Darkness Creeps Over Lucent

Having cut guidance for 2006, CEO Pat Russo has to move fast to keep on track the turnaround she just got started over the past few years

Things were looking up for telecom equipment giant Lucent Technologies (LU). Since becoming chief executive in 2002, Pat Russo had succeeded in returning it to profitability after a drought that resulted in three years of losses (see BW Online, 10/23/03, "Light at the End of Lucent's Tunnel"). She slashed jobs and beefed up the division that caters to wireless carriers, lessening Lucent's reliance on areas of telecom that are in decline. Investors and Wall Street analysts lauded Russo's efforts.

But Russo got no accolades on Jan. 13, when she cut Lucent's guidance for the fiscal year that ends in September. Lucent now expects 2006 sales to be flat or increase by a low single-digits percentage. It had been calling for sales growth in the mid single digits. The year's sales got off to a dismal start, falling 12.4% in the first quarter, which ended in December, Lucent says, in keeping with the Friday-the-13th theme. Lucent releases full results Jan. 24.

If Russo gets anything, it will be some extra help running Lucent -- from Chief Financial Officer Frank D'Amelio, who becomes chief operating officer. He'll retain the CFO title until a successor is found.


  What's going on? Telecom spending was flat in 2005, and in some of Lucent's most important markets, it may not budge much this year either, analysts say. Telecom consultancy Ovum reckons global telecom equipment spending may be flat, if not down, all the way through 2010.

As a result, to keep Lucent profitable, Russo may need to slice an additional $1 billion in costs, American Technology Research analyst Albert Lin estimates. Otherwise, it may dip back into the red as early as this summer, he says.

Reduced expenses would help Lucent offset any order slowdown from key clients. Two of the largest U.S. companies, Verizon (VZ) and Sprint Nextel (S), have almost completely upgraded networks so they're capable of handling next-generation wireless services. As a result, they won't be spending as much on cellular-network gear this year, analysts say.


  Lucent's wireless business, accounting for 49% of total revenues, is also affected by massive restructuring in China's telecom industry, which contributes 9% of Lucent's total sales. This was another area of weakness that Lucent highlighted.

Cost cuts might also help Lucent more competitive in markets such as Internet protocol (IP) networking gear, says Susan Eustis, CEO of WinterGreen Research. Spending on IP equipment is set to surge to as much as $5 billion in 2007 from less than $1 billion last year, according to Forrester Research. The trouble is, Lucent isn't matching competitors' prices, even though it has a top-notch product portfolio, says Eustis. In this and several other fast-growing markets, Lucent has been losing share to gear makers Huawei and UTStarcom (UTSI), which have been offering comparable equipment sometimes at less than half of Lucent's prices.

Huawei and UTStarcom last year won contracts with well-known telcos such as British Telecom and, as a result, reached widespread credibility among carriers. Lucent is hitting a rough patch in China even as the country's spending on telecom equipment jumped 25%, to $32 billion, last year, WinterGreen says.


  Some analysts say Russo isn't responding to the market changes swiftly enough. "Management has been very slow to recognize there's a problem and do anything about it," says Richard Windsor, an analyst with investment bank Nomura in London. She needs to cut costs out of Lucent's wireless division, says American Technology Research analyst Albert Lin. And Russo has yet to address one of Lucent's long-time fundamental problems: its huge pension plan obligation.

These liabilities likely prevent Lucent from being acquired by another telecom player -- a move that, in this tough market environment, would make sense, Lin says (see BW Online, 2/11/05, "Telecom Mergers: Is Lucent Next?"). Some analysts were miffed that Lucent didn't alert Wall Street sooner, saying executives should have become aware of the shortfall in December, if not sooner. Lucent stock fell 2.2%, to $2.65, on Jan. 13.

Analysts including Lin speculate that D'Amelio's promotion is a sign that confidence in Russo has slipped. "There has been a lot of grandiose plans laid out by Pat Russo," says Lin. "If you can't turn that vision into numbers, your job is at risk." Says a Lucent spokesperson: "Having stabilized the business, she is here for the long term."


  As COO, D'Amelio will lead Lucent's sales, the product groups, the services business, the supply chain, info-tech operations, and labor relations. In a statement, Russo said the idea is to "allow me the opportunity to spend more of my time with customers and to focus on both strategic issues and growth opportunities that will help us build upon our strong technology and market expertise."

Russo has taken several steps to keep Lucent on track. Those include refocusing it on growth markets like services and government sales. Having led Lucent out of the woods, she'll quickly need to find ways to keep it from being drawn back in.

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