Chapitre VIII - Assessing the Decade
Chio, the island of wine, is now nothing more than a reef.
according to Victor Hugo
The new management that took the reins in 1995 radically transformed Alcatel Alsthom in 10 years, as we have seen. In 2005 “Alcatel,” the new name of the group, having been focused on only a part of the telecom sector, had abandoned the electro mechanic activity of GEC Alsthom and Cegelec, cables, batteries, and the media. On the other hand, Alcatel invested massively during this period in telecom but, as indicated previously, most of those acquisitions turned out badly, resulting in very large losses and necessitating a rapid depreciation of the acquired businesses. To recover from this weakened financial situation, Alcatel had to abandon complete segments of the telecom sector.
All of these disruptions were reflected in the company’s financial statements, which nevertheless must be read with care because changes were made in French GAAP. It is better to analyze the financial statements and Alcatel’s balance sheet during this decade under U.S. GAAP because it was more stable during the period. Tables, located in the Annexes, set out the principal figures for the period.
After the “cleansing” of 1995, the financial statements for the years 1996, 1997 and 1998 showed, as the CEO had announced after 1995, a considerable improvement: Net profits reached €415 million in 1996, €711 million in 1997, and €2.34 billion in 1998, for a total of €3.466 billion for this three-year period.14 But it is important to remember that the large provisions made in the 1995 financial statements would improve the financial statements of the following years. This is in fact what happened. During those three years the provisions that had been taken on the balance sheet were reduced by €1.174 billion, thus improving net profits by an equal amount. The three years also benefited from significant capital gains that resulted from the sales of assets—namely, €3.384 billion during the three year period. So, for this period the net profit (not taking into account the capital gains resulting from asset sales) was only €82 million and would have even been negative if the reversal of provisions had not been so significant. This is confirmed when the financial statements are viewed under U.S. GAAP. Under those norms the operating profit showed a loss of €1.484 billion for the three years.
The operating cash flow, which shows cash either being generated (if cash flow is positive) or consumed (if it is negative), of the group in the course of normal business operations is a better indicator of performance because it is less sensitive than net profits to the choice of accounting norms and exceptional transactions, such as mergers and acquisitions of new companies. Looking at the financial statements in this way, between 1996 and 2001 the operating cash flow was always negative, even in years when the group showed net profits. Cumulatively over this period there was a negative cash flow of €5.2 billion.
The result, over and above the capital gains realized on the sale of assets, remained negative the following years, before improving in 2004 and 2005. But the financial statements for those two years were made by applying the new IFRS norms, which, in particular, no longer provided for the annual writing off of the goodwill that had been charged against net profits in the amount of about €400 million during the preceding years. Thus, for 2004 the net profit (not taking into account the capital gains) was €437 million under the new norms, whereas under the old norms there would have been a loss of €70 million.
The worst period occurred when the internet bubble burst, when the market turned down and when Alcatel had to sell off the risky acquisitions made in the years 1998-2000. In three years (2001, 2002, and 2003), Alcatel had to show a loss of €12 billion (€11.652 billion, and €12.986 billion if the capital gains resulting from the sales of assets are not taken into account). Under U.S. GAAP, Alcatel’s loss for those three years was €18 billion. The group stopped paying dividends to its shareholders for several years, thus breaking an age-old tradition of Compagnie Générale d’Electricité and of Alcatel Alsthom, which had always paid a dividend, even during the years when the company was nationalized.
If we make an assessment of the ten years from 1996 to 2005, leaving aside 1995 (an atypical year), the poor financial performance of the group becomes evident. Profit after tax was a loss of €4.6 billion (4.662 B€). However, when one takes into account the €7 billion (6.951B€) of capital gain resulting from the sale of assets (gains which were on the balance sheet at the beginning of the period), the result is a loss of nearly €12 billion (11.613B€). One needs to add to this (which is apparent from the financial statements made under U.S. GAAP) about €11 billion of goodwill write-offs directly added to net assets under French GAAP, as has previously been indicated.
Thus, without taking into account the capital gains from the sale of assets inherited from the preceding period, the management of the group during the decade 1996-2005 produced a total loss for shareholders of €23 billion, and even €25 billion if one takes into account the reduction of charges resulting from the excess of provisions taken in the 1995 financial statements, and the effect of the IFRS norms over the two last years.
At the risk of being criticized for presenting a defense pro domo, it seems to me it would be useful to compare the overall performance of the group during the periods 1986-1994 and 1996-2005. The effect of the two radically different approaches to management is clearly shown in the numbers.
From 1986 to 1994, the CGE group (renamed Alcatel Alsthom in 1990) developed by focusing on three business areas (telecommunications, energy, and transport) and the amount spent for acquisitions (€12 billion) was over twice what was received from asset sales (€5.6 billion). The excess of the amount spent for acquisitions over the amount taken in from divestitures—€6.4 billion—was totally financed out of operating profits. Calculated after financing capital expenditures, the operating cash flow for the period was €6.6 billion. The gross margin result for the period was €6.4 billion, capital gains from divestitures were €1.6 billion, and net profits were €8 billion.
On the other hand, during the following period the group focused its activities solely on telecommunications. The amount received from divestitures (€15 billion) greatly exceeded the amount spent on acquisitions15 (€5.6 billion), thus permitting the company to finance its losses—€11.6 billion at the level of the gross margin, happily reduced by €7 billion of capital gains.
During this decade 1995-2005, Alcatel’s stock price evidently reflected the radical transformation of the group, with its upheavals, combined with the inflating, and then the bursting, of the technology bubble. On February 3, 2005, my successor gave a long interview to Le Figaro16on his “ten years at Alcatel.” The Annex reproduces a graph that I borrow from that article. The graph retraces “ten eventful years to revolutionize the group.” It illustrates the chaotic evolution of the share price and describes the events that could, over those ten years, influence the stock price.
In simplifying, one can see from the graph that the share price17 was 14€ in June 1995 and only 10.5€ at the end of December 2005, while between those two dates the CAC 40 went from 1,900 to 4,715. If the Alcatel share price had followed the CAC40 during the ten year period, it would have been 33€ at the end of the period—that is, triple its actual price at that time.
Without underestimating the relevance of the market, one can see that the 2005 value reflected in particular the decrease in net assets per share. In December 1994, before the 1995 “losses,” net assets were 12.8€ per share and 7.14€ at the end of 1995, but only 2.7€ at the end of 2005. This decrease is the penalty resulting from the cumulative looses over the ten years, but also the increase in the number of shares due to the issuances made to pay for acquisitions and which were not accompanied by a correlative increase in net assets when the goodwill was immediately offset.
For the record, I would like to remind the reader that the first day after Alcatel Alsthom’s privatization (June 3, 1987), the company’s share price was 9.85€ and that in June 1995, in spite of the difficulties bearing on the group at that time, the share price was 14€—an increase for the period (42%) similar to the increase in the CAC 40 (38%). And during the same period net assets went from 6.9€ per share to 12.8€ per share.
In 1995 the market capitalization of Alcatel Alsthom—about €10 billion—placed it among the leading companies of the CAC 40—behind Elf, but at the level of LVMH, Total, and L’Oréal, and ahead of Générale des Eaux, Carrefour, Danone and all the banks. In 2005 the capitalization of each of those companies was over twice that of Alcatel.
The group’s balance sheet in 2005, even if it had improved since the dire years 2002 and 2003, failed to attract investors’ attention. The net assets (3.368B€) hardly represented half of total assets (6.104B€) which (and this is very surprising for an industrial group, except if “it is without factories”) consisted of only €1.161 billion of fixed assets (buildings, factories, tools and means of production, etc.), but it included nearly €4 billion of intangible assets, which for the most part (3.586B€) was goodwill. Considering the difference between the acquisition price and the value on the books, 70% corresponded to acquisitions made before 1995, certain of which, as we have seen, had even been written up in 2000. The new management, in spite of its sensational declarations of 1995, had considered these acquisitions, with the benefit of ten years of hindsight, to constitute truly valuable assets of the group. On the other hand, as I have already said, the goodwill created by the recent acquisitions had melted like snow in the sun. Among the assets were more than a billion Euros of tax credits that would only have a value if the group were able to generate enough taxable profits in the following years and before the lapse of the time period in which the credits could be used.
The assessment of the decade in financial terms would appear to be a failure without question. One must avoid rewriting history because it is easy a posteriori to say what should have been done differently. Nevertheless one can add some food for thought.
How is Alcatel, now refocused on telecom, to be compared with pure telecom companies? The companies that are historically most similar, such as Lucent and Nortel, did not show any better performance and their performance during the decade resembled that of their French competitor. On the other hand, competitors such as Nokia or Ericsson, thanks to their success in mobile telephone (fixed networks and telephones), had rebounded much better after the crisis that hit the sector.
Alcatel in 1995 should instead be compared with Siemens, which was a conglomerate in many of the same business areas as Alcatel (telecom, energy and transport). Siemens, in contrast with Alcatel, had retained most of those traditional sectors during the decade 1995-2005. This strategy permitted it to weather the telecom crisis in much better form, without ever failing to show an overall profit. Its sales went from €40 billion to €75 billion, while Alcatel’s sales were reduced from €25 billion to €12.2 billion. In telecom alone, while Alcatel’s sales were 30% larger than Siemens in 1995, at the end of the decade it was Siemens that had the most sales (€17 billion in 2004). In 2006 Siemens decided, under the direction of a new CEO, to withdraw from telecom, thus following a strategy completely opposite from Alcatel.
At the end of the decade, Alcatel rightly felt weakened as it confronted the emergence of new and ambitious competitors coming from China (such as Huawei and ZTE) and from its old rivals (such as Nokia and Ericsson), which had surpassed it. Alcatel’s CEO eagerly sought an alliance that would reinforce what remained of the group but which would, if need be, make it impossible to assess his performance during his tenure. So he again reverted to the previous strategy that we have already described.
With Thales, for example: After having, as we have seen, brought its shareholding in the company to 25.3% in 1999, Alcatel reduced it in 2001 to 20% by taking 100% of the capital of the joint venture company Alcatel Space. Alcatel then sold most of its Thales shares and reduced its holding to 9.7% in 2002. In 2005, Alcatel tried to contribute its satellite subsidiary to Thales (thus reversing the 2001 transaction) and other activities tied to transport and security systems. Alcatel finally succeeded the next year. On December 5, 2006, an agreement regarding satellites was signed between Alcatel and Thales and Alcatel’s holding in Thales was increased to 20.95%. This saga has not yet ended. It is likely that, due to the lack of synergy between Thales and Alcatel, the equity participation in Thales will one day or the other be sold to generate some cash or a capital gain at the end of a difficult quarter, as has been done in the previous years.
In 2006 Alcatel again contacted Lucent, five years after the failure of negotiations in 2001. This time a merger agreement “between equals” was announced. Neither its reach, its contents, the way it would be implemented, nor the schedule for putting it into effect was detailed at the time of the announcement. After some months of putting the agreement together, it went into effect on December 1, 2006. A new chapter in the history of Alcatel undeniably opened that day and I evidently do not wish to venture there. Suffice it to say that the combined Alcatel-Lucent, number 2 in the world in telecom in 2006, brought together groups that had been first and second in 1995 and that each had painfully survived the technical revolution of telecommunications.
The first announcement on the organization of the new group and the sharing of responsibilities within the company makes one fear that this new stage marked the dissolution of Alcatel, heir to Compagnie Générale d’Electricité and Alcatel Alsthom. The new group, called Alcatel-Lucent, adopted a new logo. It kept its headquarters in France. The American shareholders had the majority of the capital, taking into account the part they held in the capital of each of the companies. The “joint” Board of Directors comprised 14 Board members, 7 Americans and 5 French. It was presided over by the present CEO of Alcatel, but who lost all executive power. The President and Chief Executive Officer, an American, came from Lucent. It was the exact opposite of the acquisition 20 years earlier of the ITT telecom activities, which made Alcatel the world leader. At that time Alcatel had a nonexecutive American CEO and a French President and was the subsidiary of a French group—CGE.
The salaried employees were no longer represented by two Board members, a practice that was instituted when the group was privatized in 1987. Instead, there were two employee representatives without the right to vote. Thus was abandoned the characteristic which had contributed, greatly in my view, to foster an attachment of the salaried employees for the group that employed them. Having those two members on the Board, elected like the other Board members by the shareholders but proposed by the fund that held the Alcatel stock owned by the employees, may not have been understood by North American protagonists of a pure vision of capitalism.
The financial markets welcomed the Alcatel-Lucent agreement with skepticism. The level of indebtedness was particularly troublesome. On December 8, 2006, the Fitch rating agency downgraded the debt of Alcatel-Lucent to “junk bond” category. In the days that followed the merger, Alcatel-Lucent’s stock was at about 10€, while the CAC 40 index was at about 5,300. The reader will remember that Alcatel’s stock was at 14€ in June 1995, while the CAC 40 was at 1,900. During this period of 11 years, from 1995 to 2006, Alcatel’s stock lost 28% of its value. If it had evolved in the same way as the CAC 40 index, Alcatel’s stock would have been 40€ in December 2006—that is, four times its value on the date of the merger with Lucent. One year later, the stock price had again lost half of its value. At that time it valued, taking into account the variations of the CAC 40, eight times less than in 1995! Alcatel’s stock price ended 2007 at less than 5€.
These are the results of the strategy followed since 1995. Some say my successor left at the peak, others may consider it as an escape from failure and an abandonment. In any case, this step marked the end of a 100-year old group which at one point was the pride of French industry.
Former colleagues at ITT (which became Alcatel in 1987) have underlined the mischievous reversal of history that Alcatel had brought about. In merging with Lucent, formerly AT&T, Alcatel regrouped the industrial activities that the American legislators, a century earlier, had separated. Those legislators broke up the dominate position of Bell Telephone and separated its telephone and telegraph activities between those that were “American” and those that were “international” by creating AT&T and ITT. Alcatel would be the catalyst for bringing those activities back together. Chemistry tells us that a catalyst is a body that makes a reaction possible and which, without being consumed by the process, survives intact or perhaps somewhat degraded at the end of the operation. What will it be for Alcatel after its merger with Lucent?
The first year of Alcatel-Lucent presented a very dark image for the company. Its share price fell 54% over the year, the largest decrease of the companies in the CAC 40. Worse, six months later the company announced significant losses—this, for the sixth consecutive quarter. So in the first 18 months since its creation, Alcatel-Lucent accumulated €4.8 billion of losses, due for the most part, it would seem, to the need to depreciate the assets contributed by Lucent, as they were probably overestimated at the time of the merger in 2006.
When the ITT subsidiaries were purchased by CGE, 20 years earlier, most of the media doubted that the merger could be a success. At that time Jean Boissonat expressed the most reasonable opinion:
The merger poses a fundamental question: Is it a good transaction for CGE? This has been debated for six months. It is clear that the transaction constitutes a wager in a certain sense… But also one cannot say that when an American company purchases a French one, it wins, and when a French company purchases an American company, it loses. The truth is that the fate of this transaction depends on the quality of the future management of CGE… It is simple. There are no good or bad companies, there are only good and bad managers. This is something that’s forgotten in these times.
Mutatis mutandis, this opinion of Jean Boissonat, expressed 20 years ago, strangely remains true in 2007.
On December 31, 2007, Les Echos summarized the situation under the title “Red Lantern:”
In the list of the greatest disillusions, Alcatel-Lucent without a doubt occupies the top place. The company whose stock price fell the most in 2007…The assessment is hardly more cheerful over three years, since the price of Alcatel’s stock has fallen 56%, while the CAC 40 has gained 50% over the same period. The shareholders therefore cannot help but note that the merger of Alcatel and Lucent, which occurred one and half years ago, was the principal factor in this collapse….For Alcatel’s shareholders alone, the bill from the merger is beyond imagination since the overall value of their shares has plunged from €18 billion to €6.9 billion. In view of this catastrophic assessment, investors can ask why the company’s top executive, Serge Tchuruk, who promoted and defended the merger, is still in his job. It is indeed curious that a CEO, who knew how to enrich himself in ruining his shareholders, has not attracted more of the wrath of his Board and of the Establishment, while his equivalent at VINCI was pilloried because of his greed, but who, he at least, made a fortune for his shareholders while he was making one for himself.
July 2008 brought the outcome of this pitiful descent into hell for Alcatel. Overwhelmed by having to announce a sixth quarter of losses and pressured by Board members who were weary from the tensions and rivalries within the two-headed management team, CEO Serge Tchuruk and President Patricia Russo announced they both would resign before the end of the year, considering that their mission had been accomplished!
ended the 13 year reign of my successor. What has he left of the
Alcatel Alsthom group whose management he took over in 1995?
14 This optimistic presentation of the group’s situation paradoxically had a favorable consequence for me. In his judgment rendered in May 1997, which in fact condemned me, the Tribunal d’Evry estimated that the possible moral prejudice “taking into account in particular the spectacular [sic] turnaround of the Alcatel group after the departure of Pierre Suard, will be limited to one symbolic Franc.” This is more proof of the extreme clairvoyance of this Tribunal!
15 This is the part of the acquisitions added to the balance sheet. A substantial amount, as we have seen, was written off the balance sheet because it was directly written off against net assets after the acquisition.
16 I invite the reader to look at this article, which sheds a different light on the life of Alcatel during this decade!
17 The nominal price of Alcatel’s stock had been divided by 5 during the period. All the figures cited above correspond to the new share price.