Scene:
Court of Public Opinion, Circuit Court of Fools
Characters:
Magistrate, Circuit Court of Fools
Fools -- Individual Members of the Jury
Executioner -- The stock market
Richard McGinn -- CEO, Lucent Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LU)") else Response.Write("(NYSE: LU)") end if %>
Magistrate: Has the Jury reached a verdict?
Fool 1: Is that a joke? We had the verdict before we even started the trial. (scattered giggles)
Judge: Then what say ye?
Jury SpokesFool: You've read TMFVerve's classic exposition on the management of working capital, and you still have to ask? Lucent's inventories are bloated, accounts receivable are out of control, and growth is slowing. These are the telltale signs of a struggling business.
Fool 1 (mumbles): I think he means the company sucks. (more giggles)
Judge: OK, that's enough of that. Executioner, what say ye?
Executioner: I decree that Market Cap shall be 4.5 times trailing-12-month revenues.
Mr. McGinn: 4.5! This is a joke! I demand a new trial.
Judge: Not another outburst from you, sir! Now, if you can control yourself, you are allowed one final statement before we adjourn.
Mr. McGinn (pauses, regains control, then launches): We are the world's leading supplier of microchips to the communications industry. I hear that this is a pretty good business nowadays. Ever heard of a little thing called wireless? But what do I know?
Consumers are stretching the capacity of existing networks to handle all the Internet traffic now flowing through them, not to mention the broadband services -- like interactive TV -- that are just around the bend. Local, national, and international telephone companies and Internet service providers are ready to spend whatever it costs to upgrade their networks. But there is a holdup. You see, the optical component suppliers -- who make the subsystems that go into the networking gear -- can't make these delicate, little, complex components fast enough.
Well, fortunately for us, we make and sell a lot of these optical components ourselves. In fact, only 25% of our optical components production goes into our own gear. We sell the rest to other network system providers such as -- oh, I don't know -- Nortel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NT)") else Response.Write("(NYSE: NT)") end if %> and Cisco <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>. Frankly, we think overwhelming demand is, in general, a good thing. But what do we know?
Oh yeah, Fools. Did you hear that we're going to spin off the part of our business that makes these optical components and chips for wireless? It's true. We want this division to be unencumbered when it comes to selling to Lucent's competition in the network building business.
Early next year, we'll put up for public offering some new shares in this spin-off. We might as well raise a little extra capital, while the price is good, to expand more rapidly into this red-hot market. Any joker off the street these days that mentions "wireless" or "optical" and "IPO" in the same sentence can make billions in a few hours in the public markets. What do you think the market will pay for an established provider of both wireless and optical components?
You look interested. Let's look at a little data. Bailiff, put up the first slide, please.
Market TTM Cap/ Y-Y
Cap Rev Rev Growth
LUCENT
Entire company* 149.6 33.1 4.5 20%
Microelectronics ? 6.2 ? 39%
division
*pro forma
OPTICAL COMPONENTS COMPETITION
JDS Uniphase 91.1 1.43 63.7 501%
SDL 24.4 0.29 84.5 156%
Corning 64.8 5.62 11.5 75%
WIRELESS CHIP COMPETITION
Broadcom 45.8 0.74 62.3 106%
Texas Instruments 97.4 10.58 9.2 21%
Note: Market cap, revenue in $billions
Take a good look, ladies and gentlemen. Don't you think this little Lucent microelectronics spin-off -- with $6 billion in sales and an annual growth rate of 39% and increasing -- might be worth a little more than 4.5 times revenues? Like, say, maybe three times this much? The bulk of this new components company will go to current Lucent shareholders, so you have two options if you want a piece of this action -- buy Lucent now or wait for the add-on IPO. I'll let you decide which plan will get you more shares for the dollar.Fool 1: What a wacky pitch! Give me one good reason why we shouldn't just buy more Cisco?
Mr. McGinn: Maybe because Cisco's shares are selling at 26 times revenues?
Fool 2: Pay no attention to this man, Fools! He's trying to hoodwink us with a value investing argument, and as we well know, this is always a flawed approach. This company is rotten to the core. Just look at its Flowie.
Fool 3: Yeah, its Flowie stinks!
Fool 4: Hey, McGinn, have ya seen Cisco's Flowie? (more giggles)
Mr. McGinn: Ah yes, the Flowie. Let's talk about the Flow Ratio. We'll break the discussion into two parts -- inventories and accounts receivables.
First, in the backbone network market, we missed the boat on optical switches and Nortel is eating our lunch right now. Everyone knows this and we've admitted it openly to our shareholders. An unfortunate byproduct of this slip is that we are stuck with some hard-to-move inventory of older, slower circuit-based switches.
So our inventories are not pretty at the moment. This is our fault. We know this and we're working rapidly and effectively to catch up with Nortel. And as we close this gap, we'll get our inventories back under control.
Second, let's talk about receivables.
Our network services division is one of the two largest players -- along with Nortel Networks -- in the network backbone segment of the market. And this market is defined by a very small number of very large buyers -- regional, national, and international telephone providers such as AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %>, SBC Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBC)") else Response.Write("(NYSE: SBC)") end if %>, and the other Baby Bell combinations.
Any time you have a small number of powerful buyers, you can expect these suppliers to exert a lot of pressure for favorable pricing. Historically, telephone equipment suppliers have provided generous financing plans in order to establish a strong relationship with these large buyers, especially the ones that are aggressively building out next-generation networks.
Well, it so happens that building out next-generation networks is exactly what our current customers are doing, and we are helping to finance this growth. So our receivables don't look so hot right now. But you know what? In return for helping to finance their expansion, we get our hooks into the ground floor of their new networks. Think this might pay off in the long run?
Finally, a word about Cisco. Fools, Cisco is not a force in this backbone market. Nope. It makes the bulk of its money in the enterprise market, building LANs for organizations and connecting them to Internet service providers.
It just so happens that the enterprise market has the opposite flavor -- many, many small buyers. So Cisco buyers just don't have the leverage that ours do. Moreover, in Cisco's core market, they have nobody on the level of Nortel to compete with, as we do in our core. But if Cisco wants to get into our market -- and they'll have to in order to meet growth expectations -- all this changes. You can expect to see those squeaky-clean receivables grow a little.
Don't believe me? Let's take a look at Nortel's balance sheet versus ours. You'll see that inventories and receivables represent 15% and 30%, respectively, of Nortel's revenues for the quarter ending 3/31/00. Comparable numbers for Lucent are 17% and 33%. So while we do admit fault when it comes to Nortel's lead in optical switches, we don't think our Flow Ratio proves that our finances are being managed badly. Cisco has this same lesson in store for them, when -- or should I say if -- they decide to take us on in carrier networks.
Fool 4: Your Flowie is 2.8! What a joke!
Mr. McGinn: Look, gents. The Flowie is a reflection of competitive strength, not a driver. Moreover, it's a reflection of past competitive strength, not future, and investing is all about future results. We are one of two major players in the demand-driven market for optical networks. We'll catch up.
Fool 3: Judge, is this guy done yet? (To fellow jury members) C'mon, Fools, let's go buy some Cisco.
Fool 4: You got it, Foolish brother! I'm going to spend a little time on the Cisco website. It rocks. I'm outta here.
(Jury filters out, slapping high-fives all around)
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