Mixed Quarter but the Nokia Deal is On Track… Where’s the Cost Savings?
Key Takeaway
- The Q1 results included a modestly higher-than-expected top line with
operating profitability that met expectations. We came away from the earnings
call feeling less confident about their ability to hit the full €950M Fixed Costs
savings target. Barring any surprises, we expect the Nokia transaction to move
forward. Our rating remains Hold.
- Nokia Deal Still on Track... CEO Michel Combes got asked numerous questions on the
pending deal. Management teams of both companies have stated that the deal will not be
affected by one poor quarter of results from Nokia. The Nokia transaction remains on track
to close in 1H’16.
- Negative Q1 Fixed Cost Savings? We’re Having Flashbacks to Prior
Restructurings... In Q1, the organization did not capture any Fixed Cost savings that
accrued to the bottom line. The company stated that all savings were reinvested back into
the business (R&D + Sales & Marketing). While they reaffirmed the €950 million expected
for Shift Plan savings by year-end 2015, it seems the Fixed Cost savings are getting harder
and harder to generate. Net savings have declined each of the past 3 quarters. The situation
reminds us of the company’s six prior restructurings (pre-Shift Plan) where they missed their
targets as savings were plowed back into the business. In total, we believe the industry may
simply be too competitive for Alcatel-Lucent to deliver on their cost savings targets and run
the business at high-single digit operating margins over sustained time periods.
- The Cash Performance Was Much Worse than Advertised… Per the headline figure
from the company --Net Cash at Q1-end was €262M, down versus €326M at Q4-end. On
the Balance Sheet however, Current Liabilities increased roughly €500M Q/Q after running
at very consistent levels (€1.2 to €1.4 billion) over the past 3 years. That certainly helped
cash look much better. The additional Q/Q increase in Receivables factoring also helped cash
balances.
- Tweaking Estimates… For 2016, our revenue and EPS projections move from €14.299
billion and €0.20 to €14.384 billion and €0.16. We continue to rate the shares a Hold and
expect the business to trade in-line with Nokia given the all-stock terms of the deal.
- Valuation/Risks
Risks: 1) Balance Sheet / Cash Burn; 2) management execution against the Shift Plan; and 3)
lumpiness in spending trends among the major North American service providers. Our new
Price Target is €3.50, which equates to the current consideration Alcatel-Lucent shareholders
will receive on the deal.