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Agere: Is a Little Good News Enough?

Agere Systems spent the first year of its life -- since the initial public offering of 42% of its shares last spring -- facing an unfriendly world. An outgrowth of the ailing telecommunications gearmaker Lucent Technologies, Agere watched sales of its optical and electronic components for communications networks and computing slow to a trickle, as customers went on spending diets or out of business. Each quarter brought more bad news, putting into question the idea of an Agere spin-off from Lucent.

Recently, there has been good news for Agere (AGR.A). On May 13, Lucent (LU) announced the long-awaited details of the scheduled June 3 spin-off of its 58% stake in Agere, signaling Lucent's optimism that it can get a decent price for Agere shares. And analysts say sales at Agere, a solid No. 2 in its key markets, seem to have bottomed out: On Apr. 23, it beat the Street's sales estimates for its second quarter, posting -- for the first time in more than a year -- a sequential increase. Sales rose 2.6%, to $551 million, from $537 million in the first quarter.

Granted, that's still only half its year-ago quarterly sales, and the company remains unprofitable. Still, the Street seems to have crowned the Allentown (Pa.) company as the best stock in the beleaguered communications components sector. Twelve of 17 analysts rate the company a buy or strong buy. At a closing price of $3.68 on May 28, it trades at roughly twice projected 2003 sales -- a 40% discount on its peers, says Ping Zhao, an analyst with Sanford Bernstein. The stock could rise 114% within 12 months, to $7.50, according to the mean estimate.

FINANCIAL CHALLENGES. That outlook seems a tad too bullish, considering the liquidity and debt-restructuring challenges Agere faces in the short term. And while some of its chip products are selling like hotcakes, the market for its optical products, accounting for 40% of sales, has yet to bottom. That market is expected to struggle for another year, with prices continuing to decline.

The prices for Agere's parts aren't falling as sharply as those of archrival JDS Uniphase, says Tom Hausken, an analyst with tech consultancy Strategies Unlimited. And its independence from Lucent should provide a sales boost, says Joseph Wolf, an analyst with UBS Warburg. Clients such as gearmakers Cisco Systems and Nortel Networks might increase their orders once Agere is separated from their bitter rival, he says.

Agere's financial problems, though, are daunting. At the end of March, it had $1.1 billion in short-term debt, $960 million of which is a drawn-down credit line. Of that, at least $210 million must be repaid in September for the credit line to be renewed. Agere could use some of its $1.6 billion in cash on hand to reduce the debt and still have money to run for another six quarters, assuming its burn rate stays the same and there are no additional cost cuts or sales declines, estimates Shayna Malnak, an analyst with Williams Capital Group. But that wouldn't solve all of its balance sheet problems.

STOCK ISSUES. To renew its credit line, Agere must raise $500 million in cash by September by issuing debt or equity. On May 21, Agere announced it would issue $220 million in 7- and 12-year notes convertible into common stock. "It will be a relatively easy raise," believes James Jungjohann, an analyst with CIBC World Markets.

Still, the company needs another $280 million. To keep its spin-off tax-free, however, Agere might be prohibited from issuing much more equity in the next two years. The $220 million could potentially be it. Issuing more junk-rated debt in this environment could be tough. Analysts believe Agere's creditors would be willing to restructure the debt, but that's far from certain. Because it is in a quiet period, Agere was unable to comment for this story.

Meanwhile, although completion of the spin-off would be a positive, Agere's stock price will take another hit in the short term, since a number of funds that track the Standard & Poor's 500-stock index will have to sell Agere stock as Lucent spins it off. The reason: Those funds can hold S&P-listed Lucent, but they can't own Agere, which will not be part of the benchmark index, says Jungjohann. Over time, the stock will rebound from this technical selling pressure, but just when that might happen depends on Agere's revenues and its overall financial condition continuing to improve.

ROSY CHIPS. In a troubled industry, things do seem to be looking up for Agere. The company gets 15% of revenues from chips used in wireless local-area networks (LANs), according to UBS Warburg. Sales of such chips are booming. And the global market for wireless LAN chipsets -- several chips combined into one unit -- will grow to 26.1 million in 2003, from 14.3 million in 2002, estimates Allen Nogee, an analyst with tech consultancy Cahners In-Stat. The chipsets are used for high-speed Internet access in corporate offices, for wireless downloads of videos from computers to TVs in the home, and for in-car Internet access.

Computer storage chips, used in PC hard drives, account for 24% of Agere's total sales. That market should nearly double, to $1 billion-plus next year, from $558 million in 2002, according to IDC. And Agere's sales of other components for PCs and the new Apple iMac should ramp up further as the computer market recovers in late 2002.

Another factor in Agere's favor is its technology, which is "right on the edge with anybody," says Hausken. On May 7, Agere came out with a new radio-and-antenna kit for the latest-generation wireless LANs. In June, it should ramp up production of a new chip for wireless LANs -- code-named Ruby -- which, analysts say, is a hit with clients.

CUT TO THE QUICK. Having the hottest technology does not shield a company from criticism, however, especially at a time when most players in the industry are struggling to survive. Agere might want to consider cutting research expenses to between 20% and 25% of revenues, from the current 33%, says Arnab Chanda, an analyst with Lehman Brothers.

Some analysts say Agere also may need to look at selling more noncore businesses or assets, even though it has already undergone a drastic restructuring. And it's no small issue that the future of some of Agere's biggest customers may be in doubt.

When compared with its rivals, though, Agere's light is shining a bit brighter. If it figures out a way to resolve its liquidity problems, it could satisfy investors with high-risk appetites. Kharif writes for BusinessWeek Online from Portland, Ore.

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