February 13, 2015

Alcatel-Lucent

(ALU-NYSE)

Current Recommendation

OUTPERFORM

Prior Recommendation

Neutral

Date of Last Change

02/13/2015

Current Price (02/12/15)

$3.92

Target Price

$4.75

SUMMARY We are upgrading our recommendation on Alcatel-Lucent to Outperform from Neutral, due to robust fourth-quarter 2014 results. The company reported a positive earnings surprise of 150% benefiting from its ongoing repositioning through The Shift Plan that was formulated in 2013. It is now shifting focus from older technologies (2G and 3G wireless equipment) to high-potential newer ones like Internet routing. Also, management intends to trim approximately 15% of costs by 2015. As of Feb 6, 2015, the total cost savings represent over 70% of the targeted savings through The Shift Plan. Moreover, the company saw strong IP Routing revenues, thanks to new deals and new product introductions. Going forward, Alcatel-Lucent aims on leveraging innovation to drive growth and generate positive free cash flow from this year.

SUMMARY DATA 52-Week High 52-Week Low One-Year Return (%) Beta Average Daily Volume (sh)

$4.37 $2.36 -7.33 2.29 8,050,163

Shares Outstanding (mil) Market Capitalization ($mil) Short Interest Ratio (days) Institutional Ownership (%) Insider Ownership (%)

2,766 $10,843 1.87 3 1

Annual Cash Dividend Dividend Yield (%) 5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%) P/E using TTM EPS

$0.00 0.00

-3.7 N/A N/A

23.1

P/E using 2016 Estimate

16.3

Zacks Rank *: Short Term 1 3 months outlook

Type of Stock Industry Zacks Industry Rank *

2 - Buy

Large-Blend Communications 65 out of 267

ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $)

2013 2014 2015 2016

Q1

Q2

Q3

Q4

Year

(Mar)

(Jun)

(Sep)

(Dec)

(Dec)

4,261 A

4,795 A

5,043 A

5,313 A

19,516 A

4,079 A

4,393 A

4,074 A

4,598 A

17,144 A

3,491 E

3,830 E

3,993 E

4,527 E

15,841 E 16,291 E

Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses)

Q1 (Mar)

196.0

P/E using 2015 Estimate

Average,

Risk Level *

2013 2014 2015 2016

Q2 (Jun)

Q3 (Sep)

Q4 (Dec)

Year (Dec)

-$0.20 A

-$0.08 A

-$0.11 A

$0.08 A

-$0.73 A

-$0.01 A

-$0.06 A

-$0.01 A

$0.10 A

$0.02 A

-$0.02 E

$0.02 E

$0.06 E

$0.11 E

$0.17 E $0.24 E

Projected EPS Growth - Next 5 Years %

* Definition / Disclosure on last page 1 EUR = $1.2489 (period average from Oct 1, 2014 to Dec 31, 2014)

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9

OVERVIEW Based in Paris, Alcatel-Lucent is a leading global provider of IP and Cloud networking, ultra broadband fixed and mobile access. The company started its restructuring strategy The Shift Plan , an initiative taken by the CEO Michel Combes in 2013. The Shift Plan is a company strategy intended to reposition and establish itself as the specialist of Internet Protocol (IP) and Cloud networking, ultra broadband fixed and mobile access. The three-year long plan is scheduled to be completed by 2015. Notably, the company has already seen improvement in its cash and balance sheet position in the past few quarters. The company operates its business in two primary segments: Core Networking and Access. Core Networking Segment (45% of revenues for 2014 came from this segment) Alcatel-Lucent is a world-wide leader in in the IP (Internet Protocol) market. The three main businesses of the Networks Group are IP Routing, IP Transport and IP Platforms. Together they provide end-to-end communications networks and individual network elements. The company s IP product portfolio of routers and switches support IP-based applications and services, which in turn monetize network investments of service providers and lessen customer agitation. The company provides state-of-the-art network infrastructure including trending services like emerging Software Defined Networking (SDN). IP Transport division of the segment specializes in providing infrastructures and services for enabling reliable and efficient optical transmission while cutting down the costs significantly. The company s IP Platform business has been designed to bring together the service providers and customers, in order to enhance the user experience while maximising the benefits from the data-driven technology. Access Segment (55%) Under this segment the company provides services through four business divisions namely, Wireless, Fixed Access, Licensing and Managed Services. The company is a leading service provider, for both wireless communications infrastructure and fixed broadband access, addressing the rising demand for broadband services across the globe. Apart from these services, the segment also holds licenses for various wireless, optical and data networking technologies. Further, the segment provides cost-effective managed services solutions for diverse industries to enhance their networks.

REASONS TO BUY Alcatel-Lucent came up with strong fourth-quarter 2014 results on the back of successful ongoing repositioning as per The Shift Plan, which was formulated in 2013. Under this, the company succeeded in repositioning and establishing itself as the specialist of IP and Cloud networking, ultra broadband fixed and mobile access. Now halfway through the plan, the company has already shifted its focus from the older technologies (2G and 3G wireless equipment) to potentially newer ones like Internet routing. Per the plan, management intends to trim costs by approximately 15% by 2015. In the fourth quarter, the company achieved fixed cost savings of about 30 million. As such, consolidated fixed cost savings under the plan currently stand at 675 million. As of Feb 6, 2015, the total cost savings represent over 70% of the targeted savings as per The Shift Plan. We expect this initiative to fuel its growth momentum and improve its quarterly earnings, going forward too. Alcatel-Lucent remains a beneficiary to the significant growth in both wireless and wireline networks across the globe. The increasing demand for wireless technologies and smartphones in the emerging markets coupled with next-generation super-fast 4G Long Term Evolution (LTE) technologies has Equity Research

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significantly boosted the company s performance. The company registered 11 new LTE contracts wins in the fourth quarter 2014 across North America and EMEA regions. With that, as of Feb 6, 2015, Alcatel-Lucent has 76 small sales customers and 133 mid wholesale portfolio contracts. Moreover, the company is benefiting from cloud infrastructure, which enjoys highest demand among wireless, semiconductors and software companies. This apart, Alcatel-Lucent is perfectly positioned in the structurally growing optics and IP Routing markets to gain from the growth in wireline infrastructure. In fourth quarter 2014, Alcatel-Lucent posted a robust double-digit rise in IP Routing revenues, with growth across all operating regions aided by customer wins. To further strengthen its IP Routing offering, Alcatel-Lucent enhanced its portfolio through the launch of technologically advanced products like Virtualized Service Router and the 7750 SR. Apart from this, the company expanded its global collaboration with HP to put in its IP routing and optical products into the latter s existing routing and storage portfolios. We believe such moves will boost the convergence of IT and telecommunications and pave the way for future bottom line strengthening. Alcatel-Lucent remains focused on strengthening its balance sheet by improving the cash balances and lowering debts. At the end of the year, the company s cash and cash equivalents increased to 5,550 million from 4,858 million as of Sep 30, 2014. Also, its free cash flow improved to 264 million from free cash flow of a negative 205 million, as of Sep 30, 2014. Apart from this, AlcatelLucent executed the capital opening of its subsidiary Alcatel-Lucent Submarine Networks (ASN) through an IPO and penned several contracts in the quarter under review. This is expected to strengthen the company s position in the telecom submarine systems and its diversification into the Oil & Gas industry. Also, the financing will enable a greater visibility and optimum capital distribution. Going forward, the company aims on leveraging innovation to drive growth and generate positive free cash flow from this year.

RISKS Alcatel Lucent faces tough competition in each of its product lines. The company faces intense competition from other key players like Avaya, Cisco Systems, Ericsson, Fujitsu, Huawei, ZTE and Nokia Siemens Networks (NSN). The rapid technological upgrades in the market make it necessary for the company to continuously improve its offerings in order to maintain its premier place in the industry. Furthermore, although Alcatel-Lucent s extensive business restructuring initiative bodes well for the long term perspective, it augments its near term debt level until it is completed. Hence, it remains a matter of concern for the company. Customer concentration is a major risk for the company. Alcatel Lucent is dependent on a few large customers for a significant percentage of its revenues. The contribution from the company s largest customers such as AT&T, Verizon and Sprint account for around half of its total revenues. The loss of one or more key customers or reduced spending by these service providers could significantly reduce revenues, profitability and cash flow.

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RECENT NEWS Alcatel-Lucent Q4 Earnings Excel on The Shift Plan

Feb 6, 2015

Alcatel-Lucent reported a positive earnings surprise of 150% in fourth-quarter 2014. In particular, the company declared adjusted earnings of $0.10 per American Depositary Share ( ADS ), which zoomed past the Zacks Consensus Estimate of $0.04 as well as the prior-year quarter figure of $0.07. The company is benefiting from its ongoing repositioning as per The Shift Plan, which was formulated in 2013 to transform itself from a telecom generalist to a specialist in IP networking and Ultra-Broadband services. The company is now shifting focus from older technologies (2G and 3G wireless equipment) to high-potential newer ones like Internet routing. Under this plan, management intends to trim approximately 15% of costs by 2015. In the fourth quarter, the company achieved fixed cost savings of about 30 million ($37.5 million). As such, consolidated fixed cost savings under the plan currently stand at 675 million ($843 million).

Inside the Headlines Revenues came in at 3,682 million ($4,598 million), a decline of 6% year over year. However, revenues marginally beat the Zacks Consensus Estimate of $4,553 million. Going by geographies, quarterly results were impacted by the prevailing softness in the North American market, where revenues declined 11% year over year. Revenues from Europe and Asia-Pacific were down 11% and 1%, respectively. Nevertheless, the company witnessed notable growth in the Rest of World with revenues increasing 7% year over year. As per the segments, Core Networking segment revenues increased 4.4% year over year to 1,802 million ($2,251 million). This was driven by year-over-year rise in two sub-segments revenues, IP Routing (19.6%) and IP Transport (5%). However, an 11.6% decline in IP Platforms revenues was the headwind. On the other hand, revenues in the Access segment declined 5.6% year over year to 1,871 million ($2,337 million). This was due to year-over year decline in revenues of Wireless Access (2.3%) and Managed services (48.4%) sub-segments. Nevertheless, Fixed Access revenues rose marginally by 1.3%, while Licensing revenues remained flat on a year-over-year basis. Gross margin for the quarter increased significantly by 130 basis points (bps) year over year to 34.7%. Liquidity & Cash Flow Alcatel-Lucent ended the year with marketable securities, cash and cash equivalents of 5,550 million ($6,931 million), long-term debt of 4,875 million ($6,088 million) and total equity of 2,694 million ($3,365 million). The company reported free cash flow of fourth-quarter 2013.

264 million ($330 million), as compared to

361 million in

Note: 1 EUR = $1.2489 (period average from Oct 1, 2014 to Dec 31, 2014) One Alcatel-Lucent ADR corresponds to one ordinary share.

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VALUATION

Alcatel-Lucent s current trailing 12-month earnings multiple is 196.0x compared to the 60.3x average for the peer group and 19.0x for the S&P 500. Over the last 5 years, the company s shares have traded in a range of 3.4X to 196.0X trailing 12-month earnings. Therefore, the stock is currently trading in the middle of its historical range. We have upgraded our recommendation on Alcatel-Lucent to Outperform as we expect it to perform higher than the broader market. Our target price is $4.75 or 27.9X 2015 EPS.

Key Indicators

P/E F1

P/E F2

Est. 5-Yr EPS Gr%

P/CF (TTM)

P/E (TTM)

P/E 5-Yr High (TTM)

Alcatel-Lucent (ALU)

23.1

16.3

9.3

N/A

196.0

196.0

3.4

Industry Average S&P 500

29.8 16.5

55.4 15.4

18.4 10.7

26.1 15.1

60.3 19.0

151.4 19.4

19.4 12.0

Corning Inc. (GLW)

16.1

15.0

9.6

9.3

16.0

17.0

6.5

67.8

14.7

JDS Uniphase Corporation (JDSU) 45.4 26.9 14.7 13.2 43.4 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow

P/E 5-Yr Low (TTM)

P/B Last Qtr.

P/B 5-Yr High

P/B 5-Yr Low

ROE (TTM)

D/E Last Qtr.

Div Yield Last Qtr.

Alcatel-Lucent (ALU)

2.0

3.6

0.5

-0.5

1.3

0.0

-7.5

Industry Average S&P 500

2.4 5.3

2.4 9.8

2.4 3.2

-9.3 25.5

0.0

0.4 2.1

61.3

Equity Research

EV/EBITDA (TTM)

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Earnings Surprise and Estimate Revision History

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DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of ALU. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121 companies covered: Outperform - 15.3%, Neutral - 76.9%, Underperform 7.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each th stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.

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