Alcatel defends next-gen investments

Alcatel defended its investment in next-generation technologies and emerging markets--at the cost of profits--in its third-quarter earnings conference call today.

The company’s wireline communications revenue was up 7% from a year earlier to about 1.3 billion euros in the third quarter. Mobile communications revenue was up 22% year-over-year to nearly 1.1 billion euros. And private communications revenue declined 3% to 928 million euros. In total, third-quarter revenue was up about 9% from a year earlier to nearly 3.3 billion euros. Net income was up 36% from a year earlier to 266 million euros.

Consistent with Alcatel’s warnings earlier this year, added costs related to its investment in emerging markets and new technologies such as next-generation mobile equipment weighed on the company’s operating margins, leading to a more than 25% drop in operating profit from a year earlier (to 278 million euros).

Alcatel’s chairman and chief executive officer Serge Tchuruk said he was not satisfied with the 9.4% operating margins the company reported for its wireline communications group (better than the 6.9% of its enterprise group but worse than the 10.6% of its wireless group) but that it was a necessary evil in the aggressive pursuit of new technologies and markets. “We’re in a business where, if you want to go into new areas, be prominent in the new next-gen products, you have to accept some costs before you get the reward,” he said. “We have clearly done so. If we were to have said, ‘Let’s not be aggressive,’ we could make a 10% margin. We have decided--and I take full responsibility for that--not to do it.”

In addition, the most fertile markets for next-generation mobile technology are also among the most challenging, he said. “The driving market has been the emerging world, where our market share is 15% to 25%, depending on the region. It has never been an easy market. It requires a lot of know-how.” As early as next year, he said, the developing world could become more than half of the global next-gen mobile market.

With regard to next-generation, or NGN, mobile core products, Tchuruk added, “I’d be very surprised if we don’t see the first indications of reward in the first quarter of next year. The marketplace is not crowded on this particular type of technology. We really hope to break through on this.”

At the same time, Alcatel absorbed some criticism for missing out on some big contracts related to the IP multimedia subsystem (IMS) architecture, especially in the wake of announcements from Lucent Technologies, for example, which recently reported winning IMS-related contracts from SBC and Cingular Wireless.

“We probably haven’t gone as fast in NGN and IMS as we would have liked to, but we hope to make up for lost time,” chief operating officer Mike Quigley said.

Meanwhile, Tchuruk called Alcatel’s results in the wireline segment, driven by triple-play deployments, “the first recovery in that segment since 2001.” The company pointed to a rapid acceleration in sales its IP DSLAMs, which accounted for less than 10% of its product shipments at the beginning of the year but are expected to be about a quarter of all product shipments in the fourth quarter. Alcatel’s revenues from IP routing should exceed that from multiservice wide-area networking equipment (which includes legacy frame relay and ATM technology) in 2006, Quigley said.

The company didn’t paint a rosier picture for the fourth quarter, however, predicting growth to slow in the wireless sector and flatten in the wireline sector while declines in the private networking group continue.

“We believe Alcatel will probably face another quarter during which it will incur costs preparing itself for addressing new markets with new technologies (emerging markets, NGN in mobile, etc.),” Jean-Charles Doineau, Ovum-RHK’s Telecoms Technology Practice Leader said in a statement issued today. “The challenge will definitely be the payback period."