Commentary: Lucent: Suddenly, the Hole Is Even Deeper

By Steve Rosenbush

On the morning of May 29, Alcatel's (ALA ) acquisition of Lucent Technologies (LU ) looked like a done deal. The companies had already sent advance troops to New York for a press conference. A meeting hall had been reserved for the following morning at the St. Regis Hotel. Coffee and pastries for a cast of hundreds were waiting. All that stood in the way of the big announcement was a pair of board meetings to approve the $24 billion deal. "When I woke up that morning, it sure felt like a deal that was moving forward," said one person close to the talks.

Anyone need a couple of hundred pastries? By late afternoon, both companies issued a joint statement saying the talks had been halted, scuttled by disputes over who would ultimately control and run the merged company. The sobering fact that both lost value as the talks progressed didn't help, say people familiar with the matter.

POUNDED. For Alcatel, being jilted is a minor embarrassment. But the entire weeklong charade will haunt CEO Henry B. Schacht and a much-wounded Lucent for months, and possibly years, to come. Lucent has lost ground since secret negotiations began back in March, and it is clearly even worse off than it was when news of the pending deal broke on May 18. For starters, long-suffering shareholders have been hammered once again: Shares fell $2, to $8, during the talks and are off 88% from a 52-week high of $63. Tense divisions within its management ranks have been exposed. And would-be suitors now know the easy terms that Lucent is willing to accept. But perhaps most damaging is the perception management has created that it doesn't believe the company, whose beginnings go back to Alexander Graham Bell's original research labs, can thrive on its own.

As details of the Alcatel talks emerge, questions are already rising about Schacht's motivation to do the deal. Indeed, well before the news hit that Alcatel was making a play for Lucent, Schacht was out quietly peddling his company to any European telecom company that would listen. Trips to Europe in late February and early March with Vice-Chairman Bernardus J. Verwaayen, a former KPN executive, says one person familiar with the matter, yielded merger talks with a number of companies, including Siemens, Marconi, Nokia, and, of course, Alcatel. As the Alcatel talks progressed during April, Lucent began crowing about how its second-quarter results demonstrated that its recovery was under way. The evidence: Revenues for the second quarter were 36% higher than revenues in the first, a $1.8 billion operating loss notwithstanding.

Now investors have to wonder how strong the turnaround is. "After the Alcatel episode, investors are going to ask, `If things are going so great, why did you even think about selling out?"' says Steve Levy, telecom-equipment analyst at Lehman Brothers Inc. "It sets back any effort to restore their credibility with the financial community."

So just what was Henry Schacht thinking? Although the talks were ongoing for months, the deal fell through largely over his complaints that it would not wind up as a merger of equals. But he had long known the structure of the deal: That Alcatel would walk away with a 58% stake in the new company, and that it would name the chairman and CEO. That's why many Street and industry observers think Schacht was really looking for an eleventh-hour excuse to quash the deal after investors clearly signaled their displeasure with it. "The financial issues played a larger role in this than most people realize," says Paul Johnson, telecom-equipment analyst with Robertson Stephens.

BIG SPLIT. The financial community isn't the only group whose confidence has been shattered by the derailed merger. The episode has also split management in two. Schacht and senior leaders such as Executive Vice-President Bill O'Shea supported the Alcatel deal until it fell apart. Younger managers wanted Lucent to wait a few quarters, until the turnaround was further along, people familiar with the matter say. Then it could either go it alone or negotiate a better deal with a potential partner. Now it may be more difficult to retain key executives.

Lucent, though, is going to need to keep all the talent it can to weather the next year. The company faces no immediate cash crunch: It had $1.4 billion in cash at the end of March and access to $3.5 billion in short-term credit, which can be used to pay off $750 million in debt that comes due this summer. But it still carries a heavy net debt load of $4 billion and needs to strengthen its balance sheet through asset sales. Its optical-fiber unit is already on the block, and Lehman analyst Levy expects its sale will raise $3 billion to $5 billion.

Such sales will buy time. But Lucent will now have to turn back to the tough slog of sorting out its problems without help from a stronger partner. That means getting back to operational basics. Lucent still has a long way to go before it delivers on its promise to cut $2 billion in costs. It has already slashed 10,000 jobs but may need to cut 10,000 more. It is also nowhere near its goal of reducing receivables and inventory by $2 billion.

Even if Lucent could accomplish all that, there's still the problem of getting the right products to market at the right time for a new world of digital data and fiber optics. That won't happen until the company finds new leaders who aren't cut from the same telco cloth as the current regime. And the company still needs to find a successor to the 66-year-old Schacht.

As for the botched Alcatel deal, it was a bizarre, if fitting, end to the latest chapter in Lucent's rapid decline. Although Alcatel CEO Serge Tchuruk agreed to move to the U.S. to head the combined company, Lucent still wanted soothing assurances about a merger of equals. But that was never in the cards. Now Lucent must face the music on its own.

Rosenbush covers telecommunications from New York.

    Before it's here, it's on the Bloomberg Terminal.