Information Technology: Communications
Can Rich McGinn Revive Lucent?
Innovative rivals and angry investors have the market leader on its heels
The bright light of an early June afternoon is flooding into the glass-walled office of Richard A. McGinn, matching the sunny mood of Lucent Technologies Inc.'s chief executive. Never mind that his company's stock is down 21% for the year. Forget that the telecom equipment giant stunned investors back in January, when it said it would miss revenue targets for the quarter--lopping $23 billion off the company's market cap in a single day. Ever the optimist, McGinn has no doubt that Lucent will bounce back. "I think that what you have is a normal reaction to a miss in a quarter," he says. "Nokia had a miss a couple of years ago and has come back strong. Nortel had a down period a couple of years ago."
Clearly, Lucent has made progress since its January surprise. The optical business, which makes gear for speeding up voice and data traffic, accounted for much of the trouble early this year. Since then, Lucent has received $3 billion in orders for its latest optical product. Lucent bolstered its position in the fast-growing market by agreeing to pay $4.5 billion for Chromatis Networks, a leading maker of optical gear for local telephone networks. Meanwhile, McGinn is undertaking a dramatic restructuring of the company in an effort to keep revenues rising at 20% or more a year. Already, he has unveiled plans to spin off the slow-growing unit that makes telecom equipment for corporate offices, an $8 billion business.
And McGinn's revamp isn't over. Business Week has learned that Lucent is finalizing plans to spin off its $3 billion Microelectronics business, which makes the semiconductors and other components used in communications gear. An announcement is likely to come in the next few weeks, people close to the company say. McGinn figures that the move will give Lucent's stock a boost because investors are enthusiastic about chip stocks these days. The unit could command a market cap of $30 billion to $40 billion, analysts say. What's more, McGinn thinks the spin-off will let Lucent focus all its energy and money on the communications business--instead of the capital-intensive chips market.
Even after his recent moves, McGinn has much work to do before Lucent is back on track. The problems at the company are deeper than most outsiders realize. The company has long dominated the business of selling communications equipment to big phone companies, such as former parent AT&T and Bell Atlantic Corp. But as new technologies are emerging to carry voice and Internet traffic, Lucent is trailing more agile rivals, especially Nortel Networks Corp. and Cisco Systems Inc. "Lucent has an amazing brand and penetration, but on the product side they appear to be directionless across the board," says analyst Paul Johnson of Robertson Stephens. "It's just sort of shocking."
Quite a comedown for a company that traces its legacy to Alexander Graham Bell. Lucent's biggest problem is that it has virtually no presence in the market for Internet routers, the Next Big Thing in telecom equipment. The market for these boxes--which direct traffic on the Net--is expected to explode over the next few years as phone companies increasingly send voice calls over the Net along with data. Phone company spending on the routers is projected to surge from $1.7 billion now to $12 billion in 2003, according to investment bank CIBC World Markets. Lucent does not have a competitive product, and analysts give it little hope of gaining ground. CIBC analyst Martin Pyykkonen expects that Cisco and upstart Juniper Networks Inc., the two largest players in Net routers, will dominate the market for some time."A DISASTER." The reason for the pessimism is that Lucent's biggest bet so far to get into the Net market has been a loser. Last year, it spent $900 million for Nexabit Networks, a startup with what was supposed to be a cutting-edge Internet router. But the deal has been "a disaster," says Johnson. The Nexabit product just made it to market this month, a couple months later than analysts expected. It has only one customer so far, a Dallas-based startup called vCities. And the former president of Nexabit, Mukesh Chatter, recently left Lucent to join a startup. McGinn says it's much too early to count Lucent out in the Net-router market. He points out that several phone companies are testing Lucent's products and that he has an advantage over Cisco and Juniper because Lucent has a more complete line of communications products.
The Net-router market isn't the only place Lucent is struggling. Another fast-growing slice of the communications industry is optical equipment, which carries voice and data traffic on glass instead of the traditional copper wire. The optical market is projected to grow 46%, to $23.6 billion, this year, according to Robertson Stephens. Nortel, which had a 35% share of the market in 1999, is expected to boost its share to 45% this year and 50% in 2001. Meantime, Lucent's share is expected to be stagnant, at about 25%. "Nortel is absolutely No. 1 in optical," says Johnson. "They continue to gain share against everyone."
Even McGinn's spin-offs are raising eyebrows. Some analysts suspect that the CEO is trying some financial engineering to please Wall Street--although Lucent's ability to compete may be hurt in the long run. Consider the corporate office-equipment business. Although jettisoning the slow-growing business will make Lucent's revenue growth look higher, it will eliminate one way in which Lucent stays in touch with corporate customers.
The spin-off of the semiconductor business also has potentially damaging side effects. Separating the unit from the mother ship may decrease the cooperation between the two businesses, says Pyykkonen. For example, engineers at Lucent may have a harder time getting employees at the chip business to work around the clock to crank out a new semiconductor that would help run communications gear. Other communications companies, such as Motorola Inc., have reaped big benefits from having an in-house chip facility.FORMIDABLE. Despite its recent troubles, McGinn argues that Lucent will remain a formidable competitor. It is, after all, the largest company in the $200 billion communications-equipment industry, with sales last year of $43 billion. And while rivals such as Cisco and Ericsson argue that the communications world will revolve around their particular specialities, Lucent is developing the broadest line-up of products and specializes in getting all the technologies working together. "People try to make it so simple and, in fact, it's never quite so simple," he says. He vows that Lucent will continue to dominate its market. "We will be the leader," he says. "We are regaining momentum."
Indeed, in the fast-growing wireless market, Lucent has demonstrated that it can develop cutting-edge technology. It holds 22% of the $21 billion wireless infrastructure market, second only to Ericsson's 28%. What's more, Lucent is the leading supplier of data-networking products for phone companies because it sells a lot of older, pre-Internet technologies. Analysts think the company will continue to have a strong position in these older product lines, although they are becoming less important with the booming popularity of the Net.
McGinn has a lot to prove to his investors. Lucent's revenue growth is expected to be between 17% and 20% this year. Not bad--except that Nortel is increasing revenues 34% and Cisco Systems is growing 53%. Lucent argues that comparisons are unfair because its revenues are much larger than its rivals. But analysts don't care. "No one is going to get too excited about growth in the high teens--not in the communications-equipment business," says analyst David Toung of Argus Research Corp. Lucent will have a tough time catching its rivals: It still derives about 12% of its revenue from sales of traditional telecom switches, a unit growing 5% a year.
Can Lucent fully regain its stride? Analysts think McGinn has a chance. "It is still a very good company," says Steven D. Levy of Lehman Brothers Inc. "All of these problems are fixable." Now McGinn needs to fix them quickly to get investors to share his optimism.By Steve Rosenbush in Murray Hill, N.J.Return to top