Description

Lucent Technologies is trading at replacement value, excluding the expected
spin-off by year-end. Replacement value is around $6 per share, Agere is
worth $2.00 on an after-tax basis. The risk of liquidity concerns for the
company are being abated, Lucent is deleveraging its balance sheet, and has
plenty of cash on hand to burn through and to continue to invest in R&D.
Needless to say, any improvement in overall tech cap ex spending will bode
well for company - the upside in the stock is 30% to todays fair value and
70%+ with modest assumptions in cap x spending. Supporting these upside
opportunities, the company has identifiable catalysts to spur stock price
appreciation.

Lucent seems to out of liquidity risk: Lucent ended the quarter with $3.069

billion in cash, $77 million in short-term debt, $3.262 billion in long-term

debt, and $1.885 billion in convertible preferred debt. Lucent still has
access to $4 billion in short-term credit facilities, but has no drawn
balance on them. It is very likely that Lucent will burn an additional $3.0
billion in cash in fiscal 2002 and $406 million in fiscal 2003. The current
cash on hand and existing credit facilities should provide Lucent ample
liquidity as long as the company does not violate any of its debt covenants.

Lucent still plans to spin out Agere by June. However, in order to do so,
Lucent must show neutral or positive EBITDA as defined by its debt covenants

in its credit facility in the March quarter. The risk of not having a
positive EBITDA by the March quarter is limited. If Lucent does not achieve

neutral or positive EBITDA in the March quarter, the company believes it
will be able to secure another extension from the IRS to implement a
tax-free spin of Agere at a date later than June of this year. Lucent is a
quarter-by-quarter story. The company had revenues of $3.5 billion last
quarter, which were down 27% sequentially, and 9% year-over-year. Gross
margins were 13.7%, which was up from the previous quarters gross margins
of 11.5%. The low gross margins were do to one-time items and low volumes.
Lucent is guiding to gross margin above 20% for the March quarter, with
volumes and product mix expected to have the most impact. The longer-term
target of 35% is tied to the success of new products, ongoing cost
reductions, additional volume, and product rationalization. The balance
sheet for the company is in good shape and getting better. Account
receivables DSOs were 84 (still high!) but down from 88. Inventory turns
also improved to 4.4x down from 4.6x. Cash flow from operations was
negative but improved from the pervious quarter. The company is also
deleveraging: Total debt decreased to $3.339 billion from $4.409 billion as

Lucent used the $2.1 billion in cash from the sale of its optical fiber
business to pay down debt. Cash increased to $3.069 billion from $2.39
billion while total vendor financing exposure declined dramatically to
$2.487 billion from $5.314 billion. Mobility and Integrated Network
Solution (INS) divisions had sequential improvement in China, but were down
in all other major regions. Within INS, all product areas were down
sequentially in double digits with Optical being down more significantly
than Switching/Access. On a geographic basis, overall revenues were down 26%

and 29% sequentially in the United States and internationally, respectively.

Mobility showed sequential declines in the United States and internationally

of 30% and 7%, respectively. INS sales showed sequential declines in the
United States and internationally of 22% and 34%, respectively. INS has
several potential catalysts based on what I have read. These include: (1)
Dramatic capital spending reductions by wire line operators in the United
States and overseas. (2) A major transition in several Lucent product areas
in optical and data networking. (3) Continued rapid declines in legacy
circuit switching products without a ramp of next-generation soft switch
products.



Valuation on asset value:
Last Q Assessed
Cash and Equivalents $3,069 100% $3,069
Receivables 3,204 70% 2,243
Inventories 2,731 70% 1,912
Contracts 783 60% 470
Deferred income taxes 2,639 100% 2,639
Other 1,945 60% 1,167
Total current assets $14,371 $11,499

PP&E 3,059 80% 2,447
Prepaid pension 4,739 100% 4,739
Deferred income taxes 3,064 100% 3,064
Goodwill 1,357 0% 0
Other 2,339 70% 1,637
Discontinued 1,270 60% 762
Total Assets $30,199 $24,149

Replacement value of Lucent
Assets $24,149
Total debt $3,339
Net Asset $20,810
Shares out 3,400
Replacement worth of Lucent $6.12

Agere value to Lucent
Stock price $5.25
Shares owned buy Lucent 1,635
$8,584
Tax (reduced tax exceptions included) 20%
1,717
After-tax proceeds $6,867
Shares out 3,400
Value of Agere $2.02


TOTAL VALUATION
Worth of Lucent $6.12
Value of Agere $2.02
Total value $8.14

Catalyst

1. Short-term: the abatement of financial distress concerns.
2. The spin-off of Agere Systems: The value of Agere to Lucent owners is about $2 per share based on Agere’s stock price of $5.25. See my valuation model. From the last conference call, Lucent also expressed confidence it could get an extension beyond June for a tax-free spinout of Agere if needed. The company also continues to expect revenues to grow 10%-15% sequentially in the current March quarter.
3. Top line catalysts in the increase in capital spending in the technology sector.
4. Catalysts from gross margins: Besides a sector recovery, we would view the success of new products within optical (Lambda Unite, Lambda Extreme, Metro EON, DMX) and wireless (OneBTS) as a sign that margins will improve into the 30%-plus area.
5. New Chief Executive