How Glowing Is Lucent's Future?

It has to face a slowing market--without AT&T's deep pockets

The breakup of AT&T isn't going to be a quiet one. On Mar. 12, the company announced its first concrete step toward separating into three parts: The largest initial public offering in U.S. history. In early April, AT&T will offer 111 million shares of Lucent Technologies Inc., its equipment business, at $22 to $25 each.

If demand for the shares is high, AT&T has the option of selling another 16.65 million shares. The offering will represent just 17% of its equipment business--the rest will be spun off to AT&T shareholders. But with it, AT&T could raise up to $3.19 billion, some $800 million more than Sears Roebuck & Co. made when it spun off Allstate Corp. in June, 1993, the previous IPO record. AT&T plans to use the proceeds to pay down Lucent's debt.

EXCESS BAGGAGE. Analysts expect the shares to be snapped right up. That's largely because Lucent, with $21 billion in 1995 revenues, is the world's largest maker of telephone equipment in a booming telecom market. It has a huge installed base: Some 60% of all U.S. phone lines are connected to an AT&T switch, vs. 30% for the nearest competitor, Northern Telecom Ltd. Phone companies, newly unfettered by deregulation, plan to increase their equipment spending this year by some 14%, to $15.6 billion, estimates Wheat First Butcher Singer Inc.

Still, it could be a struggle for Lucent to remain No.1. It will no longer have AT&T's guaranteed equipment purchases of about $2 billion a year. AT&T has promised to buy at least $3 billion worth of goods from Lucent--but only over the next three years, after which Lucent won't get preferential treatment. Lucent also must go through the wrenching process of cutting 22,000 jobs. And even though it keeps renowned Bell Laboratories, about 25% of the research facility's staff and resources will remain with AT&T. Competitors spy an opportunity. "They may have margin and profitability problems" as they go through the transition, says John A. Roth, Northern Telecom's chief operating officer. "Some products will have to be shelved and businesses jettisoned."

Granted, Lucent has formidable advantages. It starts life with $19.7 billion in assets, including $448 million in cash. Also, with its connection to long-distance giant AT&T severed, it has brighter prospects for selling equipment to local phone companies. And it signed on a strong outsider as chairman--Henry B. Schacht, ex-CEO of Cummins Engine Co. and an AT&T board member. Richard A. McGinn, who ran the business since 1994, stays on as president.

The major difficulty: Demand for big, public-network phone switches in the U.S., a market Lucent dominates, is slowing as local carriers complete their decade-long upgrade to digital equipment. Market researcher Northern Business Information estimates that annual U.S. sales of public phone switches will drop from $6.68 billion in 1994 to $5.19 billion by 1999. The shortfall may be made up by booming sales of other equipment, particularly for wireless and broadband networks, but those products carry lower profit margins.

HOMEBODY. Demand remains strong overseas, but Lucent isn't much of a player. Just 25% of its business comes from outside the U.S., far less than its major international rivals. In addition, Lucent can no longer count on customer loyalty. Phone companies now often build escape clauses into their multibillion-dollar contracts. And customers aren't willing to absorb the costs, or risks, of new technology. As AT&T notes in its February registration for Lucent's IPO, "increasingly, as a result of the financial demands of major network deployments, network operators are looking to their suppliers to arrange for financing."

Still, Lucent knows how to play the finance card. In one recent deal, Sprint Corp. and its cable-TV partners asked suppliers to finance both the goods and services for a $3.6 billion nationwide wireless switching project and pay as much as 35% in damages if the system accidentally shuts down. Lucent appears to have won 60% of the contract after Motorola Inc. dropped out (Northern Telecom got the other 40%), although the parties are still haggling over details.

Lucent believes it will be even easier to show that kind of flexibility once it is independent. McGinn is gleeful at winning freedom from a communications division that was often the main competitor of his biggest customers. "All of our customers see this as a very strong positive," McGinn says. Perhaps. But it comes at the price of going it alone in a treacherous market.

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