M&A Impact: Lucent Ascends to Data Networking Dreams

Computergram International, March 8, 1999

Since it was spun out from AT&T in 1996, Lucent Technologies has been acting more like a Silicon Valley start-up than a 123-year- old maker of phone equipment. Its shares have soared from $13.5 on April 4 1996, the day the company went public, to a high of $120 on January 8 1999 and the company had consistently produced profits and posted revenues above market expectation.

Until the end of January, that is, when Lucent broke its stride and reported a fiscal first quarter with sales well below revenue forecasts, even though profits were above expectation. Instead of reporting $10bn in revenues for the quarter, Lucent recorded $9.2bn. The news fueled worries that Lucent was going the same way as rivals, MCIWorldCom, Bell Atlantic and BellSouth, which are all suffering from a slowdown in telecoms equipment sales.

Lucent's long anticipated announcement to acquire Ascend for $20bn in stock, which came just days after the quarterly report, was enacted to reverse this tide. By purchasing the industry's fourth largest data networking vendor with a portfolio of Frame Relay, ATM and remote access equipment, Lucent hopes to stem its hemorrhaging revenues by moving into higher growth markets. It's particularly keen to move among the internet service providers where demand for Ascend's data networking products is greatest. More than 70% of internet traffic travels over Ascend equipment at some point and 90% of Ascend's revenues come from ISPs, according to Richard McGinn, CEO at Lucent.

As they transform their circuit-based analog systems to pack- switched digital networks over the next decade, carriers will continue to make hefty investments in data networking products. So the need for a telecoms companies like Lucent to unite with a networking companies such as Ascend becomes increasingly crucial. Lucent hopes to leverage its relationship with carriers to supply products for the older circuit-based systems as well as newer IP- based networks.

Ascend's ATM technology, in particular, is key to Lucent's data networking future as ATM switches become the principal vehicle through which all data traffic is routed - at least until IP networks reach the stage where they can supplant them in their ability to handle voice and data traffic.

Although the market is still in its infancy - the data networking market has been valued at $45bn this year - just 10% of the total communications equipment market, its revenue growth rate is twice that of standard telecoms equipment, according to Paul Johnson at BancBoston Robertson Stephens. Today, 80% of carrier revenue comes from voice traffic and 20% from data but McGinn believes carriers will start to see an equal revenue split between voice and data in the next five years. Consequently he is bolstering the company's data networking portfolio to capitalize on this projected market shift.

So far Cisco has dominated this market with a 55% share with Lucent owning just 2% of the market, according to Johnson. But with the Ascend acquisition, Lucent is poised to go after Cisco and now has a market leading set of ATM products with which to do so. Cisco is slated to start selling ATM equipment by July and Lucent would not have been able to compete in this market place without Ascend's ATM switches. "Cisco might have a little more time to move than its rivals," says Frank Dzubeck, at Communications Network Architects, who argues that Lucent still needs to integrate Ascend's ATM into its own core offerings before it can be truly considered a competitor. Nortel meanwhile is still dealing with its $9.1bn acquisition of Bay Networks last August.

But Lucent is bullish. CEO, McGinn, has set the ambitious target of growing Lucent's revenues by 20% this year to $36bn, excluding Ascend revenues. To put that into perspective no other $30bn company has achieved that growth rate according to Standard & Poors. The leader in the networking segment, Cisco, has been growing at 35% but Cisco is less than one-third Lucent's size. For McGinn to deliver on th is goal, Lucent must win $6bn in new business this year, while Cisco will need to generate just half of that sum to continue its growth rate.

Furthermore, the Lucent/Ascend merger has sparked off another round of consolidation in the data networking space that could make Lucent's growth ambitions even harder to achieve. Two of Lucent competitors in the carrier market place, Alcatel and Siemens bought their way into this market last week. Alcatel announced its intentions to purchase Xylan for $2bn. Elsewhere the German telecomms giant of Siemens formed an American subsidiary and acquired two privately held US data networking vendors, Castle Networks for $300m in cash and Argon Networks for $240m in cash. Siemens is also reported to be negotiating a deal with 3Com to buy its unit that sells networking equipment to telephone companies. This will therefore further encroach on Lucent's data networking ambitions.

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