I recently became long the shares of Alcatel-Lucent and believe the stock could be a strong performer in the next few months. I also believe the rational for being positive on ALU also holds true for the telecom equipment sector as a whole, although ALU likely offers a higher relative return, although with more risk, than other stocks in the sector. I believe that combination of the telecom equipment sector being out of favor for most of 2012 and an improving and no longer weakening telco capital spending environment, will make for solid stock returns for telco equipment suppliers in 4Q12 through 1H13. I think high beta names like ALU, are likely to show the most significant returns over this period.
Specific to ALU, my main two points on becoming positive on the shares are the postponement of any bankruptcy risk and the improving telco capital spending environment. While I am not sure if ALU will ever hit their 2015 financial targets, these targets are so far out into the future that they are not likely to be that relevant to the stock in the next six months if the risk of bankruptcy has been delayed by a couple of years and telco spending is showing signs of improvement. ALU is still a very risky stock, but it appears to me the upside potential outweighs the downside potential over the next six months.
Bankruptcy Risk Dramatically Reduced: On December 14th, ALU secured a 1.6B Euro credit facility. While the company had to pledge part of its patent portfolio and according to the press its “crown jewel” IP routing business to secure this credit facility, the new facility will allow ALU to financially move forward with its 1.25B Euro cost reduction program. While not eliminating the potential of a bankruptcy in the future, this new facility delays this potential outcome for several quarters if not 2-3 years. Even one of the sell side analysts that is still negative on ALU shares wrote that this new credit facility “extends the window of survival for the group from 2015 to 2018.” Well, if the risk of bankruptcy has been extended to 2018, and sentiment is very negative on the shares, it seems to me that the stock can work for the next 3-6 months if anything positive happens beyond the new credit facility.
Telco Capex Is Cyclical and Poised to Improve: I believe ALU, and other telecom equipment stocks, will have a positive first six months of 2013 as telco capital spending is poised to improve after a difficult 2012. This is especially true in the US mobility market. The acquisition/investment in Sprint by Softbank, the T-Mobile/PCS merger and the increased capital spending plans outlined by AT&T at its analyst day in November clearly suggest that the Verizon/AT&T duopoly in the US Mobility market is about to be challenged. This challenge will partly be in the form of strong network investment by the challengers Softbank/Sprint and T-Mobile/PCS. Telecom equipment stocks tend to do well when major telcos are investing heavily to win share against each other. After showing a flat year in spending growth in 2012, the US mobile market is likely to show capital spending growth of at least 10% in 2013. We are also even seeing signs of wireline capital spending stability by major telcos in both the US and Europe. Specifically, both AT&T and Deutsche Telekom have outlined upgrades to their wireline networks in 2013 that will lead to flat to growing capital spending growth in their respective wireline networks, after declining in 2012. Overall, both AT&T and DT will grow total capital spending in 2013 over 2012 on the order of 15%+.