Lucent's High-Wireless Act Looks Shaky

When you're Lucent (LU), you make the most of your small victories.

The whittled-down networking gearmaker put its best foot forward with its second-quarter earnings report Monday. Finally, the long-anticipated spinoff of the money-losing chip business Agere (AGRA) is at hand, which will cut losses and cash needs. With an additional 6,000 Lucent employees leaving the payroll, gross margins are improving too.

Most notably, Lucent noted that second-quarter numbers benefited from a jump in wireless revenue. But investors and analysts say that could actually be bad news because the shift comes just as the biggest wireless players -- Ericsson, Nokia and Motorola -- are all seeing demand sag, laying the groundwork for spending cutbacks. Some industry observers say that even if wireless sales stabilize, Lucent could be hamstrung as the sector endures an inevitable winnowing-out.

"The big risk is consolidation," says CIBC World Markets analyst Steve Kamman. "It would take between six to 12 months for a deal to close, but any announcement would put capital expenditures on ice until the deal is complete."

Lucent shares bucked a sinking trend in telecom Monday, rising 22 cents to $4.51 even as its big customers sold off amid worries about the industry's financial health. Still, the stock remains more than 90% below its boom-era high and below its 1996 IPO price as red ink continues to flow.

High Hopes

Every step forward in Lucent's hexed two-year turnaround journey has been met with yet another challenge. In this instance, the company has based its hopes on the rather flimsy assumption that wireless spending will continue apace even as other sectors endure massive cutbacks.

The company is already feeling the pain of spending cutbacks at the likes of Verizon (VZ) and WorldCom. In its second-quarter earnings release, Lucent declined to offer a specific financial forecast for coming periods, instead returning to the well-trodden sequential bottom-line improvement promise. In service of reaching that goal, the company trimmed its quarterly break-even revenue target to just under $4 billion from $4.25 billion, reflecting sliding costs but also the reality of dropping sales.

Meanwhile, wireless gear sales accounted for 46% of Lucent's fiscal second-quarter revenue, nearly double 2000 and 2001 levels. Lucent's top four customers include Verizon, AT&T Wireless (AWE), Sprint PCS (PCS) and Cingular. While those players too have been trimming their spending plans, they haven't yet pulled the pursestrings tight the way their wireline rivals have.

Worries, Worries

That said, investors and analysts aren't quick to put their faith in wireless phone companies these days. In an eerie echo of what began to happen to the long-distance companies in the late 1990s, subscriber growth is slowing and debt levels are ballooning. Moreover, the sheer number of wireless companies -- as many as six competing in each city -- may soon dwindle through mergers. And industry observers say the big players, such as Lucent's customers, could easily find themselves combining as the industry's economics get even tougher.

Even without a near-term tie-up, the wireless service providers will likely look for ways to manage their cash burn. "They have two options," says New Jersey state employee pension fund manager Bill Trent. "They either reduce their capital spending or they stop the cutthroat pricing."

To be sure, some analysts expect the wireless dollars to keep flowing Lucent's way. Lehman Brothers analyst Steve Levy says Lucent has a stable outlook because it has stable wireless customers that aren't likely to merge soon. "I'm pretty skeptical about consolidation," says Levy, who has a strong buy on Lucent and whose firm has no underwriting ties to Lucent. "It's just not easy to put these companies together."

But investors point out that when the pressure builds, something has to give, and spending usually goes first.

"We saw $3 billion in capital spending cut last week, we'll probably see another $3 billion cut this week," says pension manager Trent, who has a small position in Lucent. "You really can't buy Lucent until you get a recovery among the service providers. And the service providers aren't earning the cost of capital, so they have to quit buying capital."

>To order reprints of this article, click here: Reprints