Lucent's Woes 'Not a Market Issue'

SAN FRANCISCO -- Lucent's (LU Quote) ailments may have stunned Wall Street, but few expect a sectorwide contagion.

"This is not a market issue," CEO Richard McGinn told analysts in a somber, candid conference call with analysts late Thursday, during which he used the word "disappointment" repeatedly. "This is us not executing against a plan."

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Skeptical pros have criticized Lucent for using accounting maneuvers to look like a fast-growing company. For at least two quarters last year, the company posted negative cash flow, thanks to soaring receivables and inventories. A strong performance in the September quarter temporarily allayed concerns about its organic growth. But Thursday's announcement rekindled concerns that Lucent needs to adjust to telephone carriers' demands for new network technologies.

"It took a few quarters to show, but I think they have run out of places to hide," says Truc Do, an equity analyst with SoundView Technology Group, who has rated the stock a hold for about a year and whose firm has no banking ties to Lucent. "They have to come clean with their guidance. Their business is shifting, and they need to react to it."

Analysts were caught off guard by the news, and no one more so than Steve Levy, an equity analyst with Lehman Brothers. Levy raised his price target for Lucent to 95 from 90 early Thursday. Levy, whose firm hasn't performed underwriting for Lucent, rates the stock a buy.

Investors were also sideswiped by the news. J. Michael Gallipo bought Lucent shares for his Monument Telecommunications fund shortly before the company warned late Thursday. While stunned at the news, he does not anticipate a broader problem for the sector. "I certainly have heard nothing from the carriers that they are going to bring down spending," Gallipo says.

We Make the Things That Make Your Fund Go Down Mutual funds with the biggest bets on Lucent Technology
Fund	% assets in Lucent
Ameritor Investment	29.8%
Ameritor Industry	12.7
Rydex Telecommunications	10.6
Rydex Technology	7.6
Ameritor Security Trust	6.9
RSI Retirement Core Equity	6.5
American Growth	5.9
White Oak Growth Stock	5.7
Turner Large Cap Growth	5.7
Marsico Focus	5.6
Weightings may have changed since holdings were reported. Source: Morningstar.

From what Lucent told investors Thursday, the company's problems are largely its own creation. Phone carriers have shifted their spending toward new technologies, and Lucent concedes that it couldn't manufacture the right new products fast enough. "We gave our customers who had a need to meet capacity requirements a reason to go elsewhere."

As a result, "traditional customers have been shifting away from Lucent," says Do. "AT&T (T Quote) stopped buying tandem switches from Lucent and started buying switches from Nortel (NT Quote)," he says. Nortel has become a leader in new optical offerings as well, Do says.

Nortel hasn't changed its guidance for the quarter ended in December. A First Call/Thomson Financial survey of analyst estimates predicts Nortel will earn 42 cents per share. But the stock was also down 14% at 77 in extended trading Thursday, having closed market trading at 85. Late Thursday, both Cisco and Nortel said they were comfortable with current estimates for the quarter.

What does Lucent have to do to win back investor confidence? For starters, says Do, it must reignite revenue with new wireless and optical-network offerings. Companies such as Cisco (CSCO Quote) and Ciena (CIEN Quote) now sell advanced optical products.

"It really starts to do away with the need to buy more" of Lucent's conventional fiber-optic systems, says Andy Kessler, partner with Velocity Capital and contributor to TSC. Currently his fund is not invested in Lucent, Cisco or Ciena.

Until then, it could be rough going. "I have a fear that [Lucent is] going to be swimming upstream," says Kessler.