Trouble ahead for AlcaLu‾

Another quarter, another profit warning. Alcatel-Lucent's announcement is a continuation of the trends seen over the last two quarters and has worried already nervous investors, as evidenced by the 9% drop in the share price that followed. It will undoubtedly increase the pressure on CEO Pat Russo.

Neither Ericsson nor Nokia Siemens Networks shares were markedly affected by last Thursday's disclosure, so this appears to be an Alcatel-Lucent phenomenon. So what is Alcatel-Lucent doing wrong‾

The announcement laid the blame on "a change in capital spending" among North American mobile operators, the former Lucent's stronghold. Revenues in the wireless business group of the carrier segment have been declining since the merger and laying the blame here shows that they have not been able to turn things around quickly.

Unfortunately for Alcatel-Lucent, our forecasts predict that capex among North American mobile operators will fall by 1% between 2007 and 2012. Therefore, reduced customer spending is unlikely to turnaround quickly and Alcatel-Lucent must be proactive in its response.

The statement did confirm that the forecast cost savings for the year are on target. Therefore, as we saw in the Q2 results, the merger is succeeding in cutting costs, but is not yet generating new revenue. However, Alcatel-Lucent conceded that the margins provided by the savings will be eroded by price pressure. The gathering clouds are too dark for a silver lining at the moment.

Financial instability is not something customers look for in a supplier, so the longer Alcatel-Lucent struggles the harder it will become for them to sell. To avoid being sucked into this vicious circle the focus must now be on sales growth, but how‾

It won't be a surprise to see changes at Alcatel-Lucent over the coming months in several areas. An injection of fresh ideas, energy and morale is needed in the management team at all levels. Alcatel-Lucent will hope that the senior management shuffle in August will help, but it may not be enough. Also, asset disposals may also be an (albeit short-term) option to boost cash. Finally, refreshing the product portfolio offers longer-term hope, but will not be a quick fix.

It is still too early to say that the merger has failed completely. However, pressure to deliver on the promises made before the merger is mounting and tough decisions await Alcatel-Lucent over the coming months.

Steven Hartley is a Senior Analyst focused on analysing the telecoms market for our EuroView service.

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