What If The Wireless Unit Is Finally Sold? https://seekingalpha.com/article/3054526-alcatel-lucent-what-if-the-wireless-unit-is-finally-sold?
Apr. 7, 2015 9:25 AM ET | 1 comment | About: Alcatel-Lucent (ALU), Includes: ERIC, NOK
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
M&A is hot in the tech space and we remain convinced Alcatel-Lucent is the most obvious target in the telecom equipment segment.
A sale of Alcatel-Lucent’s large Wireless unit would make great strategic and financial sense.
In our view, the stock could be worth more than $6 ex. Wireless.
While it seems as if there's not a single day without M&A in the Pharma & Biotech space, we now see the M&A spree expanding to other tech sectors as illustrated by the recent NXP (NASDAQ:NXPI) - Freescale (NYSE:FSL) and Hewlett-Packard (NYSE:HPQ) - Aruba (NASDAQ:ARUN) deals.
In our view, the potential Intel (NASDAQ:INTC) - Altera (NASDAQ:ALTR) deal is a sign of more to come, specifically in the telecom equipment space, as such a deal would give Intel a credible offering in programmable chips and push its server technology into the wireless networking space (virtualized networks).
We stick to our view that the most obvious M&A opportunity in the telecom equipment segment is Alcatel-Lucent (NYSE:ALU). While the company's turnaround is a reality, Alcatel-Lucent is still hampered by its legacy businesses, notably the wireless division which was loss-making last year. Rumors about a potential sale of the business to Nokia (NYSE:NOK) thus make sense as such a deal would allow Alcatel-Lucent to focus on its fastest growing and most profitable assets (IP, SDN, NFV) and would provide Nokia with the opportunity to become the number 1 player in wireless (on par with Ericsson (NASDAQ:ERIC)) and to materially grow earnings amid tough market conditions thanks to revenue and cost synergies.
While the strategic rationale is pretty obvious, the financial merits of a Wireless disposal are also a no-brainer as we see two likely positive implications for the Alcatel-Lucent stock price.
First, while Wireless accounts for a large part (35%) of the company's revenue, it is currently valued by analysts below EUR2bn/$2.2bn or less than 0.5x sales, which is not really surprising for a loss-making or poorly profitable business. But given Nokia's ability to extract significant synergies and to use in the future Alcatel Wireless' huge tax loss carryforwards (Alcatel-Lucent had EUR11.5bn/$12.5bn of tax loss carryforwards at end 2014, many of them being related to Wireless), we believe Nokia could offer at least a 0.7-0.8x sales multiple (the mid-point between the current valuation and that of European peers) or EUR4bn/$4.4bn, suggesting EUR0.70/$0.80 per share upside. We show different multiples and outcomes in the sensitivity analysis table below.
Source: AtonRâ
Second, we believe that a Wireless disposal would spark a significant rerating of Alcatel-Lucent's core business. The company reported a 4.7% operating margin last year and is expected to deliver this year a high-single digit margin. But when excluding Wireless, the picture is much more attractive: Alcatel had an 8.7% margin last year and would generate as soon as this year a margin in the low teens, hinting at a yearly EPS around EUR0.25/$0.27.
That would put Alcatel-Lucent on par with its European peers Nokia and Ericsson and would justify similar valuation multiples. When applying the multiples of Nokia and Ericsson (around 20x 2015) to Alcatel-Lucent's EPS, we get to a EUR5/$5.4 valuation for the core business. This, combined with the Wireless upside, would lead to a valuation around EUR5.7/$6.2 for Alcatel-Lucent.