Sources: Alcatel, Lucent in Merger Talks

PHILADELPHIA – French telecommunications equipment maker Alcatel is in talks to acquire struggling U.S. rival Lucent Technologies Inc. to form a global powerhouse serving many of the world's largest telecommunications customers, sources familiar with the situation said on Friday.

A decision may be reached "sooner rather than later," the sources said.

Negotiations, which have been held on and off over the past month, may heat up next week, and a deal could be forged by June, they said. One investment banker, who declined to be named, said Lucent has also talked to other potential suitors.

Alcatel and Lucent declined to comment.

If the two companies agree on a deal, Alcatel (CGEP.PA) would pay less than a 20 percent premium over Lucent's current stock price, the sources said. Lucent has a market capitalization of about $34 billion, while Alcatel's is about 43.6 billion euros, or $38.3 billion.

A deal would combine Lucent's strength in North America with Alcatel's power in Europe. Alcatel also would gain Lucent's renowned Bell Labs research and development arm, and its expertise in CDMA (code division multiple access) wireless technology, switching, transmission and core network products. Alcatel, meanwhile, has strength in edge network products, optics and digital subscriber line (DSL) technology.

"It makes sense for both, but it doesn't make a great deal of sense. They would both get something out of it, but it wouldn't be a compelling deal. There's many reasons why you'd want those two to be together, but none of them stands out," said Dresdner Kleinwort Wasserstein analyst Ariane Mahler.

Shares of Lucent gained 26 cents, or 2.65 percent, to $10.07 in heavy trading on the New York Stock Exchange. Alcatel stock was down 6.33 percent at 33.72 euros, underperforming the DJ Stoxx technology index which was up 1.68 percent at the time. Alcatel bond yields also widened by around 10 basis points on worries that a transatlantic combination with Lucent could lead to a credit rating downgrade.

The negotiations, which grew out of Alcatel's interest in Lucent's fiber optic cable business, come at a time when the industry is struggling with a slowdown in equipment spending by telecommunications carriers.

Those pressures have complicated Lucent's own internal problems. The company faltered with several product development missteps, management turnover and massive losses. Its stock has fallen about 82.5 percent over the past year and has underperformed the Standard & Poor's 500 index by about 80 percent.

Industry sources told Reuters last month that the initial talks between Alcatel and Lucent faltered because of differences on valuation and Lucent's apprehension about getting easy merger clearance from authorities in Washington.

"The question is whether or not Lucent management wants to be short-term oriented and respond to people upset by the share price, or if they believe in their brands and believe they can turn the ship around and really return true value to shareholders," said Richard Steinberg, president of Steinberg Global Asset Management, a Florida asset management firm.

"It's always easy to have a quick fix," he said. "The question is, is that really what's best for the employees, the shareholders and for the customers of Lucent? I don't think it is."

Steinberg said he would prefer that Lucent continue to shed non-core units and focus on its strengths. "Figure out what you're good and what you're not and run the business. Don't sell it to the French for a song and a dance," he said.

Lucent's financial woes and aging technology, as well as potential culture clashes, could cause substantial headaches for Alcatel, analysts said.

"It would be a major distraction to Alcatel management to make this integration work because it would require more layoffs, a lot of products that would need to be canceled and getting customer buy-in on product cancellations are not always easy,'' UBS Warburg analyst Nikos Theodosopoulos.

Analysts and portfolio managers have said Lucent could cut as many as 20,000 more jobs, or 22 percent of the work force remaining after the completion of the 15 percent reduction announced in January.

"The market does not like this deal, if it does happen, and is putting masses of pressure on Alcatel shares," said Simon Kirton of Aberdeen Asset Management. "The market thinks it will be difficult to integrate the two companies."

Alcatel also has its own problems. On Wednesday its shares tumbled after the company announced that a key client, Canada's 360networks, had delayed two major contracts.

In London, Standard & Poor's ratings agency on Friday placed Alcatel on creditwatch negative, citing suspension of the contracts. The agency also said that Alcatel's A long-term debt ratings and A-1 short-term ratings could be hit by any deal to buy Lucent.

Late last month, Alcatel scaled back its outlook for this year and said it would outsource mobile handset production to cope with slowing growth.

"Our advice would be that they should sort themselves out before they embark on trying to buy something almost as big as themselves," said a Paris-based trader.

Analysts at ABN Amro said a combination would dilute Alcatel earnings per share by as much as 75 percent in 2002 before any synergies. Potential cost cuts in R&D, manufacturing and marketing could produce annual savings of $1.5 billion to $2.0 billion.