Stumbling Lucent tries to get back on track

The company has an enormous portfolio of valuable patents and good prospects of a turnaround over the long haul, but it's trapped in a tough financial squeeze.

7 min read
To all appearances, Lucent Technologies is a behemoth that should easily crush all comers.

When it was spun off from AT&T five years ago, the communications, software and data-networking giant took with it the fabled Bell Laboratories, long the leader in telecommunications advances. Lucent shares soared from a split-adjusted initial public offering price of $6.38 in April of 1996 to a peak of $71.25 in March 2000. Last fall it boasted 126,000 employees in its growing worldwide operations.

But on four occasions since late 1999, the company was forced to warn it would fall short of financial targets. In October 2000, the company fired CEO Richard A. McGinn. And in January, Lucent executives faced a most humbling experience, announcing they were eliminating 10,000 jobs and imposing a $1.2 billion restructuring charge. Another 6,000 employees will leave Lucent when it sells two factories in Ohio and Oklahoma. The company had already said it would spin off its microelectronics and optical components businesses, stripping away another 16,500 employees. Altogether, the moves will cut the work force to about 90,500--28 percent below last fall's level.

"It is a stumbling giant, so to speak," says Wharton management professor Lawrence G. Hrebiniak.

Revenues from continuing operations fell to $5.84 billion in the quarter ended Dec. 31, from $7.91 billion in the year-earlier period, and the company reported a $1.02 billion loss for the quarter, compared with a $1.08 billion profit a year earlier. Investors were especially shocked that the quarter's revenue fell $500 million short of what the company had predicted only a few days before Christmas.

All these disconcerting events have been reflected in Lucent's stock price, which has fallen 75 percent, to about $18, in just 11 months.

Of course, many technology companies have suffered in that sector's slump. The share price of Lucent rival Cisco Systems has fallen by half, from $77.50 to around $37, while shares of another top competitor, Nortel Networks, have dropped from $86 last summer to about $38.

The rise and fall of a titan
But people who have studied Lucent say it is not just a victim of a market downturn. Its management culture can be blamed as well. Investor pessimism is reflected in Lucent's price-to-earnings ratio of about 48. By comparison, investors are still willing to pay a sharp premium for Cisco, which has a PE ratio above 88.

"Everyone thought the company would do wonderfully, but it has had a lot of problems," says Hrebiniak, who has served as a consultant to AT&T. In decades as a monopoly, Ma Bell became bureaucratic and slow moving, and Lucent took this culture with it when it was spun off, he said. These habits don't serve well in the newly competitive telecom environment. In 1999, for instance, competitor Nortel beat Lucent to market with a faster generation of optical telecommunications equipment, triggering Lucent's first warning about disappointing results.

"The managers needed to hit the ground running, to formulate competitive strategies," Hrebiniak said. "I just don't think the company was prepared to do that?It didn't see the competition it was going to get."

The soaring technology market pulled Lucent along in the late 1990s, masking its internal weaknesses, Hrebiniak added. That changed when conditions got tougher in 2000. "Market downturns have a wonderful way of showing the internal problems that organizations have."

"It's a typical example of what happens when a company in the Old Economy fails to adapt to the new pressures that we have right now--the e-commerce world that we have today," said Amiya Chakravarty, operations and technology management professor at Tulane's A. B. Freeman School of Business. Chakravarty had wide access to Lucent for eight months of study last year. His research centers on how e-commerce affects the flow of supplies in the process of creating finished products.

Lucent has had serious problems adapting to changes brought by the Internet, especially in the ways companies deal with their customers, Chakravarty said. In the Old Economy, a company that supplies a product like a car part would not be concerned about where the car manufacturer got its other parts. But in the New Economy, companies like Dell Computer and Cisco have adopted "the notion of total service to the customer," he noted. They do care about such things.

"The newer way of doing business would be, let me look at what my customer wants, the totality of his needs. If there are certain things I cannot do myself, I will come up with alliances or joint ventures with other suppliers, and together we will provide what the customer needs," Chakravarty said. Using the Internet, nimble companies can quickly build, modify and terminate such partnerships. Cisco actually builds very little itself: "Their competitive edge is managing the total chain, and this is where Lucent has not done very well at all."

Something old, something new
Lucent is more comfortable with traditional approaches, such as tooling up a factory to produce something new. In addition, Lucent has long been separated into divisions, which, at best, merely duplicate one another's activities, but, at worst, compete with each other, Chakravarty pointed out. "They are like little fiefdoms. Each division is run by different individuals. They are like companies within the company. It was not easy to make them work together toward the company's goals."

Wharton international management professor Bruce Kogut said Lucent is a "wonderful company" with an enormous portfolio of valuable patents and good prospects of a turnaround over the long haul. But it is trapped in a tough financial squeeze. Lucent is a longtime financial sponsor of the Reginald H. Jones Center for Management Policy, Strategy and Organization, which Kogut runs.

It takes enormous amounts of capital to develop new telecom products. But Lucent is not in a position to sell more stock, does not have profits to fund research and development, and is being viewed warily by the debt markets.

In January the company said it had obtained a new $4.5 billion credit line from J.P. Morgan Chase and Salomon Smith Barney. But paying off the new debt takes precedence over paying off older debts, making existing bondholders nervous. The old bonds already have been downgraded. "Lucent is very sensitive to a cash squeeze," Kogut said, noting that some competitors have greater internal resources on which to draw. General Electric, for instance, has a ready source in its GE Capital financial services arm.

The cash-flow problem led Lucent to offer buyers deep discounts in an effort to grow sales. Observers like Chakravarty say that while discounts are common as the end of each quarter approaches, Lucent sometimes went further by promising discounts down the road as well. Some believe this started a vicious spiral, with discounts begetting a greater need to book sales to generate cash.

In one instance, Chakravarty said, the company thought about inserting an outside distributor between itself and some of its customers. That would allow the company to move products out of its own inventory, where they were a drag on performance until sold. It would have been a kind of accounting sleight of hand to make the company's sales look better than they were. It wasn't done, but demonstrated the kind of thinking that was becoming prevalent, he said. Such a move would run counter to the best practices today, which emphasize eliminating middlemen, not adding them, he added.

Putting on a pretty face
The pressure to dress up financial results became clear in December, when Lucent announced it was restating results for the quarter that ended in September. The company admitted it had been overly aggressive in recording sales--to the tune of $679 million. The restatement provoked shareholder lawsuits claiming the earlier, higher statements constituted fraud. These came on top of other suits claiming investors had been misled about financial results. There are several dozen suits in all, seeking billions in damages.

The board has replaced McGinn, who lost the optical communications race with Nortel, with Henry B. Schact, the former chairman and CEO who oversaw Lucent's initially successful spinoff from AT&T.

Schact, acknowledging the company has a "focus and execution problem," has directed the cutback and reorganization plan. He is well regarded and seems to be aware of the cultural and structural problems analysts have described. But he was brought out of retirement as only an interim CEO while the board searches for a permanent one, and uncertainty about future leadership hangs over the company.

Schact said many of the job cuts will eliminate overlapping functions in sales and marketing. Hrebiniak agrees: "I think Lucent is doing the things it needs to do. It probably has a lot of fat in the system, and it needs to get that fat out of the way quickly?I think the company will be okay. It has a ton of good patents and decent technology. What Lucent has to learn is to get to market more quickly. It has to learn to get closer to customers and to satisfy them." Added Chakravarty: "What Lucent is doing right now is what it should have done a long time ago."

But the cutback and restructuring announcements, while generally supported by Wall Street, have yet to excite investors. Shares closed at $19.63 on January 24, the day of the announcement, up only 81 cents. In the next week they drifted back down to the pre-announcement level of around $18.

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