by Paul McWilliams, editor Next Inning
A subscriber recently asked us if
Alcatel-Lucent (
ALU) is a viable buyout candidate. Here's our assessment of the stock's outlook and its buyout potential.
Central
to ALU's challenge is its high fixed cost structure. Current management
has addressed that more effectively than what we saw previously, but
there is still progress that needs to be made before ALU can realize the
cost flexibility it needs to optimize its model.
Beyond the complications these high fixed costs present, ALU was hit
last year by delays in capital spending on next generation wireless
networks.
At the beginning of 2011 it was widely believed we
would see capital spending on these networks begin to build meaningful
traction during the second half of the year. That didn't happen.
While
all of the companies that were betting on this traction suffered,
companies with high fixed cost structures suffered the most.
In
short, companies that operate with a high fixed cost business model,
particularly companies that operate in cyclical end markets, get hit the
hardest when there is a cyclical downturn or a push out of an expected
spending pattern.
The reason is simple; companies with high fixed costs models have
inherently low cost flexibility and are, therefore, very sensitive to
fluctuations in revenue.
Prior to the management change at ALU,
and its subsequent focus on adjusting the structure of its operating
model to reduce fixed costs, it was in a prime position for a takeover
by a private equity. However, its stock price was higher then, so that
part of the equation wasn't there.
Today we see ALU addressing
the right priorities, but the stock price is far lower. This opens an
opportunity for private equity that wasn't there before.
1) The
price is low enough today that a private equity group could offer a
substantial premium that would likely be acceptable by the board and the
shareholders.
2) ALU is already taking the right steps to improve its operating model.
3) ALU is positioned well to participate in the build out of next generation networks.
I
think given the prospect that ALU will report revenue this calendar
year above $20B, the company could bring $4 per share in a buy out
pretty easily and, possibly, something in the range of $5 to $6.
However, as an investor I would not buy shares of ALU based on the thought it will become an acquisition candidate.
That
said, I think if ALU executes as I expect it will, and the demand for
next generation wireless networks builds traction as most observers are
forecasting it will this year, I believe ALU will merit a price of $4 to
$6 on its own.