Let's call the whole thing off

With the cancellation of talks to merge equipment giants Lucent Technologies and Alcatel, Lucent has suffered yet another ugly bruise to its injured image. The questions now are how Lucent will survive this most recent blow and how it will proceed.

The proposed deal between the two companies — rumored to range between $23.5 and $32 billion — potentially could have let Lucent escape its tailspin. The deal was so close to being finalized, the companies reportedly drafted press releases announcing the merger. But differences emerged at the management level, which caused Lucent to become hesitant and pull out of negotiations.

Although it's not clear which party initiated the discussions, Lucent ended them after much of the senior management detected that the proposed deal would not be a “merger of equals,” said a source close to Lucent. That fact disturbed some of the long-standing management, who sensed they could be displaced soon after the deal's completion.

“Alcatel's CEO [Serge Tchuruk] and Henry Schacht got along fine,” said David Boland, senior product manager for Equipe Communications, a competitor of Alcatel and Lucent. “It was the Lucent and Alcatel senior management that had problems. Lucent felt it wouldn't get enough seats on the board.”

Other reports indicated that Schacht wanted the chairman spot and that Alcatel resisted.

Although a merger with Alcatel may have appeared to be a parachute for Lucent, the logic behind the deal is questionable. With Alcatel's strong presence in Europe and Asia and Lucent's strong U.S. customer base, the deal sounded good on the surface.

“In theory, it made a lot of sense,” said Lawrence M. Harris, managing director at Josephthal & Co. “With Lucent as a key supplier to providers like AT&T and the RBOCs, and Alcatel as a leading supplier in Europe and Asia, it would have been attractive.”

But turning around Lucent while trying to blend two different corporate cultures would have been challenging, Harris said. And supporting two product lines performing the same functions would have been troublesome, he added.

“Do they continue to develop both?” he asked. “How would they consolidate?”

Most agree the combination could have worked in the wireless arena with Alcatel and Lucent having differing strengths in GSM and CDMA products, respectively. But 75% of their product lines overlap, Boland said.

“There were very little product synergies between the two companies,” he said. “Their only synergies were geographical. This really had little to do with technology; it was more to do with globalization.”

Lucent must pick up the pieces. But the failed merger attempt is just one of the long string of devastating events for the company.

The ugliness started when the company missed earnings in January 2000 by 18¢ per share and had a steep decline in sales. That was followed by technology misses such as Lucent betting on OC-48, while Nortel Networks went with OC-192.

“Lucent's equipment is solid,” said Doug McEuen, senior analyst at Pioneer Consulting. “It is just that some of their decisions have hurt them.”

Because of its size and considerable debt — credit-rating agencies are expected to scrutinize Lucent after downgrading its debt to one step above “junk” status — it will be difficult for Lucent to merge. While companies such as Nokia, Ericsson and Siemens may sound like good partners, they may lack the money or inclination to buy Lucent. Also, Lucent may not be interested.

“We are focusing on our restructuring plan, and we have made significant progress with it,” said a Lucent spokeswoman. “We are continuing to execute on that.”

But executing the restructuring plan can't happen soon enough, Harris said. “They will have to move more quickly on things such as head-count reduction and facility disposals,” he said.

Harris believes Lucent has three options: it can merge or sell the entire company, sell the company in pieces or go it alone. At this point, Harris believes Lucent should restructure to try to resurrect the company.

While Lucent has made a habit of selling or spinning off units, selling attractive divisions such as the optical equipment division would leave the company with gaping holes (see figure). And assets such as its metro optical division may be its only hope, according to McEuen.

“Whether or not metro alone can be their saving grace is tough to call,” he said. “It might not save them, but it could put them in the right direction.”

Although Lucent has posted notable contract wins with Verizon Wireless for a 3G network and with Qwest Communications in a large DSL deal, some believe the Alcatel merger snafu will make sales even more difficult for Lucent.

“They will have to work a lot harder to win over the minds of carriers,” McEuen said. “It's not just the Alcatel incident that will make carriers second-guess Lucent. That was already going on.”

Lucent competitors see the collapse of the deal as a way to Lucent customers. Confusion created in the market is an opportunity for smaller, newer companies to step in and win service provider business, Equipe's Borland said.

“It will be a great opportunity for us.”

Lucent has divested several divisions in an effort to boost revenues

Lucent Power Systems

Power division sold to Tyco International in November 2000 for $2.5 billion. Now known as Tyco Electronics Power Systems

Avaya Communications

Enterprise communications division was spun off last year, with all shares being distributed as a stock dividend to Lucent shareholders

Optical Fiber Solutions

On the auction block. Bidding on division led to full merger talks with Alcatel

Agere Systems

Microelectronic division's IPO generated a disappointing $3.6 billion for Lucent. Spinoff is expected to be finalized in September

Competitors' wish list

Bell Labs — Lucent's crown-jewel R&D arm Wireless — A leader in CDMA networking Optical Networks — Lambda Router shows potential