From the beginning, Lucent Technologies Inc.'s spinoff of Agere Systems Inc. has been dogged by problems and miscalculations.
First, Agere's initial public offer-ing price was repeatedly slashed in the first half of this year as Lucent, in a desperate bid to raise capital, loaded the unit with $2.5 billion in debt and then pushed ahead with the shaky share sale.
This week, Lucent's cash problems resurfaced, and again Agere's fate and hopes for full independence hang in the balance. To strengthen its financial position, Lucent said this week it will postpone by six months the final leg of the Agere spin- off, a move that highlights the communication equipment maker's precarious financial situation, according to analysts.
"The possible delay of the distribution of Agere shares is disappointing, which we believe is indicative of [Lucent's] intention to closely manage its available cash over the next several quarters," said Christin Armacost, an analyst at SG Cowen Securities Corp. in Boston.
Lucent's cash position did improve in the June quarter, to $2.3 billion from $1.4 billion in March, but analysts said the company still has a long way to go. To survive, Lucent's management is holding onto its Agere lifeline and has opened discussions to modify the terms of a financial agreement signed with lenders, including J.P. Morgan Securities and Salomon Smith Barney Inc., before Agere went public in April.
"We're in discussions with our banks to amend the covenants under our credit facilities," said Frank D'Amelio, Lucent's senior vice president and chief financial officer, during a conference call with analysts. "We may explore an alternative plan for achieving full independence for Agere through a secondary offering of the Agere shares held by Lucent."
All signs point to the fact that Lucent's stockholders, who had been promised a free distribution of Lucent's 58% stake in Agere by Sept. 30, may receive only a portion of that amount, if any. Analysts said Lucent is still in the intensive-care unit despite several months of cost-cutting, reduced vendor financing, and tighter inventory and receivables management.
"While we were impressed by Lucent's expense controls and cash improvement during the June quarter, we believe the company continues to struggle to achieve meaningful growth and profitability," said Paul Silverstein, an analyst at Robertson Stephens Inc., San Francisco. "Lucent's June quarter was very similar to Nortel's recently reported June quarter, with continued weakness in demand and visibility."
Agere sees possible conflict
A troubled Lucent is bad news on several fronts for its microelectronics and optical components unit. First, Lucent's majority stake in Agere means the company cannot independently determine its future, as management acknowledged in a recent Securities and Exchange Commission filing.
"We'll be controlled by Lucent as long as it owns a majority of our common stock, and our other stockholders will be unable to affect the outcome of stockholder voting during that time," Agere said in the filing. "We may have potential business conflicts of interest with Lucent with respect to our past and ongoing relationships, and because of Lucent's controlling ownership, the resolution of these conflicts may not be on the most favorable terms to us."
Partly due to the continuing concern about Lucent's relationship with Agere, and also because of the current market downturn, the chip maker's stock price has stayed in the $6-per-share IPO range since April, according to Drew Peck, an analyst at SG Cowen. On Thursday, Agere's shares closed at $5.55, down from its high of $9.50.
"The stock overhang should be prolonged," Peck said. "The impending release of Agere shares has been well publicized and largely discounted since the original offering."
That's not all. An insolvent Lucent could pose a major hazard to Agere's financial health. Aside from being its majority owner, Lucent is also Agere's principal customer, accounting for 15% of the company's sales in the quarter ended March 31, down from 21% in the March 2000 quarter.
The extent of Lucent's problems was demonstrated in last week's announcement that the company plans to cut up to 20,000 jobs in addition to the 24,500 full-time and contract positions eliminated since January.
The latest job cuts will cost the company approximately $2 billion in cash and between $7 billion and $9 billion overall, hence the decision to push off plans to distribute its Agere shares and instead raise additional funds by conducting a secondary offering.
In order to distribute the Agere shares to its stockholders, Lucent must first generate $2 billion in nonoperating cash to be paid to its lenders under the terms of a loan agreement it signed earlier this year. The $6.5 billion credit facility was secured with substantially all of Lucent's assets, including its Agere stake.
Lucent could have easily met that target if fate had not thrown a wrench into its financial engine as slowing demand for telecommunications equipment crippled its sales while spiraling vendor financing and manufacturing costs reduced its cash.
This week the company unveiled several transactions that are expected to boost its cash position. It sold its fiber optic cable unit to Japan's Furukawa Electric and Corning for a total of $2.75 billion. It also agreed to sell its Columbus, Ohio, facility to EMS provider Celestica for between $550 million and $650 million (see sidebar below).
When Lucent announced its fiscal third-quarter results last week, the company noted that its accounts receivables had de- creased sharply, to $4.6 billion from $6.1 billion, in the March quarter, while inventories declined more than $1 billion sequentially.
"Our aggressive management of inventory, combined with our intense focus on collection, improved cash flow from operating activities by more than $1.54 billion in the quarter," D'Amelio said. "This is the second quarter in a row that we have collected about $6.5 billion."
More hurdles to clear
As commendable as these steps have been, Lucent still faces major hurdles in its operations, some of which bear directly on Agere. Sales have continued to drop and were at $5.8 billion in the June quarter, down 22% from $7.4 billion in the year-ago quarter. And the company still carries a hefty vendor financing commitment of $5.5 billion, though down from $6.9 billion in the prior quarter.
Lucent's gross margins have also come under severe pressure. The company posted a gross margin of 16% in the June quarter, down from 17% sequentially and 42% in the year-ago period.
"While the sale of the company's fiber optics business could significantly reduce the level of capital Lucent needs to invest in its business, we think Lucent still needs to significantly raise its gross margins on its remaining business," Robertson Stephens' Silverstein said. "Unless Lucent significantly improves its gross margins, we believe it will eventually bleed its cash resources dry."