Debt problems dog Lucent

Like a worm crawling along a razor's edge, Lucent Technologies is in the delicate position of having a very slim margin for error. The vendor's financial position continued to deteriorate last week, as both Moody's Investors Service and Standard & Poor's downgraded their ratings on the vendor's debt to a step above “junk” status. In addition, Lucent revealed it has yet to close a $4.5 billion credit facility announced in January.

Although they exist only on paper, credit ratings have practical implications. For Lucent, that includes virtually shutting the company out of the market for commercial paper, or short-term debt. Lucent's short-term debt was downgraded to “Prime-3” by Moody's, making it extremely difficult for the vendor to raise money at a reasonable rate of interest, said Bob Ray, Moody's senior vice president.

In addition, the credit-rating change limits Lucent's operational flexibility—particularly the ability to offer vendor financing—and raises the cost of any new borrowings, said Lawrence Harris, analyst at Josephthal & Co.

Because Lucent is experiencing negative operating cash flow, those new borrowings are necessary to fund its $1.6 billion restructuring plan and continuing operations.

Lucent's cash outflows for fiscal 2001 are expected to be huge, according to Steve Levy, analyst at Lehman Brothers. Levy predicts a 24% decline in sales for Lucent in 2001—including its microelectronics spin-off Agere—and losses in each of the remaining three quarters.

“If it were not for a sizeable tax-credit benefit, the outflow from cash operations would total at least $4 billion,” Levy said in a recent research note.

But Lucent is not in a cash crunch—at least not yet. As of Dec. 31, 2000, Lucent had $3.8 billion in cash on hand and was in the process of negotiating $6.5 billion in credit facilities. That $6.5 billion includes a $4.5 billion, 364-day credit facility from J.P. Morgan and Salomon Smith Barney that was announced in January.

However, that financing deal is not complete, according to a recent 10-Q Lucent filed with the SEC. The ratings downgrade means the terms will be more expensive for Lucent. In addition, Lucent's current untapped $2 billion line of credit expires on Thursday, Levy said.

Lucent denies that closing the deal or the expiration of the current credit line would pose a problem. “We have sufficient cash to fund our operations for the near term and may not draw on these credit lines for some time to come,” said a Lucent spokeswoman.

In the short term, Lucent's most important milestone is the initial public offering of Agere. Slated for the end of March, the deal could reap as much as $3.75 billion, which Lucent could use to reduce its $8.1 billion debt load.

“After they separate out Agere, they'll have the IPO proceeds, which will substantially reduce short-term cash needs,” said Bruce Hyman, a director at S&P. “As soon as you get past April 1, the balance sheet starts to look better.”

Cash from the IPO and the $2.5 billion in proceeds from the sale of Lucent's power systems business to Tyco International will trim Lucent's gross debt and help keep the company's rating at investment grade. But spending needs, operating cash deficits and the potential funding of committed vendor financing obligations may dull the net effect, according to Ray.

“The costs of implementing the cost-reduction efforts are going to offset some of the debt reduction,” Ray said.

For example, the amount of vendor financing on Lucent's books—a source of concern for analysts and investors—continues to grow. “[Lucent] has $3 billion in financing commitments that could be drawn at any time, creating a need for liquidity,” according to a Moody's report.

In addition, Lucent is negotiating a $1.6 billion loan to Telefonica to build out its third generation wireless network and may need to do more financing of wireless operators' 3G needs to maintain its market position in CDMA wireless gear.

Meanwhile, Lucent's long-term survival depends on the execution of the cost-cutting plan, cultural reform—most notably, ending deep software discounts and the pursuit of questionable carriers' accounts—and the shedding of unprofitable product lines. For example, Lucent announced that it was dropping its PathStar product line, a voice-over-IP gateway that was in trials with cable operators.

“They are looking to sell off anything that's not nailed down,” Levy said.

At the same time, Lucent has to restore its credibility with customers, ramp revenues for new products, and start getting the right products out to market promptly, Hyman said. All that will be a tall order in a market with contracting growth.

“It's unfortunate the company is going through these issues when many carriers are expressing reluctance to spend on new equipment,” Harris said.