Moody's Lowers Rating on Alcatel-Lucent (ALU) from B2 to B1, Outlook to Stable
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Moody's Investors Service has today downgraded Alcatel-Lucent's (NYSE: ALU) debt ratings to B2 from B1 and changed the previously negative outlook on the ratings to stable. The downgrade affects both the Corporate Family Rating (CFR) and the Probability of Default Rating (PDR). Concurrently, Alcatel-Lucent's senior debt ratings were downgraded to B3, LGD5 (75%) from B2, LGD5 (75%) and the ratings for the two convertible bonds of Lucent that have been guaranteed by Alcatel-Lucent on a subordinated basis have been downgraded to Caa1, LGD5 (77%) from B3, LGD5 (75%).
RATINGS RATIONALE
Today's one-notch downgrade of Alcatel-Lucent's ratings was driven by Moody's view that, in 2012 again, the company will not be able to generate positive free cash flows from continuing operations. Moody's notes that Alcatel-Lucent has been consuming cash from operations since the 2006 merger between Alcatel and Lucent Technologies, and that, because of continued pressure on its operating performance, visibility of when the company might start to generate cash for debt reduction is limited. At the same time, the rating agency notes the dwindling options for further asset monetisations without materially affecting profits, further to the conclusion of the disposal of the highly profitable Genesys operation in Q1 2012. Alcatel-Lucent's future cash consumption could be absorbed by its currently substantial cash reserves, which could be bolstered further by increased royalty collections resulting from the agreement with RPX. However, Moody's notes that the reserves are finite and that the company's funds from operations continue to be weak.
In view of lacklustre investment activity among European telecoms companies and the technology shifts into areas in which Alcatel-Lucent is less competitive than in legacy products, Moody's believes that the company's successes in IP routing/switching, High Leverage Networks and selected markets, like USA, China and France, are likely to be insufficient to ensure material revenue growth for the company in 2012. Given the sustained fierce price competition, especially in view of the market share strategies of its leading competitors, Moody's believes that Alcatel-Lucent's plan to cut EUR200 million of its annual fixed costs, together with additional EUR300 million reductions in variable cost, may still prove insufficient to achieve reasonable profitability.
Despite recording weak revenues and operating losses in Q1 2012, Alcatel-Lucent's management was able to contain cash burn to around EUR100 million in the quarter (which is slightly below that of Q1 2011), although a large part of this was attributable to working capital releases in connection with lower business volumes. Moody's believes that sustained cash generation will require fundamental improvements in product positioning and cost structure, since opportunities for sustained reductions in working capital have been largely exhausted.
Alcatel-Lucent's rating is underpinned by its solid liquid balances. After consuming almost EUR4.0 billion cash in the five years since the merger, the company's reported cash and marketable securities remained substantial at EUR5.2 billion at the end of March 2012. However, Alcatel-Lucent's liquid resources are constrained by (i) cash needs for operations (estimated by Moody's to amount to 3% of sales, or around EUR500 million); (ii) around EUR1.1 billion cash held in countries in which it is subject to exchange controls; and (ii) upcoming debt maturities of around EUR930 million in the next 15 months including the US$765 million (EUR599 million) 2.875% Series B convertible bonds due in 2025, with a 15 June 2013 put option. The net balances still leave almost EUR2.7 billion headroom for cash burn, but the cushion is shrinking. Weak funds from operations and volatile working capital requirements raise the probability that Alcatel-Lucent may continue eroding its sizable liquid resources.
Moody's stable outlook for Alcatel-Lucent's ratings assumes that the company will achieve stable revenues and positive operating profit in 2012 by implementing cost savings. Alcatel-Lucent's liquidity position should have a comfortable cushion if the company shows a path towards positive free cash flow for 2013, by continuing on an improving trend over 2011.
WHAT COULD CHANGE THE RATINGS UP/DOWN
The B2 rating would come under downward pressure if (i) the operating margin as adjusted by Alcatel-Lucent does not trend up towards a mid-single-digit margin, (ii) if Alcatel-Lucent fails to reduce negative cash flow from continuing operations to below EUR300 million in 2012 (having recorded negative EUR590 million for the last 12 months) with a trend towards positive thereafter, or (iii) if cash and cash equivalents were to decline below 40% of gross adjusted debt (60% at the end of Q1 2012).
Although currently unlikely, upward rating pressure would require Alcatel-Lucent to generate a material LTM free cash flow and to sustain sales growth and an operating margin of above 5%.
RATINGS RATIONALE
Today's one-notch downgrade of Alcatel-Lucent's ratings was driven by Moody's view that, in 2012 again, the company will not be able to generate positive free cash flows from continuing operations. Moody's notes that Alcatel-Lucent has been consuming cash from operations since the 2006 merger between Alcatel and Lucent Technologies, and that, because of continued pressure on its operating performance, visibility of when the company might start to generate cash for debt reduction is limited. At the same time, the rating agency notes the dwindling options for further asset monetisations without materially affecting profits, further to the conclusion of the disposal of the highly profitable Genesys operation in Q1 2012. Alcatel-Lucent's future cash consumption could be absorbed by its currently substantial cash reserves, which could be bolstered further by increased royalty collections resulting from the agreement with RPX. However, Moody's notes that the reserves are finite and that the company's funds from operations continue to be weak.
In view of lacklustre investment activity among European telecoms companies and the technology shifts into areas in which Alcatel-Lucent is less competitive than in legacy products, Moody's believes that the company's successes in IP routing/switching, High Leverage Networks and selected markets, like USA, China and France, are likely to be insufficient to ensure material revenue growth for the company in 2012. Given the sustained fierce price competition, especially in view of the market share strategies of its leading competitors, Moody's believes that Alcatel-Lucent's plan to cut EUR200 million of its annual fixed costs, together with additional EUR300 million reductions in variable cost, may still prove insufficient to achieve reasonable profitability.
Despite recording weak revenues and operating losses in Q1 2012, Alcatel-Lucent's management was able to contain cash burn to around EUR100 million in the quarter (which is slightly below that of Q1 2011), although a large part of this was attributable to working capital releases in connection with lower business volumes. Moody's believes that sustained cash generation will require fundamental improvements in product positioning and cost structure, since opportunities for sustained reductions in working capital have been largely exhausted.
Alcatel-Lucent's rating is underpinned by its solid liquid balances. After consuming almost EUR4.0 billion cash in the five years since the merger, the company's reported cash and marketable securities remained substantial at EUR5.2 billion at the end of March 2012. However, Alcatel-Lucent's liquid resources are constrained by (i) cash needs for operations (estimated by Moody's to amount to 3% of sales, or around EUR500 million); (ii) around EUR1.1 billion cash held in countries in which it is subject to exchange controls; and (ii) upcoming debt maturities of around EUR930 million in the next 15 months including the US$765 million (EUR599 million) 2.875% Series B convertible bonds due in 2025, with a 15 June 2013 put option. The net balances still leave almost EUR2.7 billion headroom for cash burn, but the cushion is shrinking. Weak funds from operations and volatile working capital requirements raise the probability that Alcatel-Lucent may continue eroding its sizable liquid resources.
Moody's stable outlook for Alcatel-Lucent's ratings assumes that the company will achieve stable revenues and positive operating profit in 2012 by implementing cost savings. Alcatel-Lucent's liquidity position should have a comfortable cushion if the company shows a path towards positive free cash flow for 2013, by continuing on an improving trend over 2011.
WHAT COULD CHANGE THE RATINGS UP/DOWN
The B2 rating would come under downward pressure if (i) the operating margin as adjusted by Alcatel-Lucent does not trend up towards a mid-single-digit margin, (ii) if Alcatel-Lucent fails to reduce negative cash flow from continuing operations to below EUR300 million in 2012 (having recorded negative EUR590 million for the last 12 months) with a trend towards positive thereafter, or (iii) if cash and cash equivalents were to decline below 40% of gross adjusted debt (60% at the end of Q1 2012).
Although currently unlikely, upward rating pressure would require Alcatel-Lucent to generate a material LTM free cash flow and to sustain sales growth and an operating margin of above 5%.
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