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Telecom Mergers: Is Lucent Next?

Steve Rosenbush Telecom analysts believe that the time may be right for a merger between Lucent Technologies (LU) and another big communications-equipment company. The issue isn't whether Lucent can survive on its own. It seemed perilously close to extinction during the dark days of the tech bust, but it has done a good job getting its financial house in order. Lucent has cut debt, generated a profit, and built up a sizable store of cash over the last three years.

The big question is: What sort of future would it have as an independent player in a rapidly consolidating industry? Lucent has limited growth prospects, and those already are figured into the stock price, according to telecom analysts Brantley Thompson and Christopher Fine of Goldman Sachs. "We would not be adding positions based on limited upside potential," the analysts recently advised investors.

MAKES SENSE. That's why some analysts think Lucent, spun off from AT&T (T) in 1995, might be better off combined with another big player. Telecom analyst Tal Liani of Merrill Lynch issued a report on Feb. 11 analyzing what a combination of Lucent and wireless equipment maker Motorola (MOT) would look like. Liani, who cautioned that he had no information indicating whether talks were under way, said a deal would make lots of sense for Lucent. He said it would have a negative impact on Motorola's financial profile in the short term but would benefit it over the long run.

The market, which has been cheering proposed mergers among Lucent's customers, seemed to like the idea. On Feb. 11, Lucent rose 10 cents, or more than 3%, to $3.38. Motorola shares rose 5 cents, or less than 1%, to $15.93. Lucent declined to discuss the matter, and a Motorola spokesperson declined to comment.

The pressure on telecom-equipment makers to bulk up may be intensifying now because their customers are consolidating. SBC (SBC) has agreed to buy AT&T (T), and Verizon (VZ) has reportedly made an "informal offer" to acquire MCI (MCIP). Those sorts of deals would involve huge cost cuts. Most would be staff, but capital spending would come down as well. That would reduce the already limited growth prospects available to companies like Lucent.

A WIN-WIN? A Lucent-Motorola merger would ultimately put them in better position to face the future. Liani says a combined company, with revenue of $44 billion, would be able to find cost cuts of its own. "While execution is the biggest risk, a simple model shows that a small 200-basis-point operational margin improvement...translates into significant savings, which enables Motorola to pay up to a 30% premium for Lucent's stock over the current market value before the deal turns nonaccretive," Liani wrote. Lucent has a market cap of about $16 billion, which means a merger could be worth up to $20 billion.

The combined company would be able to expand into new markets without adding sales force or industrial capacity. Lucent could move deeper into the wireless market, reducing its reliance on the declining market for traditional wired gear. Motorola could move beyond the wireless handset market with a more effective strategy for building and selling wireless infrastructure.

Could other combinations with Lucent make sense? Possibly, but potential partners like Ericsson (ERICY) and Nokia (NOK) would have trouble paying for the deal. Siemens (SI), which is looking to expand its presence in the U.S., might have an easier time because its telecom-equipment unit is part of a huge conglomerate. Wireless technology giant Qualcomm (QCOM), which has a market cap of $60 billion, also has the financial wherewithal to make a deal work.

For better or worse, the U.S. telecom are in consolidation mode. That means their capital budgets are going to fall, putting pressure on suppliers like Lucent. It's probably just a matter of time before the equipment makers start merging, too. Rosenbush is a senior writer for BusinessWeek Online in New York

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