S&P Upgrades Alcatel-Lucent (ALU) to 'B+'; Sees Reporting Positive FOCF Over Next 12 Months

Standard & Poor's Ratings Services said that it had raised its long-term corporate credit ratings on Alcatel-Lucent (NYSE: ALU) and its subsidiary Alcatel-Lucent USA Inc. to 'B+' from 'B'.

At the same time, we raised our issue ratings on the debt issued by Alcatel-Lucent and Alcatel-Lucent USA to 'B+' from 'B'. The recovery rating remains at '4', indicating our view of average recovery, at the lower half of the 30%-50% range, in the event of a payment default.

All the ratings, including our 'B' short-term corporate credit rating on Alcatel-Lucent, remain on CreditWatch with positive implications.

The upgrade reflects our expectation that Alcatel-Lucent will report positive post-restructuring free operating cash flow (FOCF) in the next 12 months, thanks to significant cost savings in recent quarters and lower restructuring costs in the future. It also reflects our view that Alcatel-Lucent's liquidity has improved to "exceptional" from "adequate."

In the second quarter of 2015, Alcatel-Lucent reported positive FOCF for the first time since 2006. It is on track to achieve its fixed-cost savings target of €950 million by the end of 2015 compared with the end of 2012, after reducing fixed costs by €746 million as of the second quarter of this year. We expect the company's cost base and restructuring outlays will further decline in the coming quarters because we understand the cost-cutting program (excluding synergies from the merger with Nokia) will soon be completed.

Consequently, we expect Alcatel-Lucent to report an improved operating margin of 6%-7% in 2015 and 2016, compared with 4.7% in 2014. We also anticipate that FOCF will be positive in 2016, after being at breakeven in 2015 and at negative €420 million in 2014. However, Alcatel-Lucent's financial risk profile remains constrained by our expectation of still-high Standard & Poor's-adjusted gross leverage ratios, including debt to EBITDA above 5x in 2015 and 2016, and close to break-even FOCF in 2015.

Our assessment of Alcatel-Lucent's business risk profile as "weak" reflects the company's still relatively low profitability relative to that of many peers, which is partly due to continued restructuring needs and smaller scale in the wireless business. In addition, the group faces volatile demand and fierce competition, particularly in the Wireless Access division, which in 2014 generated 36% of Alcatel-Lucent's revenues and ranked No. 4 worldwide with a 12% market share. These weaknesses are partly offset by Alcatel-Lucent's solid diversification in terms of technologies and products, as well as its leading positions in fixed-line access, internet protocol (IP), fiber optics transmission, and core network technologies.

We intend to resolve the CreditWatch on Alcatel-Lucent after its merger with Nokia closes, which we anticipate will occur in the first half of 2016. At this stage, we expect to equalize our corporate credit ratings on Alcatel-Lucent with those on Nokia after the merger.

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