TEXT-S&P revises Alcatel-Lucent outlook to negative
Overview -- We expect French telecommunications equipment supplier Alcatel-Lucent to report higher cash flow losses in 2012 and 2013 than we anticipated, due to telecom carriers' more cautious spending and fierce ongoing competition. -- We are revising our outlook on Alcatel-Lucent to negative from stable, but affirming the 'B' ratings. -- The negative outlook reflects the possibility of a downgrade over the next six to 12 months if the group's currently strong cash balances and adequate liquidity profile were impaired by continued significantly negative free cash flow or a lack of refinancing. Rating Action On Aug. 13, 2012, Standard & Poor's Ratings Services revised its outlook on French telecom equipment supplier Alcatel-Lucent to negative from stable. At the same time, we affirmed our 'B' long-term and 'B' short-term corporate credit ratings on the company. Rationale 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 EUR0.6 billion in 2013 and EUR0.5 billion in 2014. This is particularly the case if the group does not extend the maturity of its EUR837 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 EUR650 million-EUR700 million in 2012, compared with negative EUR539 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 EUR674 million in the first half. Consequently, we expect the group's cash balances, including short-term marketable securities of EUR5 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 EUR0.6 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. Liquidity The short-term rating on Alcatel-Lucent is 'B'. We view the group's liquidity as "adequate," as defined in our criteria, and calculate that liquidity sources should exceed liquidity needs by about 1.2x in the 12 months from June 30, 2012, and by more than 1.3x in 2013. As of June 30, 2012, we estimate the company's liquidity sources at about EUR2.7 billion for the next 12 months and at about EUR3 billion in 2013. These include primarily: -- Surplus cash. As of June 30, 2012, we calculate surplus cash at about EUR2.5 billion. We deduct about EUR2.5 billion from the group's reported cash and short-term marketable securities of EUR5.0 billion, which we consider to be tied to the operations and seasonal working capital needs, or held in countries subject to exchange control restrictions (about EUR1.2 billion as of Dec. 31, 2011), mainly China. The group conducts a significant proportion of its operations via a 50%-owned joint venture in China. In addition, because Alcatel-Lucent is active in many countries and has captive insurance and finance subsidiaries (both regulated), we believe that other material cash balances may not be immediately available for liquidity purposes. As of June 30, 2012, the group reported cash and equivalents of EUR2.9 billion and short-term marketable securities of EUR2.1 billion; and -- Moderate positive funds from operations (FFO) before capitalized development costs in 2012 and about EUR0.4 billion in 2013, compared with EUR0.2 billion in 2011. We do not include the group's undrawn EUR837 million RCF in our 12-month liquidity assessment because the RCF matures in April 2013 and has not yet been refinanced. We estimate liquidity uses of up to EUR2.2 billion. These mainly include: -- Annual capital expenditures of about EUR0.6 billion; -- Sold accounts receivable of more than EUR0.8 billion (Alcatel-Lucent reported outstanding amounts of EUR952 million as of Dec. 31, 2011, and EUR846 million as of June 30, 2012). While we understand the sale of such receivables to be nonrecourse to Alcatel-Lucent, we view them as essentially short-term instruments and debt-like in nature; and -- Debt repayments of EUR0.6 billion in June 2013 if holders of the group's Series B convertible bond ($765 million outstanding as of June 30, 2012) exercise their put options. We understand, however, that Alcatel-Lucent could choose to repay part of the convertible bond in shares. We expect Alcatel-Lucent's cash flow generation to remain seasonal, including more favorable working capital developments in the fourth quarter than in other quarters. However, we also expect these patterns to be somewhat influenced by revenue developments and the company's working capital management. Recovery analysis The unsecured notes and the unsecured revolving facility issued by Alcatel-Lucent and its subsidiaries are rated 'B'. The recovery ratings on the notes and revolving facility remain at '4', indicating our expectation of average (30%-50%) recovery prospects for unsecured lenders. Furthermore, we maintain an issue rating of 'CCC' on the group's convertible trust preferred securities. Our hypothetical default scenario concentrates on the company utilizing existing cash balances due to high operating losses, assuming a continually weak operating environment, with constrained capital expenditure budgets from telecom carriers and increased competition among telecom network equipment providers. In addition, we assume that research and development costs will remain significant as the company continues to develop products to remain innovative. We also assume meaningful restructuring costs in light of falling revenues and intense price pressure. We estimate the group's stressed enterprise value at the hypothetical point of default in 2015 at about EUR3.2 billion. In addition, we assume that Alcatel-Lucent would repay debt on the path to default through cash balances and that holders of the Series B convertible notes would exercise their put options in 2013. However, we also assume that Alcatel-Lucent would retain an RCF, leading to average (30%-50%) recovery prospects for noteholders after deducting prior-ranking claims. We note that recovery prospects may be weaker than we currently envisage should the company incur secured debt on the path to default, for example, if Alcatel-Lucent were to refinance its RCF on a secured basis. Outlook 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. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated. -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Alcatel-Lucent Corporate Credit Rating B/Negative/B B/Stable/B Alcatel-Lucent USA Inc. Corporate Credit Rating B/Negative/-- B/Stable/-- Ratings Affirmed Alcatel-Lucent Senior Unsecured (2 issues)* B Recovery Rating 4 Senior Unsecured (2 issues) B Recovery Rating 4 Alcatel-Lucent USA Inc. Senior Unsecured(4) B Recovery Rating 4 Preferred Stock CCC *Guaranteed by Alcatel-Lucent USA Inc. (4)Guaranteed by Alcatel-Lucent. Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.