The Monkey Wrench in Agere's IPO

Lucent is desperate to take the microelectronics unit public, but with growing signs of trouble, Agere is no bargain

The absolutely, positively worst time to ask for money is when you really, really need it bad. You knew that already, but it's a hard lesson that telecommunications giant Lucent Technologies (LU ) is learning again right now as it gets ready to sell $6.5 billion in Agere Systems stock. Yes, that's right: $6.5 billion. Agere Systems.

And no, it can't help that only a nano-slice of the world has ever heard of Agere, Lucent's microelectronics unit, or that even fewer can pronounce its name (a-GEAR). Yet these are the least of Lucent's worries as underwriters, led by Morgan Stanley Dean Witter, try to find buyers for Agere's mid-March initial public offering. In a nuclear winter for tech investors, the deal's size--the second-biggest U.S. IPO ever--is daunting. As a backup, Lucent is rumored also to be shopping Agere to the big telecom companies. The worst of it, though, is that all of Wall Street knows just how badly Lucent wants to sell. As Lehman Brothers analyst Steve Levy told me: "Lucent needs to get this deal done."

Lucent thirsts for the $3.8 billion it aims to draw from the IPO to ease a liquidity squeeze that in February sent it, hat in hand, to its banks. Less understood are Agere's own prospects and what the deal means for Morgan Stanley. Agere and Morgan Stanley are staying quiet ahead of the IPO, but securities filings lay out its details. Here's how I size them up for each player--and you:

For Lucent, Agere figures to fetch a miserable price, far below whatever it saw last July when it announced plans to spin off the unit. Some bulls even hallucinated a market cap for Agere of $100 billion. Since then, market multiples of leading Agere rivals have collapsed. Fiber-optics-parts maker JDS Uniphase (JDSU ), for one, has seen its value shrink in that time from $90 billion to $30 billion. As recently as Feb. 7, Agere indicated it expected a market capitalization of $23.4 billion. By Feb. 26, that sank to $17.4 billion, as Agere cut its indicated IPO price to $13 a share from $17.50. That's why Lucent now aims to sell about 37% of Agere, up from the 20% it expected in July. It may cut the price again. If you own stock in Lucent, none of this is good.

As for Agere, does Lucent's agony make it a bargain? It might, except that there are mounting signs of trouble in Agere's own kitchen. After years of eroding margins (chart), Agere saw operating income of just $5 million on sales of $5.1 billion in the year ended Dec. 31. Prospects for a fast turnaround are poor. "We are experiencing softening demand," Agere's filing says, "which may result in a significant operating loss" in the current quarter. Many rivals, including JDS and Broadcom, also keep warning of disappointing sales and profit.

SELLING PRESSURE. Any comeback will be further hindered by the $2.5 billion in new bank debt that Lucent is dumping on Agere. It's due to be repaid next February. Lehman analyst Levy, an early and correct skeptic on Lucent, guesses Agere's profit outlook makes the stock worth less than $7. I can't say that's right. Yet what's inescapable is the ton of potential selling pressure on Agere: Lucent plans by Sept. 30 to distribute the rest of its stake, 835 million shares, to its own investors. Count on many of them to ditch Agere.

And Morgan Stanley? Its role as Lucent's banker is unusually close. Of the 500 million shares set to come public in the IPO, just 300 million will be sold directly by Lucent. If Morgan can find public buyers for the next 200 million, it will first buy them from Lucent. How? By returning another chunk, up to $2.5 billion, of Lucent commercial paper that it has been accumulating in its own account. Why? It's another way Morgan is trying to help Lucent out of its liquidity jam. The risk is that if Morgan can't find buyers for the extra 200 million Agere shares, it's stuck with the Lucent paper until it matures, and Lucent stays mired in short-term debt.

The details may make your head spin. But it's just this simple: Lucent wants you to put up the cash to ease it out of a squeeze. In return, you would get shares that figure to be under a cloud, at least for most of 2001. Lucent's timing in the deal is rotten. Yours doesn't have to be.

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By Robert Barker

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