole to fill, and will require significant new wins in LTE, software-defined networks and the backbone of ALU’s current product portfolio, its routers. Cost-cutting alone will not be enough, though Combes still has about 50% of his promised reductions still to deliver. He has pledged to reduce expenses by around $1.38bn by 2015, and has managed $658.4m so far, and to sell another $1.38bn in assets (so far he has divested units worth about $482m).
In the fourth quarter of 2013, ALU did return to profit, but was not expected to repeat this in Q114 because of what CFO Jean Raby called ‘non-recurring elements like financial and pension costs, as well as restructuring costs’. He added that ALU was about halfway through its cost reduction program, which would end around the third quarter of 2015.
However, cheered as the markets are by the focus on profitability, the slack sales record does raise fears that ALU’s improvements are too reliant on the cost cuts – which cannot go on forever ‘and that they will eventually limit organic growth. As in the new quarter, the last quarter of 2013, when the firm made its first profit in two years, saw lackluster revenue – little changed from the year- ago period at €3.9bn, and behind analyst predictions of €4.18bn.
The wave of giant 4G contracts, particularly in the US, are tailing off and ALU will need to replace that business; shift towards higher margin capacity and services deals; and build more aggressively on providing an end-to-end, converged IP platform.