January 13, 2014

Communications equipment vendors Alcatel Lucent (ALU) and Juniper (JNPR) currently constitute newsworthy counterpoints to each other in the domains of corporate and balance sheet strategy.

ALU, the result of a merger between what were (at the time) industry titans Alcatel and Lucent, has seen its share price climb from a little over EUR 1 in May to EUR 3.27 at the time of writing. The company appointed a new CEO (M. Michel Combes) in April and a new CFO (Jean Raby) and COO (M. Philippe Guillemot) in September. They implement a programme which had three key components: (1) a rationalisation of the company’s product portfolio and R&D efforts, (2) cost-cutting and (3) a EUR 956 million rights issue and a pair of senior note issues (~EUR 1 billion) designed to fund repayment of high-cost debt.

This restructuring involved shedding of non-core businesses, a willingness to invest less in key mobile markets dominated by large customers, and a focus on IP networking and ultra-broadband access. In effect ALU resolved, even at the risk of some customer relationships, to focus on excellence in a smaller number of key growth markets. Management’s rigorous focus on fixing the balance sheet supporting these initiatives deserves praise.

A more focused company was helped by improvements in certain market segments; ALU reported that Q3 2013 revenues climbed 7% and that gross margin increased almost 5% points versus the year prior period (to 32.6%). This is not to say that ALU has achieved a towering valuation: revenues of EUR 14.6 billion are set against an enterprise value of only EUR 10.3 billion (0.7x turnover, though this will rise as non-core divisions such as Alcatel Enterprise are sold).

Across the Atlantic a different debate about focus was taking place amidst the shareholder base of Juniper Networks. Juniper grew up as a core routing/networking provider but over time broadened its offerings into a variety of new areas, including network security.

Unlike Alcatel Lucent, JNPR trades at a somewhat loftier price/sales multiple. Buttressed by more reliable and impressive results (gross margins run almost double Alcatel’s), JNPR’s $4.6 billion of revenue supports a $10 billion enterprise value (almost 2.2x). Juniper recently appointed a new CEO (the former Chief Technology Officer of Barclays Bank).

Yet activist hedge fund Elliot Management has decided that Juniper lacks focus. In a move clearly designed to provide strategic direction for both the new CEO and the board, Elliot issued a presentation calling for $200 million of reductions in corporate expenses, the buyback of $2.5 billion of common shares (the company boasts $2.8 billion of cash) and a review of non-core routing operations with a consequent “focus on projects and areas where Juniper has clear competencies and the greatest risk-adjusted return on investment”. Elliot’s proposal echoed ALU’s drive towards augmented focus, but differ in the desire to drain the cash reserves. Technology companies have historically aimed for balance sheet architectures laden with cash: this is a consequence of the industry tendency towards sudden and dramatic swings in demand, and a consequent need to fund corporate re-invention.

Elliot has, of late, been targeting more and larger technology companies. Riverbed Technology (RVBD) received a $3 billion offer from the fund, an offer clearly designed to provoke and stimulate other potential strategic acquirers. Elliot also concluded a standstill agreement with Compuware (CPWR), which had a similar public disagreement with Elliot and which will now accept two Elliot nominees onto its board.

Spurred by Elliot’s proposals and news of its 6.2% stake, JNPR shares rose 7,5% in initial trading. Juniper’s response was tepid, noting that it had not received Elliot’s presentation and that it welcomed “constructive input”.

It is hard not to conclude that the trend amongst public investors will be to favour technology companies that narrow their focus and aim for product excellence and market leadership in key segments. This has been a highly effective strategy during certain market periods. On the other hand it is not always clear how to take a large company and steer it, its R&D team and its sales and marketing forces unerringly towards the hottest segments.

The communications equipment industry is grappling with the development of software defined networking and software defined data centres. The era dominated by the powerful “box” is fading. Communications technology firms must perforce make decisions regarding new products and resource allocation within the context of a shifting market, investor calls for focus, and the reality that public markets investors can trade in and out of a position much faster than a communications technology R&D programme can be brought to successful fruition.