What is going on with Alcatel-Lucent?

Alcatel-Lucent reported earnings on Friday. It was its first full quarter since it completed the merger and results were somehow disappointing. Company is still struggling itself after the recent trans-Atlantic merger and that continues to cause big troubles. Further, slump in wireless revenue, which fell 15% to €1.2 billion ($1.62 billion) from a year earlier, is creating new headaches as they now face a new threat to its business. So far, problems are coming from more competition in emerging markets such as India, Russia and Africa as well as rival Swedish firm Telefon AB L.M. Ericsson, which is very strong in wireless equipment and GSM technology.

So, let’s focus on the wireless sector for a moment. Alcatel-Lucent launched a new base station during the first quarter, which seemed to cause some orders decline in anticipation of the new product. Also, the company walked away from several bidding processes for wireless-equipment contracts due to competitive pricing pressures, in particular in Latino America. No customers or specific projects were mentioned and not much detail was given either. I find really hard to believe that one single region of the Emerging Markets world has caused such an impact on the wireless business, especially when the company never really focused on that region.

I’d like to also comment on some of the reasons why the two telecom-equipment makers first merged. In theory, they announced the merger as response to increasingly competition in the telecom-equipment business, especially from low-cost manufacturers in China. The combined company would deliver €1.4 billion in annual cost savings by 2009, by cutting 9,000 jobs, merging research and development, and trimming redundant products from its portfolio. It looks like Alcatel-Lucent is still on track to deliver the expected €600 million in synergies in 2007. Layoffs, which will account for about half of the cost savings, have already begun at U.S., Asian and European offices. However, there is a lot of room for improvement and progress seems to be very slow. It will be interesting to keep track of this part of the story.

Bottom line, I still can’t figure out what’s going on with Alcatel-Lucent. Company continues to struggle and I don’t really see an understandable path for recovery. I still remember two or three ago when I thought they were in the best position to beat Cisco. Clearly, it hasn’t materialized and in fact, I think they have already missed the train.

Cisco Fiscal Third Quarter Earnings Results

As stated when I started this blog about a month and half ago, it is not my intention to discuss financial results directly related Cisco Systems, Inc. However, since Cisco is a key player in the Telecommunications and Data Networking industry, I can’t let this news go by easy.

First, Q3 marked the one year anniversary of the acquisition of Scientific Atlanta. Going forward Cisco will provide guidance and comparison simply to year over year combined numbers. The company achieved record revenue of approximately $8.9B, a 21% year over year increase, slightly above guidance of 19-20% provided in the Q2 conference call. Cisco standalone revenue increase was approximately 17% year over year. This continues to be one of the fastest standalone year over year revenue growth rate the company has seen in several years. Order growth continued to be very solid with product book to bill of greater than 1. Non-GAAP net income was $2.1B, an increase year over year of approximately 16%. Non-GAAP earnings per share were a record $0.34 and GAAP earnings per share were $0.30, which were increases of 17% and 36% respectively year over year. Cash generated from operations was $2.4B, and Cisco repurchased $1.5B of common stock. Cash, cash equivalents, and investments were at $22.3B at the end of the quarter.

John Chamber’s comments:“Q3 was a very strong quarter. Our vision of how the industry was going to evolve appears to be playing out very much as we expected. We believe our differentiated strategy is also achieving the benefits to both Cisco and our customers that we thought were possible. We have a high degree of confidence in our strategy and business momentum. In addition, I would not underestimate the potential that collaboration enabled by Web 2.0 technologies could have on Cisco’s and the entire IT / Communications industry’s growth over the next five to ten years. I believe the next wave driving growth of both the Internet and IT sales will be built around collaboration and Web 2.0 capabilities. “

“We believe that Cisco is uniquely positioned. We are not aware of any other company in the IT and communication industry that is even close to these types of growth numbers and market share gains across such a broad array of products. From our customer segments to geographic theaters and product and technology markets, we are focusing on approximately 20 areas. It is extremely unusual to overachieve on almost all of our focus areas as we did in Q1 and Q2. Even in very strong quarters, such as this one, we would expect at least 1-2 of our focus areas to be in the low to mid single digit range or even negative.”

Some comments from equity analysts:

SCOTT MORITZ - THE STREET
Shares sank 6% early Wednesday despite a strong earnings report and enthusiastic talk from CEO John Chambers. In a conference call after the close Tuesday with analysts and investors, Chambers said the company's gains at the expense of smaller rivals allowed it to boost fourth-quarter revenue guidance. Cisco now expects year-over-year revenue growth of "15% to 16%" for the quarter, Chambers said, "above the high end of the guidance we have given." But that wasn't enough for some observers. Asked when the company would feel confident enough about the outlook to raise guidance to the 15% to 20% annual growth range, Chambers declined to fuel a more bullish case. "Growth in the midteens is good for a company of this size," Chambers said. "I'm going to resist the nudges at this point."

MERRILL
First, operating margins declined again this quarter, suggesting no material margin upside exists. Second, the strong trends are already reflected in the expectations. The EPS beat was a function of buybacks and not from positive business surprises. Third, Cisco beat revenues by ~$116mn, yet Scientific Atlanta grew $113mn sequentially. While this is not an apples to apples comparison, it is difficult to quantify how much of the trend is related to an abnormal and temporary boost in demand for set-top boxes and how much of it represents sustainable upside. How many large cap tech stocks grow 16% per annum and maintain high profitability? Very few. We are convinced that in the long run, Cisco will continue to generate value for shareholders. However, in the near term, we expect the stock to remain range bound, as in our view, Cisco is at the peak of its current cycle with risk of some momentum moderation post-4Q. Secondly, similar to this quarter, we believe it will be difficult to generate earnings surprises as the Street’s expectations already reflect the current business momentum.

Microsoft and Yahoo Chapter III

Today I’d like to spend some time discussing last week’s talks between Microsoft and Yahoo about a possible merger. Even tough it appears that merger discussions are no longer taking place; it doesn’t mean the two companies couldn’t cooperate in other ways. In fact, this is the third time both companies discussed a potential mega merger. So let’s analyze benefits and consequences from both sides.

For starters, it’s becoming pretty obvious that Microsoft’s online division has not lived up with Steve Ballmer’s expectations. There has been no progress against Google in Internet search. Further, Microsoft lost a deal to Google last month to buy online-advertising specialist DoubleClick. So it is time to consider other alternatives. One option would be to install new management to the online group, a fix that Microsoft has often used in the past. Also, Microsoft could unify the online group's services and the technology that underlies them, which are currently managed by different vice presidents. By having two groups working closer, they could compete against Google more effectively. Another option for Microsoft is to form a partnership with Yahoo as they have done in the past with questionable success. Yahoo previously provided Microsoft with search technology and advertising. However, Microsoft broke that relationship last year, as it phased in its own online-ad system, which has yet to attract a critical mass of advertisers. Bottom line, nothing really interesting from this side.

Yahoo doesn't appear interested in a major deal with Microsoft, specially these days that they have been working and depending largely on a new advertising-system upgrade, called "Project Panama”. Panama is now running and it seems that the system will contribute to company revenue, starting this quarter. Besides, Yahoo’s executives believe they have found the right strategy and are wary of any combination with Microsoft, for whom Internet activities remain only a small part of its business. On the other hand, Yahoo could benefit from some technical expertise coming from Microsoft as they could manage the technical platform and infrastructure of the companies' combined Internet activities. In addition, Yahoo's current staff could be in charge of the consumer parts of the businesses, such as Yahoo News, Finance and email. So, there might be some benefits for Yahoo.

At this point, any integration of the two companies' operations would also be a daunting prospect and it doesn’t seem doable in the short term. However, it’s clear that Google’s dominance in Internet search really worries both Microsoft and Yahoo and certainly the former has lots of power to try to turn things around. Only time will tell how this story unfolds, but definitely let’s wait for the next chapter.

Why Cablevision going private may sound right

Let’s get the facts straight first because this deal about taking Cablevision private has lots of interesting aspects. Cablevision Systems Corp.'s founding family has convinced the cable company's board to accept its $10.6 billion privatization offer, but first has to convince a majority of the non-family investors that their latest offer of $36.26 a share fairly values the company. Some investors already are saying they plan to vote against the deal. Of course, the valuation dispute comes at a time when Wall Street is becoming increasingly bullish on cable companies, which have been pulling ahead of competitors by selling bundles of phone, TV and high speed Internet services.

Now, let’s try to see the strategy behind the deal. Why the Dolan’s family would put $2Billion of their own money and raise more than $8Billion in debt to buyout their own company? There has to be a compelling reason and undoubtedly there is one. From a financial perspective the answer is free cash flow. Even though cable providers face new competition as phone companies roll out TV services and video migrates to the Internet, much of the heavy investment of the past decade, used to launch networks with new products such as high-speed Internet hookups, is coming to an end.

In the past, investors wanted operators to generate cash flow that could be used to buy back shares or pay dividends. But now, the decline in its capital spending has turned Cablevision into a cash-generating machine capable of throwing off hundreds of millions of dollars a year. Cablevision’s network is way ahead of Comcast and Time Warner Inc and is already prepared to offer all its customers a bundled package of services, including digital TV, phone and high-speed Internet. That means they will start generating free cash flow long before their competitors and that is what investors, both public and private, want to see. But that ability to generate huge amounts of cash will also make them desirable targets unless their stock prices become really expensive. We’ve already seen some examples, such the other two big cable companies, Cox Communications Inc. and Insight Communications, which recently have gone private following the same rationale.

Of course, there is the flip side of the coin. Even though Cablevision is very well positioned moving into the coming years, it is also one of the most vulnerable to increased competition. However, this potential lost revenue should not affect Cablevision as savings from reduced capital expenses would be really important. On the other hand, there is no certainty that cable networks and their infrastructure will remain updated for ever. In reality, it is the opposite. With the amount of development and evolution that Video on demand and IPTV will generate, cable operators would have to continue to heavily invest in capital expenditures, but that is another round of discussions. More to come on this for sure.