By Chris Rugaber (TMF RFK)

The communications equipment business is a pretty sweet one to be in these days, but you wouldn't know it from looking at Lucent's stock price or financial results. The company's shares are down almost 40% this year, while frequently mentioned rivals Nortel and Cisco are up 43.6% and 17.3%, respectively.

Many investors already know this, and I'm sure Paul has offered some rationalizations for the company's past performance. Since no one is going to invest in Lucent based on the company's recent results, the question becomes whether a so-called "buying opportunity," based on a possible future turnaround, now exists. I say no.

The company has made both financial and technological missteps, and there's no sign at this point that Lucent has its act together. Lucent has fared poorly in developing and selling products for the next generation of communication networks that will carry video, voice, and data. In addition, as the Fool has discussed extensively, Lucent's financial management has been pretty shabby in recent quarters. The company is bleeding cash, and simply can't come close to its rivals in operating efficiency.

Problems With the Product Line
First, let's start with the company's product development problems. Lucent has been losing out in several areas of the communications networks business. Probably the most frequently cited example of this is its loss of market leadership to Nortel in fiber-optic equipment, after Nortel developed high-capacity 10-gigabit systems significantly earlier than Lucent did. According to a Robertson Stephens report, Nortel will continue to gain market share this year and next, as Lucent struggles to catch up.

This follows Lucent's debacles in the Internet router space, now pretty safely dominated by Cisco and Juniper Networks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JNPR)") else Response.Write("(Nasdaq: JNPR)") end if %>. According to a recent Business Week article, the company's $900 million purchase last year of Nexabit Networks, as part of its efforts to improve its router offerings, has been a "loser," with the primary product arriving late and selling little. In addition, the company is also losing market share in the wireless infrastructure area to Ericsson <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ERICY)") else Response.Write("(Nasdaq: ERICY)") end if %>. Lucent's wireless business posted sales growth of only 18% in the most recent quarter, which trails the industry average of 20-25%, according to a Merrill Lynch report.

However, the company continues to sell plenty of old-world telephone circuit switches, a product line that grew precisely 1% in the most recent quarter, but which nevertheless represents approximately 15% of the company's sales.

Essentially, the old-world voice products that the company sells to large telecom carriers are dying off, and Lucent so far hasn't moved fast enough or effectively enough into new products and technologies.

Operational Mismanagement
Lucent's problems are not just in product development. The company doesn't utilize the Internet nearly as well as a company such as Cisco, which plugs its subcontractors right into its network so they can receive product orders directly. According to yet another article in Business Week (not available online), Cisco "sells 80% of its networking equipment over the Web and produced $650,000 of revenue per employee last year. Lucent sells just 30% over the Web and brought in just $250,000 per employee last year."

Then there are the company's well-known balance sheet problems. Lucent's bloated accounts receivable and inventories were largely responsible for the stock's blowup in January. The company's Foolish Flow Ratio, a measure of working capital management developed by the managers of the Rule Maker Portfolio, is now at 2.89, according to preliminary balance sheet data from the quarter ended in June. The lower the Flow Ratio the better, and the Rule Maker Portfolio prefers a Flowie below 1.25.

The latest figure continues a series of sequential increases that go back at least five quarters. Such a high Flowie indicates that the company waits too long to collect on its invoices (high accounts receivable), carries too much inventory, and pays its suppliers too quickly (low accounts payable). The net effect of this combination is to reduce Lucent's cash flow.

In fact, when capital expenditures are subtracted from the company's (already low) operating cash flows, on a trailing-12-month basis, Lucent is free cash flow negative to the tune of almost $1 billion. And in the most recent quarter, a Merrill Lynch report estimated that the company lost $300 million in cash flow from operations -- before capital expenditures were factored in. If so, the cash flow statement in Lucent's next 10-Q filing will not be pretty.

Things Are Not Getting Better
Late-1980s pop musician Howard Jones sang that "things can only get better," but then he never followed Lucent. The company's balance sheet has yet to improve, and the planned spin-offs of the enterprise networks and microelectronics segments, along with several recent acquisitions, have only served to further muddy the financial picture.

The company may in fact get its act together in the next several years -- after all, it will probably generate over $43 billion in revenue this year, so it's not without resources -- but investors should remember that Lucent has guided revenue and earnings estimates lower in each of the last three quarters, and may do so again. Even if Paul convinces you the company is on the rebound, why not wait for evidence of that rebound to appear, before committing your hard-earned savings to it?

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