Gorilla in the mist

By Om Malik

Like aging heavyweights, Lucent Technologies and Nortel Networks are on the mat, bloodied by the telecom downturn. Fans of Cisco Systems are hoping that this is Cisco’s chance to mop up in the telecom carrier market and become the undisputed king of networking. It could happen, but if anybody thinks it’s going to be easy, they’ve got a nasty surprise waiting for them. It’s called Alcatel.

In light of the Worldcom debacle, and continuing cutbacks in carrier capital expenditures, the contention might seem laughable. After all, in late June, Alcatel announced that it would register an operating loss–not a profit as previously projected–in 2002, and was planning 10,000 fresh job cuts. The stock plunged to a 13-year low of $6.98 a share. Beyond its short-term troubles, however, Alcatel is well-positioned to take the top spot.

The Paris-based company has $21.8 billion in sales (more than Cisco, Lucent, or Nortel) and a dominant position selling equipment in Europe and Asia. The only place Alcatel lacks a big toehold is North America, where Lucent and Nortel have locked it out of lucrative relations with the Baby Bells.

With North America accounting for some 50 percent of global telecom equipment revenue–about $100 billion in 2002, according to RHK, a South San Francisco, California, research group–it’s a market Alcatel is again preparing to go after.

Despite the overall revenue comparison, Alcatel ranks second in telecom sales. The company’s telecom business–including optical gear, PBX systems, and DSL modems–accounts for just 74 percent, or roughly $16.1 billion, of its sales. Lucent and Nortel have telecom sales of $18.1 billion and $14.7 billion, respectively.

Still, Alcatel’s $16.1 billion feels safer than the others’ rapidly vanishing streams of revenue. Alcatel’s sales were down just 5 percent in 2001, while Lucent and Nortel saw revenue decline 14.5 percent and 42 percent, respectively. In its September 1999 quarter, Alcatel’s gross margins were 35.2 percent. Since then, they’ve declined slightly, to 33.9 percent; Lucent and Nortel, on the other hand, have seen margins plummet from 49.7 and 45.5 percent, respectively, to just 22.9 and 19.3 percent.

In light of its competitors’ troubles, it’s time for Alcatel to make a move. With analysts, executives, and investors clamoring for consolidation in the industry, Alcatel is an obvious acquirer–a category with fewer members than you might think. Kevin Slocum, an analyst with the SoundView Technology Group, thinks Alcatel, Cisco, and Siemens could be out shopping for the likes of Corvis, Redback Networks, Riverstone Networks, and Sycamore Networks.

But back to Cisco. Although CEO John Chambers has been droning on about how the company is spending half its research and development dollars on carrier-related equipment, talk is cheap: Cisco has little to show for those efforts. It still doesn’t have even basic products–like optical cross connects–that carriers want. And efforts to buy its way in by funding next-generation carriers like Velocita and Sigma Networks have been a flop. To date, sales to telecom companies account for a mere 15 percent of the company’s $18.4 billion in annual sales.

Of course, Alcatel has had its own troubles busting a move. Recall the last aggressive bid to increase its share, when CEO Serge Tchuruk made a $35 billion offer for Lucent in May 2001. That deal fell apart because Lucent wanted to call it a merger of equals, but Alcatel saw it as an acquisition. It’s beyond us to explain how such details could derail a deal, but we’re talking about a pairing of French and Americans here–kind of like drinking an ’82 Bordeaux with your Big Mac. Sacre bleu!

But that’s the past. These days, unstinting support from the French government and European banks has Alcatel ready to take another shot. It’s unlikely it will make another run at either Lucent or Nortel, but that’s probably for the best. Instead, Alcatel is pursuing selective acquisitions to fill holes in its product portfolio.

What are they after? First, Alcatel needs products targeted at the network “edge,” a market likely to see near-term growth. Edge devices normally help act as bridges between two different kinds of networks–like asynchronous transfer mode (ATM) and ethernet.

Alcatel is also focused on technologies that extend the life of the Baby Bells’ current infrastructure. In January, the company bought Astral Point Communications for $135 million. Astral Point’s technology gives Baby Bells’ ATM and synchronous optical network gear an optical makeover.

Since carriers are eyeing the gigabit ethernet services business, one can bet that Alcatel will be there, too. That might be why networking circles were abuzz in May with rumors that Alcatel might be kicking the tires at Riverstone, a maker of ethernet switches and routers.

David Gross, an analyst with Communications Industry Researchers, thinks Alcatel could also sign deals with some startups. Nokia, for example, recently invested $36 million for a 10 percent stake in ailing communications equipment maker Redback Networks and the right to resell Redback products. Alcatel is rumored to be contemplating such a deal with Redback as well.

While Lucent and Nortel flail away, and Cisco keeps on talking, Alcatel is actually the company to watch in telecom equipment. When the telecom winter finally ends, don’t be surprised to see the Frenchmen at the head of the pack.

Originally published in Red Herring