By Sam Jaffe When Lucent CEO Richard McGinn announced plans in 2000 to spin off the company's microelectronics division, analysts declared the move a stroke of brilliance. Shareholders would see the stock's price increase from the spin-off while Lucent would earn needed cash.
McGinn may no longer be CEO of Lucent, but his legacy lives on with Agere Systems (AGR.A). In fact, in the long run, Agere might be more valuable to shareholders than the parent company is. Despite brighter prospects for its core business, Agere is as cheap as Lucent -- yet it doesn't have the same specter of doom hanging over it.
Agere's future is optoelectronics, also called photonics -- the lasers, mirrors, and modulators that are the building blocks of optical networks. Although that division now accounts for just about a fourth of Agere's revenue stream, it's growing so fast that by the end of 2002, it could chip in more than one-third of sales. And despite drastic cutbacks in telecom spending plans, optoelectronics is a very hot market -- especially the segment that Agere is involved with, active optoelectronics. By contrast, the cheaper passive optoelectronics made by JDS Uniphase (JDSU) and Nortel Networks (NT) are facing high inventory ratios and low capacity-utilization rates.
LOGJAM BREAKERS. Agere's optoelectronics division is humming along quite nicely. Morgan Stanley analyst Mark Edelstone, who rates the stock a strong buy, expects it to produce sales of $1.7 billion in 2002. Most of the spending by telcos today occurs in metropolitan networks, the regional networks that pose the biggest logjam today in data flow. Agere's active components are especially well-suited for equipment that goes into those metro networks. "[Passive components] are bearing the brunt of the downturn in the photonics industry," Salomon Smith Barney analyst Timothy Anderson wrote in a recent research report. He has a speculative buy rating on Agere. "Unlike JDS Uniphase, Agere Systems is not a strong player in passive optical components," he wrote.
Not everybody is convinced this stock is going to be a winner. One thing holding Agere down is its large integrated-circuit division, which fetches a far lower premium than its optical business. Morgan Stanley's Edelstone expects that in 2002 the integrated-circuit division's revenues will still account for approximately two-thirds of overall sales.
That's not to say this business doesn't have growth potential. Of the five units in the integrated-circuits division, by far the most promising is the wireless LAN unit, which makes a circuit board under the Orinoco name that allows computers to link to a wireless corporate network. The company expects sales of that product to show a double-digit increase in 2002.
BLACK INK IN 2002? Agere should be able to concentrate even more on its promising products, thanks to a major restructuring announced at the end of June. It includes selling and shutting down several factories and having contract manufacturers build more of its products. Less than 4% of Agere's products are now built out-of-house. Morgan Stanley's Edelstone thinks by increasing that percentage, the company would be able to reduce its fixed costs and improve gross margins, which are at 43%. The restructuring also calls for laying off nearly one-third of the company's 18,000 workers by the end of 2001, which should save $500 million this year.
Such moves should allow Agere to return to profitability by 2002, but it won't help its third quarter, which just ended. Analysts expect it to lose $0.08 per share for the quarter, according to FirstCall, compared to earnings of $0.04 cents per share in the same quarter of 2000. Salomon's Anderson expects Agere to earn $0.11 per share for all of 2002, compared to a loss of $.01 per share in fiscal 2001, which ends in September.
Underlying the promise of future profits is Agere's cash cushion, courtesy of its recent initial public offering. That means it could wait out the slowdown in corporate spending on telecom equipment better than its rivals. According to its most recent quarterly report, Agere held nearly $1.5 billion in current assets, more than $800 million of which was in cash and short-term securities. Company executives declined to comment on how they plan to use this cash.
TARRED BY ASSOCIATION. Despite these pluses, Agere is mouth-wateringly cheap. As of the market close on July 9, its stock rested at $6.90 a share, down some 27% from its May 25 52-week high of $9.50 a share. That gives it a price-to-sales ratio of 1.45, or less than one-third that of the Standard & Poor's 500.
In fact, Edelstone compared each Agere business unit to its pure-play competitors on a price-to-sales basis -- Symbol Technologies (SBL) in the wireless LAN arena and JDSU in optoelectronics, for example. Across-the-board, he found each Agere unit was priced at a discount to its peers. The reason is clearly psychological: Agere is still identified with Lucent, even though its business prospects are decidedly different.
Fortunately for Agere, by the end of September, Lucent will have completed the spin-off by releasing to shareholders the 58% of Agere's shares it still owns. When that happens, Agere really will be independent and ready to shake off the Lucent label that's dragging down its shares. If it can do so successfully, now might be the cheapest you'll ever see Agere's stock price. Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column
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