Moody's Lifts Outlook on Alcatel-Lucent (ALU) to Positive; Expects Credit Metrics to Continue Improving

Moody's Investors Service has changed to positive from stable the outlook on Alcatel-Lucent's (NYSE: ALU) B3 corporate family rating (CFR) and B3-PD probability of default rating (PDR). Concurrently, Moody's has affirmed Alcatel-Lucent's B3 CFR, B3-PD PDR as well as the group's existing instrument ratings (Caa1 for outstanding convertible notes, and B3 senior unsecured ratings).

"The positive outlook reflects our view that Alcatel-Lucent's credit metrics could improve following the company's stronger-than-expected results in the last nine months," says Roberto Pozzi, a Moody's Vice President -- Senior Credit Officer and lead analyst for Alcatel-Lucent. "Moreover, if Alcatel-Lucent is able to sustain the ongoing improvement in operating margins and cash flow generation, we could consider upgrading its ratings over the next 12-18 months."

Outlook Actions:

..Issuer: Alcatel-Lucent

....Outlook, Changed To Positive From Stable

..Issuer: Alcatel-Lucent USA, Inc.

....Outlook, Changed To Positive From Stable

Affirmations:

..Issuer: Alcatel-Lucent

.... Probability of Default Rating, Affirmed B3-PD

.... Corporate Family Rating (Foreign Currency), Affirmed B3

....Senior Unsecured Conv./Exch. Bond/Debenture (Local Currency) Jul 1, 2018, Affirmed Caa1

....Senior Unsecured Conv./Exch. Bond/Debenture (Local Currency) Jan 30, 2019, Affirmed Caa1

....Senior Unsecured Conv./Exch. Bond/Debenture (Local Currency) Jan 30, 2020, Affirmed Caa1

....Senior Unsecured Regular Bond/Debenture (Local Currency) Jan 15, 2016, Affirmed B3

..Issuer: Alcatel-Lucent USA, Inc.

....Senior Unsecured Regular Bond/Debenture (Local Currency) Jan 1, 2020, Affirmed B3

....Senior Unsecured Regular Bond/Debenture (Local Currency) Nov 15, 2020, Affirmed B3

....Senior Unsecured Regular Bond/Debenture (Local Currency) Jul 1, 2017, Affirmed B3

RATINGS RATIONALE

Alcatel-Lucent's B3 CFR reflects the company's persistent negative profitability and large negative free cash flows stemming from a highly competitive industry, subdued investments from telecom operators, major competitors' aggressive marketing strategies and continued very sizeable restructuring efforts. These credit negatives are to some extent mitigated by the company's entrenched market position and long-standing customer relationships, its large installed base and a solid liquidity position with moderate leverage on a net of cash basis. Alcatel-Lucent is currently executing a new strategic plan announced in June 2013 that is repositioning the company as an IP Networking and Ultra Broadband specialist whilst managing its Access activities for cash.

Today's outlook change to positive reflects Alcatel-Lucent's improving results in the last 12 months and Moody's improved expectations with regard to the company's operating performance and cash flow generation over the next year. In the 12 months to end September 2014, revenues declined by 5% to EUR13.3 billion mainly due to a reduction of non profitable contracts, whilst EBITDA rose by 44% to EUR1.5 billion (Moody's adjusted) from 2013 levels, resulting in a debt/EBITDA of 6.4x, compared to 10.1x in 2013. Although improving, the company's free cash flow after restructuring costs remained negative at approximately EUR0.7 billion (Moody's adjusted), compared to a negative EUR0.9 billion in 2013. The group's core Networking business reported an underlying operating margin of 8.2% and was cash flow positive in the first 9 months of 2014 whilst the Access division (including wireless and fixed access) reported an operating margin of 0.7% and negative cash flow over the same period.

Whilst recognising the company's improving operating performance, we also highlight its very weak track record in terms of profitability and, especially, free cash flow generation, as well as the risks associated with the ongoing strategic repositioning of the company. Legacy products still generate over one third of the company's core Networks revenues, whose rate of decline is highly uncertain, whilst a possible decline in US carrier spending -- (AT&T recently announced a 15% reduction in capex next year) could negatively affect Alcatel-Lucent's wireless business in the US (around 20% of group revenues).

Moody's currently expects Alcatel-Lucent's operating margins (Moody's adjusted) to improve towards mid single digits over the next 12-18 months but its free cash flows (Moody's adjusted) to remain negative, albeit at a reduced level.

LIQUIDITY

Since the beginning of 2013, Alcatel-Lucent has tapped the debt capital markets several times and refinanced a major part of its 2015-16 debt maturities. These transactions have allowed the company to extend the maturity profile of its debt, thus gaining flexibility to implement cost reduction measures and to exit or restructure unprofitable managed services contracts and geographic markets.

Alcatel-Lucent's liquidity profile is adequate based on the availability of around EUR4.9 billion in cash, cash equivalents and marketable securities reported at the end of September 2014. Estimated cash needs for operations of around EUR450 million (3% of revenue) and about EUR0.8 billion of cash and marketable securities held in countries subject to exchange controls, the company's liquidity comfortably covers debt maturities in the next 12 months and expected continued negative free cash flow in 2015. The company has debt maturities of EUR195 million in 2016, EUR517 million in 2017, EUR629 million in 2018, EUR688 million in 2019 and EUR1.6 billion in 2020, followed by EUR1.3 billion maturities between 2028-29.

WHAT COULD CHANGE THE RATING -- UP/DOWN

The rating could be upgraded if Alcatel-Lucent's operating performance and cash flow generation improves further on a sustainable basis, as evidenced by operating margins (Moody's adjusted) to be in the mid-single digits, debt/EBITDA below 6x, expected to be predominantly driven by an improvement in EBITDA, and if Alcatel-Lucent stopped the cash burn with free cash flow turning positive sustainably. For an upgrade, the company would also need to maintain adequate liquidity.

Negative rating pressure would develop if the company's recent improvements in operating performance were expected to reverse. Quantitatively, the B3 rating would come under pressure if operating margins reversed towards zero, debt/EBITDA remained above 6x, or negative free cash flows after restructuring failed to reduce to manageable levels. Negative pressure would also develop if we expected the company's liquidity to deteriorate.

The principal methodology used in this rating was the Global Communications Equipment Industry published in June 2008. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

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