19 Feb L’affaire ALCATEL: enfin, le complot est démasqué. Translation: how to stiff the French with bad assets when you don’t work for an I-Bank
Have you followed the strange fate of the $14.8 BN merger involving ALCATEL, the French telecommunication conglomerate, and ATT’s now-defunct spin-off, Lucent Technologies Inc.? That mythical transaction, which has been shedding red ink ever since it closed, was consummated on December 1, 2006, and with much fanfare, we might add. At last, ALCATEL had a pied ä terre in the USA. What could be better than this?
Actually, bankruptcy would have been better.
While the deal was effectively a take-over of Lucent by the French giant, it turned out, most likely for political reasons, that the former CEO of Lucent Technologies, the American Patricia Russo, was duly nominated as the first post-merger CEO. She did not last too long, as was to be expected from someone attempting to run a quintessentially French company-cum-government bureaucracy who doesn’t speak French.
The last happy day for shareholders of the “new” ALCATEL was the day the deal closed. Meanwhile, former Lucent shareholders have been ecstatic ever since. The smartest guy in the room was probably the ALCATEL CEO Serge Tchuruk, who bowed out gracefully after the deal was sealed. He has been thanking God ever since that he wasn’t around to see so much value destroyed so quickly, by so few people, without a single shot being fired. During the last quarter of 2012, led by the Dutchman Ben Verwaayen, the company wrote off another $1.9 BN, bringing total write-offs post-merger to a staggering $16 BN. Frankly, weapons of mass destruction couldn’t do any more damage.
How could such a promising trans-Atlantic love affair go so wrong, so fast? Didn’t Patricia know the fate of An American in Paris? A company can’t serve two masters, much less a master and a mistress.
So much seemingly unavoidable pain, so quickly after the merger, ought to evoke suspicion from people who don’t appreciate being played like grand pianos, or at the very least, concern all men of good will. Could a debacle of such magnitude on the Richter scale simply be an Act of God, a perfect storm? Even better, yet another unpredictable, fiendish “Black Swan” of gigantic proportions? Yeah, right! If Black Swans were more than the figment of a garden-variety trader’s limited imagination, I would actually feel better. For then, I would be able to blame everyone else but the one man truly at fault: the garden-variety trader!
ALCATEL – Lucent: the Untold ‘Fable de Lafontaine’
To understand the true story of such a monumental échec a little better, we must turn back the clock, long before this ill-fated merger was ever discussed but not before it was conceived, to 2002. Lucent Technologies spun off an entity whose eternal mission was to carry the torch of ATT-style American creativity and competitiveness into the 21st Century: Agere Systems. Quietly executed without hoopla , this transaction effectively sealed the fate of ALCATEL’s acquisition of Lucent in 2006. In 2007, Agere Systems was re-incarnated as LSI Inc., a San Jose-based company with growing revenues of $600 MM per annum, 54.1% gross margins, $676 MM of liquid or short-term investments and zero debt. LSI is, and ought to be, a darling of the Street, and it has more financial and operational flexibility than ALCATEL-Lucent will ever have.
The breaking up of a single, dying company into two asymmetric units is nothing new. I learned this trick at about 14 years of age, from my uncle Manny, who himself had learned it from Bill Zeckendorf. The idea is to reposition all of the parent’s “good” assets into the first one and the “bad” assets into the second one, and then, reluctantly sell the jewel of the crown to a naïve buyer eager to make a great deal. How in the world can this be carried off? Isn’t it utterly obvious that the first company has all the good, valuable assets, while the second has nothing but crappy, bad assets? No, it’s not. Why not? My dear Watson, I give myself away when I explain myself. But here we go anyway.
It is a simple fact of economic life that insiders always see things coming from miles (or should we say kilometers) away while naïve investors are stuck with audited financial statements and other fictions that say whatever is most convenient or expedient at the time. (Financial statements only need to be “right” on December 31st. If they are wrong on January 1st, that’s cool. Any accountant worth his salt has no need to bother with what ordinary mortals call “reality” when accounting rules offer countless possibilities for alternative realities.) Just as a TV show has many possible, credible endings, companies have many possible beginnings. At least, TV shows carry disclaimers that they are fictitious accounts and any correspondence to actual characters and events is purely coincidental. Hollywood producers will gladly tell you that the main reason for artistic license is that God’s honest truth doesn’t have the same entertainment value. The truth of a company is always dynamic. Financial statements are always static. Distorting, linearizing time is the heart and soul of financial analysis; and the untangling of this mess is precisely how professionals set themselves apart from amateurs. Otherwise, all accountants would be great businessmen instead of what they really are: tools of corporate survival.
To be sure, if a promising future, earnings stability or “exciting growth opportunities” can be measured via static ratios, mistakes are made. At this very moment, how many companies do you believe are still manufacturing fax machines, not just selling them? I’ll bet the number is down to one or two at most. So, on average each of them has a 50% market share, which is a great figure by any measure except in pathological industries like credit rating agencies, where Moody’s and S&P each have market shares approaching 100%.
The time when a company’s numbers look their absolute best is when it is nearest to collapsing in an “unpredictable” Levi jump. I myself once worked for such a company down in Delaware: Hercules Inc. It experienced its best years just before it went bankrupt. As everyone knows, the easiest way for an industrial or pharmaceutical concern to look like a great buy is to eliminate all research and development expenses. Until it goes belly-up, the firm will be experiencing its “golden age.”So when a corporation announces it is splitting itself into two or three synergistic entities, watch out. Gullible investors and adolescent sell-side analysts may be fooled easily or bought cheaply, but the company insiders will have made their play long before that. The aftermath is the stuff of a sleazy, Harlequin romance.
The Rest of the Story
It should have been clear that Lucent and ALCATEL both had mega-sized government contracts on older, depreciated technologies that had a snowball’s chance in Hell of being renewed. Lucent knew this of course, and just forgot to mention it to ALCATEL’s management, which was gushing at the thought of owning an American dream, soon to become a nightmare. None other than Bonaparte himself, easily the greatest tactician of the 19th Century, used to say “never disturb your enemy while he’s making a mistake.” The gross margin on this equipment must have been astronomical.
By contrast, Agere’s emerging technologies, despite being recognized by insiders at the time to be the mantra of the future (high-speed storage, inter-connectivity, network acceleration, etc.) had yet to move into the money and thus, could obviously not support any debt. Even better, these technologies were positioned as costly, “senseless” R&D expenditures that had been dragging on Lucent’s earnings. The logic was thus inescapable: Lucent was the “smart” move into the American telecommunication equipment market, not to mention the ubiquitous, much-vaunted, and politically speaking, mostly unrealizable “synergies” cum economies of scale that would presumably accrue as a result. Gentlemen, this was truly a no-brainer, so to speak. The only remaining hurdle in the realization of this masterpiece was the identification of some eager buyer salivating at the thought of being allowed into this exclusive club. Frankly, the average ALCATEL manager should first have wondered why he would want to belong to a club that would invite a bureaucratic maze like ALCATEL to apply for membership. Did he not know that a large, well-appointed fortress like the Bastille could have been bought on the cheap on or about July 13th 1789?
Non-linear thinking is precisely the recognition that a seemingly amazing, so-called “deal” usually turns out to be a dog when time is properly taken into account. Once again, putting the analysis in the context of time is the difference between winners and losers. Winners are those who make up their mind fast and change it slowly, while losers are those who make up their mind slowly and change it fast. All ALCATEL had to do is to let negotiations drag on forever while pretending to remain deeply interested, to come to the unfortunate and rather obvious conclusion that they were being played. The price would have dropped like a rock, and they could probably have bought the whole kit and caboodle for under $5 BN.
Instead, tremendous shareholder value has been destroyed–value that will never come back. Only JM6 (Jean Marie Messier, moi-même, maitre du monde) has ever managed to do worse at Vivendi Universal. Even a monster like Jérôme Kerviel only lost $7 BN while another Frenchman (Bruno Iksil) apparently lost $6 BN at their respective banks. What’s wrong with these people anyway? ALCATEL should have told Lucent “Je vous ai compris” and left it at that. As Pyrrhus would surely have told the Sicilians long ago, one more such victory over the Americans and we are through!