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From Bad to Worse at Alcatel-Lucent

Citing weakness in its wireless network business, the French company issues its third profit warning of the year

The news from Alcatel-Lucent just keeps getting worse. Shares in the Paris telecom equipment maker slid as much as 14% in Paris trading on Sept. 13 after the company issued its third profit warning of the year. By midday, Alcatel-Lucent was off more than 8% in New York.

Blaming weakness in its wireless network business, Alcatel-Lucent (ALU) is now forecasting third-quarter operating profit "around breakeven," and full-year revenues "flat or slightly up." Since sealing its transatlantic merger (BusinessWeek, 4/3/06) less than a year ago, the company has shed more than 40% of its market capitalization.

Five years after the telecom crash, Alcatel and Lucent had looked to be back on track in 2006, with combined sales of €18.25 billion ($25.3 billion at current rates) and €522 million ($724 million) in net earnings. Now, analyst Richard Windsor of Nomura Securities in London predicts the company will show a net loss of €1.18 billion ($1.6 billion) this year on a 3.2% decline in revenues, to €17.67 billion ($24.49 billion). By comparison, market watcher Infonetics Research forecasts that the global market for telecommunications equipment will grow 4% in 2007, to $225 billion.

Wireless Business in Jeopardy

The numbers are so alarming that some industry watchers now say Alcatel-Lucent will soon have to jettison most of its wireless business. Its big North American mobile customers, Sprint (S) and Verizon Wireless (VZ), have slowed their equipment spending. In other parts of the world, where GSM mobile technology predominates, rivals are relentlessly stealing market share. "It's only a matter of time before they throw in the towel," says Per Lindberg, a London analyst with Dresdner Kleinwort.

Alcatel Lucent's fixed-line and broadband businesses are doing fine, with expected growth of 6% this year, and the company remains by far the world leader in supplying DSL (digital subscriber line) broadband equipment to carriers. But Nomura estimates that Alcatel-Lucent's GSM and third-generation mobile-networks unit is hemorrhaging $1.1 billion a year. The drain is so bad that losses from wireless will wipe out nearly all of the company's operating profits this year—leaving Alcatel Lucent with operating margins of just 0.2% of revenues, Windsor says.

Weaknesses in Wireless

Patricia Russo, chief executive of Alcatel-Lucent, has embarked on a cost-cutting plan to save $2.5 billion over the next three years. Only a day before the profit warning, the company concluded negotiations with French unions to cut more than 1,400 jobs. But cost-cutting won't remedy the worsening problem of its wireless business, whose troubles first emerged earlier this year (BusinessWeek, 1/23/07).

Alcatel-Lucent has two big weaknesses in wireless. Its North American business, largely inherited from Lucent, is based on a wireless technology called CDMA that is gradually being phased out of the market in favor of newer-generation versions where Alcatel-Lucent isn't as strong. Elsewhere, its GSM business is getting clobbered—notably by Sweden's Ericsson (ERIC), which now controls 45% of the global GSM market.

While Alcatel's stock swoons, Ericsson's has held flat this year. "We have gained back size advantage that we had before consolidation," Ericsson CEO Carl-Henrik Svanberg told BusinessWeek during a conference with investors in London on Sept. 11.

Russo's Future in Question

Ericsson's global scale means it can pour more money into R&D to improve products. The result: "Ericsson is technologically superior," says Nomura's Windsor, who predicts the Swedish company's revenues will grow 6.6% to this year, to $28.76 billion. Because of its size, Windsor adds, Ericsson "can screw Alcatel-Lucent into the floor on pricing and still make a profit."

The misery at Alcatel-Lucent also raises questions about the future of Russo, the former Lucent CEO who now runs the merged company, while ex-Alcatel boss Serge Tchuruk serves as non-executive chairman. "The financial performance has been absolutely dreadful," Windsor says. "Investors clearly attribute some blame for that to her stewardship of the company."

Matlack is BusinessWeek's Paris bureau chief.

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