Over the past several months I have written often about my positive view on the communications equipment sector, particularly stocks with exposure to service provider capital spending. One of my favorite names as a play on this theme has been ALU. I continue to remain favorable on stocks exposed to service provider capital speeding and in particular, ALU. This week, the sector has had a strong performance, and I think the bias will likely continue to be positive in the coming months. The main drivers to the sector performance this week were:
1. Positive earnings and outlook from Ciena on Tuesday as well as its positive commentary on the global 100G optical spending cycle
2. Positive mid-quarter bookings commentary from the CEO of Juniper at a Wall Street Investor conference on Tuesday as well as his positive commentary on the service provider router market
3. The sale of Vodafone’s stake in Verizon Wireless back to Verizon for $130 billion, of which about half will be in the form of cash. Vodafone is likely to use part of this cash to increase capital spending in its other properties in Europe, which could form the beginning of a capital spending recovery in Europe.
Specific to ALU, there were two other perceived positives:
1. The sale of Nokia’s cell phone/device unit to Microsoft, which will add over $7 billion in cash to Nokia’s balance sheet. Investors are hoping that once the device unit sale closes in 4Q13, the dramatic increase in cash at Nokia will enhance the probability of Nokia acquiring the wireless division from ALU. Earlier in the year Nokia bought out Siemens’ portion of the NSNS JV and, together with other divestments in wireline infrastructure, has become focused primarily on wireless infrastructure and services. A potential sale ALU’s wireless business to Nokia is something I have written about in the past as being a positive for ALU if it were to occur given ALU’s lack of scale in wireless. Such a sale make ALU a more focussed company and more of a pure play on IP Routing and Optical where it has scale and technology leadership.
2. The new CEO of ALU, Michel Combes, spoke at an investor conference and emphasized his number one priority is generating positive cash flow, in a great part through successful implementation of his “Shift” restructuring plan and generating at least $1 billion in asset sales. I think Michel is more willing to consider a sale of the wireless unit (or part of it) than the prior CEO, but I think it is fair to say he will continue to focus on improving the wireless division’s margins and revenue growth rather than hope or depend on an asset sale as the main course of action. Michel seems more focused on returning ALU to profitability and positive cash flow than the prior management team and less wedded to the prior strategy of keeping ALU being an end-to-end equipment supplier. The fact that ALU hired an ex investment banker as its new CFO, also suggests “deal making” to enhance the cash position of the company may be a higher priority than in the past.
My sense is the positive spending commentary from Ciena and Juniper, the likelihood that European spending can only get better given a more cash rich Vodafone and the beginning of the 4G LTE upgrade cycle from China Mobile starting in 4Q13 will continue to provide a positive backdrop for technology companies exposed to service provider capital spending. While Cisco’s surprisingly soft earnings report from a few weeks ago put a damper on the sector, most of Cisco’s issues were related to tough year ago comparisons in Japan, weak spending from certain emerging markets and China (which may partly be due to political issues) and a declining set top box business. These are not indicative in my view of the service provider spending catalysts I mentioned above.
I continue to be positive on ALU and remain long the stock but highlight that it remains a volatile stock, especially after the very strong performance of over 200% off the bottom in the past year.
Disclosure: NT Advisors LLC may in the past, present or future solicit and/or generate consulting revenues from any company mentioned in this post.