More cuts likely at Alca-Lu

Rethink
Alcatel-Lucent narrowed its first quarter operating losses, but the cashflow challenges which afflicted its previous CEO still haunt new chief Michel Combes, and he is likely to initiative yet more stringent cutbacks.
 
The French giant slid back into a net loss in the quarter, with a deficit of €353 million ($460 million) compared to a year-ago profit of €398 million, the result of selling the call center business Genesys. How-ever, although figures missed analyst estimates, ALU did reduce its operating loss by 32% year-on-year to €202 million, on revenues up just 0.6% to €3.23 billion. The former figure included restructuring charges of €122 million and a financial loss of €152 million.
 
Revenue growth was driven entirely by a 15% uptick in US revenues, thanks to major deals (shared with Ericsson) with AT&T, Verizon and Sprint. North America is now the largest geographical market for ALU, at 48% of sales. Its heartland region, Europe, saw sales fall by 10% year-on-year to €771 million.
 
Gross margin was 29.4% of revenue for the quarter, compared to 30.2% in the year-ago quarter and 30.4% in the fourth quarter of 2012. The vendor said the decline in margin reflected the current “unfavorable product mix”, a factor also cited recently by Ericsson.
 
Combes, a former senior executive at Vodafone, has perhaps taken on a poison chalice, though he will be hoping he can quickly build on all the progress made by his predecessor Ben Verwaayen, whose ambitious vision and aggressive cost cutting did return ALU to profit, but not in a sufficiently sustainable way to reassure investors.
 
The deepening eurozone crisis derailed some of his plans and cashflow remained a serious challenge. That situation is scarcely improving yet. ALU reported a free cashflow loss of €533 million in the quarter, worse than the Q112 figure of €162 million. Combes' statement said cash generation "remains a challenge”.
 
The company has provided no guidance for 2013 as yet this year. Combes tried to be optimistic, saying: “Alcatel-Lucent's first quarter results reflect both encouraging trends in the marketplace and good progress with The Performance Program, for which discipline on execution remains the priority in 2013. Free cashflow remains a challenge. Strong focus will be placed on working capital management to reverse some of the negative impact incurred this quarter.”
 
 
Amid problems including cashflow and slower than expected uptake of ambitious new 4G products, Verwaayen resigned last fall, to be replaced by Combes on April 1. While Verwaayen had a reputation for grand thinking at previous, successful postings such as heading up BT, Combes is regarded as a ruthless cost cutter, based on his track record. He will unveil an updated turn-around plan in early summer, which is expected to increase the current targets of slashing 5,000 jobs and €1.25 billion a year in costs, and lead to more business sell-offs.
 
“We are actively reviewing the group's businesses and operating model to design the conditions for value creation in the future,” Combes said in a statement. While Verwaayen's restructuring was firmly focused on axing non-core businesses, and more are still to go in areas like submarine, Combes may attempt a more wholesale rethink of the businesses ALU is in, and the structure required – rather as Nokia Siemens did when it reinvented itself as a mobile broadband-only provider and got rid of a succession of units which did not directly support that business.
 
Possible restructuring options:
 
ALU has already shown some of that thinking in managed services, where it has renegotiated or backed away from many contracts which were delivering insufficient profits. CFO Paul Tufano said during the earnings call that 15 of the company's 68 managed services deals had been identified for renegotiation last summer, and 10 had now been terminated or reworked. This had already resulted in the loss of 3,200 staff, the bulk of the 5,400 headcount reductions in Q113.
 
He insisted that ALU was not quitting the outsourcing business and was looking around for new contracts, though its focus will be more on higher margin professional services deals, often related to network transformations and upgrades, rather than contracts for operating and maintaining established networks. ALU expects to lose deals worth a total of about $523 million, over time, in a unit which generated Q1 revenues of $267 million and an operating loss of $6.5 million.
 
A similar keen eye will now be turned on the larger Networks & Platforms business unit, and most think Combes will be far more willing than his predecessor to take radical decisions and even kill former sacred cows.
 
The optical segment will be under particular scrutiny, and could even be sold off, say some analysts, since it was the weak spot in the first quarter. The revenue breakdown showed the core Networks & Platforms division up by 6% year-on-year with high single-digit growth in IP and “good traction” in wireless and fixed networks, and in the Plat-forms and Services unit. These signs of robustness were partially offset by a double-digit decline in Optics.
 
 
The Focused Businesses units declined at a double-digit rate, said ALU, Enterprise at a mid-single digit rate and Submarine at a faster pace. In geographical terms, Japan was strong and China stable, but Asia-Pacific overall declined at a low single-digit rate. The “rest of the world” segment was down 10%, thanks to weakness in the Middle East/Africa and Central America/Latin America regions, somewhat offset by strong performance in Brazil.
 
ALU is not the only equipment vendor feeling the heat. Ericsson suffered a profit dip in its first quarter, hit by the tendency for its customers, especially in Europe, to opt for lower margin network modernization deals rather than big build-outs; Nokia Siemens, after a couple of turn-around quarters, was lacklustre in Q1; and ZTE only squeezed a first quarter profit because it made an asset sale.
 
The Chinese vendor spoke of “slow growth in investments in equipment by the global telecommunications industry during the reporting period”. It did turn in a profit, after losses in the later quarters of 2012, with net income of 205 million yuan ($33.3 million), up 35.9% year-on-year. However, excluding extraordinary items, particularly the sale of a stake in “surveillance supplier” Shenzhen ZNV Technology, it would have made a loss of 615.5 million yuan, on revenue which fell 2.8% to 18.1 billion yuan. 

 

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