Dueling Fools
Win or Lucent
May 26, 1999

The Bear Rebuttal
by Chris Rugaber ([email protected])

Yi-Hsin spends much of her time extolling Lucent's share price appreciation and revenue growth, and there's no doubt these two things have occurred, but I'd look hard at those numbers, given the company's cash flow problems. In addition, revenue may or may not meet CEO McGinn's goal of 19% or 20% growth this year. They're already a couple of points behind after six months, thanks to an anemic first quarter which saw only 5% revenue growth, and almost $200 million of that resulted from a restructuring of a partnership with Phillips. All this leaves aside Lucent's writing off of in-process R&D and other accounting shenanigans, since most of Yi-Hsin's numbers took that into account. The company at least gives clearer accounts of its earnings in its press releases than it does in its quarterly reports.

Yi-Hsin then lists some of the companies that Lucent has purchased, but making a lot of corporate acquisitions doesn't exactly distinguish Lucent from its rivals. Cisco has made plenty of small, focused purchases of its own, including highly-regarded GeoTel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GEOC)") else Response.Write("(Nasdaq: GEOC)") end if %>, a voice and data routing company (and a stock picked up by our Foolish 8 screen). Ericsson <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ERICY)") else Response.Write("(Nasdaq: ERICY)") end if %> is in the process of purchasing Torrent Networking Technologies, an IP router company, as well as IP telephony company Touchwave. Nortel Networks <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NT)") else Response.Write("(NYSE: NT)") end if %> has also been on a buying spree, purchasing data networking company Bay Networks, as well as high-speed broadband wireless company Broadband Networks, remote-access data networking company Aptis Communications, and optical networking firm Cambrian Systems Corp.

Many of Lucent's acquisitions are defensive in nature, a sign that it's just trying to keep up. The company's purchase of Ascend hardly assures it of any "cutting-edge technology," since this is the company that lost the router battle to Cisco. There's little reason to believe Ascend will do that much better as part of Lucent than it did on its own.

Nevertheless, Lucent needed Ascend's ATM (asynchronous transfer mode) technology, which can handle voice, video, and data. Without it, Lucent would be unable to attract business from the newer telecom and ISP companies such as Level 3, Qwest, and UUNet, which it needs because it currently gets so much of its revenues from AT&T and Sprint (AT&T provided 11% of Lucent's 1998 sales). Yet ATM could easily end up being a transitional technology on the way to an Internet Protocol (IP) world.

Yi-Hsin is correct that neither Lucent nor Cisco currently has a "killer app" that efficiently and reliably transfers voice, video, and data over the same network. Yet when she argues that Lucent's experience in making reliable equipment will be a "huge selling point," she overstates the case. Cisco has a much better record of innovation, and data networks are generally where telecommunications is going. As Fortune magazine pointed out last year, when the volume of data traffic begins to "dwarf" that of phone calls (probably within five years or less), "it will make sense to start converting phone calls into digital bits and adding them to the [data] traffic flow at very little cost." Data networks are Cisco's forte.

In addition, let's not forget other companies, such as Nortel. The second-largest telecom equipment company is already giving Lucent a run for its money in fiber optics and other phone technologies, and is way ahead in data networking equipment. It plans to gain 18% to 20% of its 1999 revenues from data networking equipment, as opposed to Lucent's 1998 figure of precisely 1%.

More importantly, Nortel is pushing much more aggressively into IP technologies. According to Forbes, Nortel's CEO, John Roth, believes that "Virtually all telecommunications will take place on the Internet within ten years," which, if correct, "will come as a shock to Lucent Technologies� Lucent� anticipates a much more measured pace of transition from today's networks to the all-Internet future."

It wouldn't be the first time that Lucent was a bit slow. While Yi-Hsin argues that "the company is well-positioned to bring competitive new products to market quickly and efficiently," in reality Lucent is fighting a reputation as being similar to its former parent: bureaucratic and lethargic. In fact, even the president of Bell Labs has acknowledged Lucent's rap as "Great technology, too slow." No one's ever said that about Cisco.

The telecom equipment market has been projected to reach $350 billion a year in the next few years. There are plenty of other companies in this field that investors may want to consider. My bearish tip is: pick a company that isn't playing catch-up technologically and that has a positive cash flow, rather than Lucent.

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