Alcatel / Lucent

Did Alcatel and Lucent announce their merger a day late? Since April 2 their combined value has slumped by €7bn, or a quarter, in spite of claimed cost synergies worth €9bn. The odds are that the deal should still go through at Alcatel’s shareholders vote on September 7 – it needs a two-thirds majority. Adjusted for dividends, Lucent is trading at only a 5 per cent discount to Alcatel’s offer. Still, before Lucent’s profit warning on June 26, there was, on average, no discount. That accident emboldened the critics, who have three points of attack.

The first is that Lucent is a legacy business with low emerging market exposure and reliance on CDMA – a 2G wireless technology with two big customers in the US but which is losing traction elsewhere. While this is true it does not mean that buying Lucent is necessarily value destructive. SBC astutely purchased a dying AT&T for its synergies and customer base. In the equipment world, Alcatel-Lucent, like the planned Nokia-Siemens combination, has the added merit of consolidating a fragmented industry.

The second criticism regards Lucent’s giant pension and healthcare schemes. The companies have played to their critics by endorsing the counter-intuitive presentation that US and European accounting rules demand. In fact, valuing assets at market prices and discounting liabilities at a conservative 5.5 per cent, Lucent’s net liability is about $2bn: material but not alarming. For the purposes of valuation, investors should completely ignore Lucent’s notional pension income and add $2bn to its enterprise value.

That leads to the most credible objection. On this basis Lucent’s EV is €10.9bn while it made a modest operating profit loss over the past 12 months. Alcatel should easily bat off claims about its strategy and Lucent’s legacy liabilities. On price, it is on trickier ground. Still, consolidation is the art of the possible.