Editor’s note: Alcatel-Lucent’s Shift Plan is delivering on its promise of margin growth, writes analyst Michael Soper of Technology Business Research. However, revenue did contract in the most recent quarter, but TBR explains why that’s not a concern. Alcatel-Lucent maintains a large operation in Raleigh.

HAMPTON,N.H. - Alcatel-Lucent’s Shift Plan is delivering on its promise of margin growth.

In 3Q14, Alcatel-Lucent’s gross and operating margins rose year-to-year for the fifth consecutive quarter, indicating that the Shift Plan is addressing key pain points that have historically kept the company a laggard among its peers. This Shift Plan is helping the company reduce SG&A costs dramatically and transition product lines away from legacy technology. TBR expects Alcatel-Lucent to achieve consistent operating margins of 5% to 6% once the Shift Plan is completed in 2015. Margin growth will continue as IP Routing – which represented 18.3% of total revenue in 3Q14 – increases within the business mix and headcount reductions are carried out.

Alcatel-Lucent’s revenue contraction in 3Q14 is not cause for concern because it is short-term in nature. The company is still feeling the impact of contract exits (which primarily impacted managed services) as part of the Shift Plan, as well as lower wireless and fixed access revenue from LTE contracts in the U.S. The company will benefit from LTE sales growth in China throughout 4Q14 and into 2015, as well as from small cell deployments and other densification efforts in the U.S.

  • Alcatel-Lucent’s IP Routing segment revenue will grow from new contracts for its XRS IP Core router

The outlook in Alcatel-Lucent’s IP Routing segment is improving as the company’s main product lines gain traction with new customers. In October, Alcatel-Lucent announced contract wins with CenturyLink, China Mobile, China Telecom, and China Unicom for the 7950 XRS IP Core router, bringing the total number of contracts for the product to 32 since its launch in 2012. Operator investment generally lags telecom vendor innovation, but two years removed from its debut, carriers view the XRS line as ready for implementation and crucial to their ambitions due to its high-capacity and space efficiency capabilities. CenturyLink will leverage the XRS to support its cloud services business, which is the operator’s primary growth initiative. Concurrently, China-based operators are in the midst of massive LTE and fiber buildouts and require an increasing amount of IP routing power to support ever-growing data traffic across their fixed and wireless networks.

Alcatel-Lucent’s contracts with these major operators will help stabilize the company’s IP Routing segment, which has fluctuated between revenue growth and decline for the past year. IP Routing is central to Alcatel-Lucent’s Shift Plan restructuring program as the company expects it to be the primary contributor to revenue and profits in the Core Networking business unit. TBR expects IP Routing, which grew 2.6% year-to-year in 3Q14, to leverage these contracts, particularly those in China, to maintain revenue growth through 2015.

  • Alcatel-Lucent will diversify its customer base to increase revenue

Alcatel-Lucent aims to diversify its customer base as part of its effort to restart revenue growth. The company is targeting cable operators, large enterprises, and web-scale companies (large internet-based firms), to grow its business. Importantly, the company will not reduce its focus on core service provider customers, which will constitute a large majority of revenue for the foreseeable future. Diversification will enable Alcatel-Lucent to mitigate some of the difficulties associated with service provider spending, including lumpiness and lower spending during pending acquisitions. Cable providers are a natural extension of Alcatel-Lucent’s business as these companies move to all-IP, but Alcatel-Lucent lacks the install base of Cisco, making it more challenging to penetrate these accounts.

 (C) Technology Business Research