Alcatel-Lucent: Sign of an Industry-Wide Malaise

Earlier this morning Franco-American telecom giant, Alcatel-Lucent, gave CEO Pat Russo and Chairman Serge Tchuruk the proverbial boot after the company reported a disastrous quarter, missing its earnings and revenue targets. The company says they resigned – which is utter rubbish because in this day and age, no one gives up megamillion-euro pay packages just because they’re feeling pious.

Much of the blame was put on macroeconomic factors and the wireless industry’s transition from CDMA to WDCMA. The company tried to point to a silver lining on the horizon (2009), but somehow it feels like wishful thinking.

Today’s turn of the events not only highlights the folly of the unlikely pairing – the worst since Billy Bob Thorton hooked up with Angelina Jolie – it also points to a larger, much deeper problem facing the telecom equipment makers in the West.

Too Many Sellers, Too Few Buyers

At the time the deal was announced in April 2006, I had pointed out that the merger of Alcatel and Lucent was driven primarily by the lack of market control by equipment vendors. As carriers continued to consolidate, most equipment companies have lost their pricing power and have been left to snivel like lowly serfs in front of industry powerhouses such as AT&T and Verizon.

In November 2007, I spoke with Krish Prabhu, the then-CEO of Tellabs, who lamented how carrier consolidation was crushing smaller players like his company. Troubles at Motorola and Tellabs are part of the same trend that has besieged the industry. Nokia Siemens, Nortel and others are also struggling to find a strong footing in what seems to be a quicksand hidden by hot tar.

At the same time, the industry is coming under sharp attack from low-cost Chinese vendors that are essentially subsidized by various governmental entities. By playing the cut-price game, they have won key contracts in fast-growing Asian, African and Latin American markets, and recently have started to mop up in Europe.

The presence of ZTE and Huawei has helped carriers squeeze blood out of a stone and destroyed the money-making potential of Western equipment makers. Companies like Alcatel-Lucent don’t really have much flexibility – they have huge cost bases that include R&D, manufacturing and little ability to play the price game in the rapidly growing Asian markets.
If these deflationary forces were not enough, some of these companies are just not prepared for the rapidly changing needs of today’s networks.

The world has gone all “IP” and the needs of telecom operators, especially the new ones with big wallets in Asia, Africa and Latin America, have evolved accordingly.

The State of The Telecom Market

The troubles of these companies come at a time when the sales of equipment to service providers and enterprises are going up, totaling $139 billion in 2007, up 13 percent from 2006, according to Infonetics Research. The research firm is predicting total equipment sales will climb to $174 billion in 2011.

Unfortunately, most of the sales are coming in areas where large incumbents such as Alcatel-Lucent have marginal presence. For instance switches, routers and IPTV gear continues to do well, as does demand for fiber broadband-related equipment. (Alcatel-Lucent has been doing well in GPON, but has seen its DSL sales slow down and profits evaporate, thanks to competition from Huawei.) China and India are beginning to account for a much more substantial part of the worldwide capital expenditure.

What makes the situation worse for Alcatel-Lucent is that they blew up in middle of an investment cycle. Why? Because the cycle has hit a plateau in North America and Europe, according to Infonetics Research. In China and India, the Chinese equipment makers are cleaning up. The growth in those two economies, much like rest of the emerging economies, is coming from the mobile buildout and lately, from WiMAX demand as well.

According to Infonetics Research, Cisco was the largest company in 2007, followed by Alcatel-Lucent. In the telecom sector, an increasingly resurgent Ericsson is running neck-to-neck with Alcatel-Lucent, which explains today’s disaster.

What Next For Alcatel-Lucent?

The shuffling of management doesn’t really address or fix the structural issues of this company specifically or industry at large. Earlier this week, there was a story in the Wall Street Journal about Alcatel-Lucent’s move into the services business. I am sure that’s going to work out eventually — they reported $1.3 billion in service-related revenues this quarter — but in the long run they would have to buy their way into the market. Alcatel-Lucent could acquire Cognizant, a telecom industry services company, but for that they would have to give up more than half of their company. And even that isn’t going to fix this company’s structural and fundamental problems.

Too bad, for at one time Alcatel looked like the king of the telecom hill. By buying Lucent it turned that hill into a heap of scrap. I think this company is headed in the same direction the relationship of Thornton and Jolie went: south.