UPDATE: S&P Revises Outlook on Alcatel-Lucent (ALU) to Negative

December 21, 2012 8:27 AM EST
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(Updated - December 21, 2012 8:41 AM EST)

Standard & Poor's Ratings Services said today it had revised its outlook on French telecom equipment supplier Alcatel-Lucent (NYSE: ALU) to negative from stable. At the same time, we affirmed our 'B' long-term and 'B' short-term corporate credit ratings on the company.

The outlook revision primarily reflects our expectations of weak operating results and high cash flow losses in 2012, which if not contained in 2013 could impair the group's still strong cash balances, which support the ratings. Furthermore, our assessment of the group's liquidity profile, which we currently view as "adequate" under our criteria, could also weaken in light of the group's expected cash flow losses and sizable upcoming debt maturities of €0.6 billion in 2013 and €0.5 billion in 2014. This is particularly the case if the group does not extend the maturity of its €837 million revolving credit facility (RCF), due in April 2013.

In our base-case scenario, we forecast weaker revenues, margins, and free operating cash flows (FOCF) in 2012 and 2013 than in our previous base case. This is primarily due the group's weaker-than-expected first-half 2012 results and our anticipation of telecom carriers' continued cautious or delayed spending in light of high economic uncertainty, particularly in Europe, and fierce ongoing competitive pressure. Nevertheless, we expect seasonally stronger demand in the second half of 2012 and industry demand to catch up in 2013.

As a result, we forecast Alcatel-Lucent to report a year-on-year revenue decline of about 3% in 2012, followed by low-single-digit revenue growth in 2013. In addition, we expect the group's operating margin (as adjusted by Alcatel-Lucent) to drop to about break-even levels in 2012, compared with 3.4% in 2011. In 2013, we expect the group's operating margins to improve modestly to about 3%, chiefly on the back of higher sales volumes, an improved revenue mix, and significant cost-cutting. In the first half of 2012, Alcatel Lucent's revenues declined by 10% year on year, and its operating margin dropped by 4.9 percentage points to negative 3.7%.

In our updated base-case assessment, we anticipate that Alcatel-Lucent's FOCF will deteriorate to about negative €650 million-€700 million in 2012, compared with negative €539 million in 2011. This will mainly be due to higher operating losses and restructuring costs, which are only partly offset by modest working capital inflows and moderate proceeds from the group's plan to monetize its patent portfolio. We assume that the group will be able to generate about break-even FOCF in the second half of 2012, after negative FOCF of €674 million in the first half.

Consequently, we expect the group's cash balances, including short-term marketable securities of €5 billion as of June 30, 2012, to remain largely unchanged at year-end 2012, which supports the current ratings. Nevertheless, we expect cash balances to deteriorate meaningfully in 2013, primarily due to the expected repayment of €0.6 billion in debt and moderate negative FOCF. We expect continued cash flow losses in 2013, primarily because of higher restructuring costs, which are only partly offset by the expected improvement in revenues and operating margins.

The negative outlook reflects the possibility of a one-notch downgrade over the next six to 12 months if Alcatel-Lucent's currently strong cash position or adequate liquidity profile were impaired by significantly negative free cash flow generation through 2013. This could result from continually weak economic conditions, fierce competition, ineffective cost-cutting measures, or lower-than-expected proceeds from the patent monetization plan. In addition, we could take a negative view if the group did not extend the existing RCF in 2012 or if capacity under this facility materially declined.

We could revise the outlook to stable, if Alcatel-Lucent were able to generate about break-even free cash flow on a sustainable basis. We would also expect the group to maintain an adequate liquidity position, including meaningful cash balances and capacity under its RCF.

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