Lucent's Ascent

Will it be the phone-gear colossus for the Internet era?

Whether it's bushels of rabbits' feet or just good management, Lucent Technologies Inc. has led a charmed life. Since it was spun off from AT&T in 1996, it has been on a dizzying three-year streak, acting more like a Silicon Valley startup than a 123-year-old maker of phone equipment. Since Lucent went public, its shares soared from 13 1/2 to a high of 120 on Jan. 8. Meanwhile, the Standard & Poor's 500-stock index hasn't even doubled. Last year alone, Lucent nearly tripled shareholders' money, compared with a 29% return for the S&P 500. Says Mark Herskovitz, co-manager of the Dreyfus Technology Growth Fund, one of Lucent's largest shareholders: "The stock has been just a monster."

Until lately, that is. On Jan. 21, Lucent Chairman and CEO Richard A. McGinn reported that revenues for the first fiscal quarter had fallen well short of what Wall Street had forecast--even though profits were better than expected. Instead of $10 billion in sales, Lucent chalked up $9.2 billion. The news fueled worries that phone companies have begun to buy less gear from Lucent and others. Lucent's stock took a drubbing that day, down 7%, to 106.94, although it came back to close at 110 on Jan. 26.

And McGinn? Despite the revenue shortfall, he's feeling luckier than ever. He dismisses the notion that overall spending on telecom gear is slowing. Oh sure, big guys such as MCI WorldCom, Bell Atlantic, and BellSouth are paring back their capital expenditures. But purchases by telecom upstarts that are building whizzy Internet-like networks will make up the difference, he says. And thanks to Lucent's Jan. 13 deal to buy Ascend Communications Inc. for $20 billion, McGinn thinks his company now has the cutting-edge technologies to land those new contracts. "We intend to lead the networking revolution," he says. "With Ascend, we will become the clear leader."

AMBITIOUS. Indeed, Ascend is crucial to McGinn's plan of transforming Lucent from the musty old maker of plain-vanilla phone gear into a colossus supplying the communications gear for the Internet era. He's so certain that Lucent is on the fast track that he vows the company's revenues, not counting Ascend, will hit $36 billion this year, up from $30.1 billion in 1998--an ambitious 20% increase.

To put that in perspective, consider this: No other $30 billion company is growing 20% or more a year, according to S&P. To be sure, Silicon Valley archrival Cisco Systems Inc., the leading maker of this new digital networking gear, has been growing at a 35% clip--but Cisco is less than one-third Lucent's size. For McGinn to deliver on his pledge, Lucent must win $6 billion in new business this year, while Cisco needs to add just half that to keep up its torrid pace.

Can McGinn do it? Despite his assurances, slowing demand for communications gear may trip him up. Several analysts insist that spending on telecom gear will drop from 15% growth in 1998 to just 5% this year. "Even Lucent's management can't really know [what spending will be]," says Jeffrey Heil, director of equity investments for the Regents of the University of California, a top Lucent shareholder. In the longer term, though, the Lucent-Ascend combo is a powerful one that could make the equipment supplier a leader in next-generation networks.

There's little doubt that the feisty 52-year-old McGinn revels in such challenges. His idea of relaxation is going head-to-head with friends in their own version of "Ironman" races--competing in swimming, billiards, golf, and basketball, all in one day. Once, rather than lose a fish he had hooked, he swam around a pier to untangle his line.

At Lucent, he's just as relentless. Since stepping up to the CEO post 15 months ago, McGinn has turned around what was widely considered a fading technology power by persuading employees to set aside their internal differences and focus on beating the pants off rivals such as Cisco and Canada's Northern Telecom Ltd. He pushes his staff to set sky-high goals for themselves--and then do whatever is necessary to accomplish them. The result: Lucent's sales are climbing twice as fast as before it became independent.

But this year, McGinn may find his Ironman ways are put to the test. The telecom industry is entering a time of wrenching change, as old phone systems give way to digital gear that will be the underpinning of tomorrow's global communications. The rise of the Internet is at the heart of this profound change. Its explosive traffic, combined with the oodles of data that corporations are zapping between offices, demands speedy networks that can chop up information into bite-size digital pieces that wing their way fast.

"IN OUR FAVOR." What's more, this new equipment is so efficient that it may eventually carry both data and voice traffic. Most phone companies already are testing the gear for voice service--and a handful are offering it commercially. That has made data-networking equipment a $45 billion market today--just 10% of the total communications-equipment market--but it's growing twice as fast as sales of standard equipment. So far, that has been a boon to Cisco, which dominates the U.S. market with a 55% share, vs. Lucent's piddling 2%, according to BancBoston Robertson Stephens analyst Paul Johnson. "I think the odds of Cisco leading the market are in our favor," says John T. Chambers, Cisco's CEO.

Not anymore, argues McGinn. With Ascend, McGinn believes Lucent has bought its way into the new digital future. Under CEO Mory Ejabat, the Alameda, Calif., company has developed products that are good enough to compete with Cisco's. When you combine Ascend's technology with Lucent's strong relationships with phone companies and its reputation for reliability, McGinn thinks he has the industry's odds-on front-runner. Others agree. "Of all the companies out there, Lucent is the one that's closest to the Holy Grail of offering customers a complete solution," says Mukesh Chatter, founder and CEO of Nexabit Networks Inc., a Marlborough (Mass.) startup.

The data market is so crucial to Lucent and its rivals that it reduces normally civil execs to snarling rivals. At a retreat for its top 60 executives last year outside Tucson, Lucent put up "Wanted" posters with the faces of Cisco's Chambers, Nortel CEO John A. Roth, and other executives from equipment makers. Chambers was not amused: "McGinn made it personal," he says. "It sent a bad message to his employees."

SHORT END? McGinn and Nortel's Roth are just as quick to sling barbs. McGinn ridicules Roth for saying that Nortel was buying Bay Networks Inc. to help sell new digital equipment to phone companies--and then backpedaling to say that Bay would instead sell to corporations, its traditional customer base. "At least, you should get your message consistent," he snaps. As for Roth, he criticizes McGinn's purchase of Ascend as buying the wrong digital technology at a sky-high price. "Twenty billion later, Lucent still needs to go shopping," he says.

Indeed, technologically, McGinn may yet find himself on the short end of the stick. What Lucent is buying in Ascend is the top maker of phone switches that use a technology called asynchronous transfer mode (ATM). This is the first generation of the technology that most phone companies are using to carry both voice and data traffic. But over time, carriers are itching to move beyond ATM to a technology called Internet protocol (IP). Just like it sounds, this is what's used on the Net. Most phone companies don't think IP is reliable enough for voice calls now--but it's getting better every day. The problem for Lucent: Cisco holds 67% of the IP market, while Lucent is a tiny blip on the radar screen. "Even after Ascend, they still have a lot of work to do," says BancBoston's Johnson.

Navigating such digital divides may prove to be as tough for McGinn as what he went through overhauling Lucent. For decades, the business that is now Lucent had been the sleepy maker of phone equipment for AT&T. It included the vaunted Bell Laboratories and its Nobel prize-winning technology. But a history of supplying the country's phone monopoly made Lucent the opposite of scrappy successes like Cisco. Lucent's engineers emphasized bulletproof reliability instead of rapid innovation. They often took years to develop products and tended to work on what they--not their customers--wanted. This was, after all, the company that became known for a variation on Henry Ford's old saw: "You can have any color phone you want, as long as it's black."

Times have changed. A galvanizing moment came in 1995, when McGinn sat down with his top 15 execs at Bernards Inn in Bernardsville, N.J. He told them Lucent's spin-off was "the chance of a lifetime" to create the kind of company they had always wanted. When it had been buried inside AT&T, the only expectation was that the unit should increase its profits 10% a year.

AIMING HIGH. The executives studied how the best big companies of that time--Motorola Inc. and Hewlett-Packard Co.--had achieved preeminence. With McGinn guiding them, the execs concluded they would have to meet an audacious goal: increasing revenues twice as fast as they had in the past. "You could just see the change in energy," says Henry B. Schacht, the former Cummins Engine Co. chief who was brought in to head Lucent during the spin-off so that McGinn could learn the ropes of running a public company. "Rich gets people to have expectations of themselves that are greater than what they would have on their own," adds Schacht.

And not just in the executive suite. McGinn also has been instrumental in revitalizing Bell Labs. Just before Lucent's spin-off, according to Schacht, McGinn told a group of 300 scientists: "You are our future." He also linked their research budget directly to Lucent's fortunes. It would start out at 1% of sales--and for every 10% increase in Lucent's revenues, the research budget would rise 10%. And he set up an internal venture-capital fund so that scientists could get money to start their own businesses--eight have been funded. "We went from less than one patent a day to three patents a day within the first calendar year," says Schacht.

The approach is paying off. In 1997, tiny Ciena Corp. clobbered Lucent with a new optical networking product that greatly increased the capacity of long-distance networks. Bell Labs' engineers scrambled to come up with a competing product--and delivered it to customers last September, in just 12 months. "We didn't even have a market position a year ago," says Daniel C. Stanzione, co-chief operating officer and president of Bell Labs. And McGinn's recent spate of purchases sends a signal, too: If Bell Labs doesn't come up with vital technology, Lucent will go out and buy it.

At first blush, it seems odd that McGinn is the one shaking up Lucent, given that he worked at AT&T for 27 years. But he was always something of an outsider. Instead of working in AT&T's core phone business, he labored in international operations, ran its computer unit, and moved to the equipment-making division in 1991.

He was known for his outspoken views in the hushed suites where radical views were largely unwelcome. McGinn, for example, objected strongly to AT&T's disastrous 1991 acquisition of NCR Corp., and he pushed for years for the Lucent spin-off. "He was always part of the outside renegade culture at AT&T," says David A. Nadler, a friend of McGinn and chairman of the telecom industry's Delta Consulting Group Inc.

McGinn's business sense surfaced at an early age. When the New Jersey native arrived at Iowa's Grinnell College in 1964, he set up a late-night snack service operating from his dorm room so students and professors could buy sandwiches after the stores had closed. McGinn jokes that he "had a positive cash flow" by the end of his first year.

PLAIN FOLKS. McGinn still seems more entrepreneurial than wing-tip corporate. He's "Rich" to everyone at Lucent, and he fetches his own lunch from the cafeteria. He favors black mock-turtlenecks over collars and ties. "Ties restrict blood flow to the brain," he says. And he says his idols are Dell Computer Corp.'s Michael S. Dell and Nelson Mandela. Indeed, McGinn pushed for Lucent to give $5 million to improve graduation rates at the predominantly African American Malcolm X Shabazz High School in Newark, N.J. McGinn also has little tolerance for those who think technology developments begin and end in Silicon Valley. At a recent speech in the Valley, he thanked the organizers "for getting me a visa" so he could visit.

What drives McGinn more than anything is his need to win. Ben J.M. Verwaayen, co-chief operating officer, recalls how McGinn reacted the first time he told the CEO that Lucent had lost what was a very small piece of business. "He turned gray," Verwaayen says. "It was like somebody had hit him in the stomach." Verwaayen tried to reassure McGinn. "You win some, you lose some," he told his boss. But McGinn would not be consoled. "I don't want anyone here to be a good loser," he snapped. "We are winners."

McGinn won't settle for anything less. He has told analysts that he expects to grow 2% to 5% faster than the industry average. How will Lucent reach that mark? By luring business away from rivals while expanding overseas and focusing on the fastest-growing markets. Besides data networking, that means Lucent must sell loads more wireless equipment, optical-networking gear, services, and software. "We're not exactly limited by opportunity," McGinn says, pointing out that Lucent may be the No. 1 equipment maker but still has less than 10% of the $400 billion worldwide market.

If McGinn's tactics of the past few years are any indication, he may yet outfox his rivals. For one thing, Lucent executives don't just listen to customers, they pepper them with questions--and then deliver the goods they need. Last year, that helped Lucent elbow its way further into the wireless market. There, it won a contract from PrimeCo Personal Communications, a top U.S. wireless company, after its equipment from Motorola had quality problems. "They spend a lot of time thinking about how to make life easier for us," says Lowell McAdam, PrimeCo's CEO. Overall, Lucent claims 30% of the U.S. wireless market, up from 25% three years ago, estimates Salomon Smith Barney analyst Alex Cena.

With the Ascend acquisition, McGinn is betting that he can make the same kind of progress in the data-networking market. Clearly, Ascend's tried-and-true ATM technology will help Lucent win over big phone companies nervous about the less proven IP technology promoted by Cisco and Nortel. But Ascend may not be the answer for the new telecom cowboys cropping up since deregulation. For example, when ICG Communications in Englewood, Colo., decided to offer voice service on an IP network, it asked Lucent to demonstrate its equipment. "It didn't meet the mark," says Robert Flood, ICG's chief technical officer. Instead, Cisco got the contract, estimated at $5 million. Analysts say Lucent will eventually acquire an IP company, such as Juniper Networks or Nexabit Networks.

While McGinn vows to improve Lucent's technology, he has more immediate concerns. He managed to calm jitters over Lucent's first-quarter shortfall by making hefty promises for the second quarter and fiscal year ending Sept. 30. A good chunk of Lucent's market cap is riding on whether he can meet his goal. "He has called the corner pocket," says Johnson. "Just winning the game isn't enough. He has to win the way he said." With Ascend in hand, McGinn is betting he has the winning shot lined up.

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