By Leila Abboud and Gwénaëlle Barzic
PARIS (Reuters) - In the final year of his turnaround plan, Alcatel-Lucent's boss is pushing the telecom network gear maker to diversify its customer base by selling Internet equipment to large technology companies and multinational corporations.
Chief Executive Michel Combes' plan to put more emphasis on so-called edge and core routers that direct traffic on the Internet has allowed the company to set itself apart from traditional mobile rivals Ericsson (ST:ERICb) and Nokia (HE:NOK1V), and leads it into competition with U.S. networking giant Cisco (O:CSCO).
Financial analysts welcome the move into faster-growing segments and new customer types but want more evidence that Alcatel can turn regular profits after years of losses. They want Combes to deliver on the central pledge of his two year old "Shift" turnaround plan - namely for the company to generate more cash from operations than it consumes.
Since it was formed in a merger 2006, Alcatel-Lucent has never been free cash flow positive and has only posted a profit in one year. When Combes took over two years ago, the company was so fragile that some of its biggest customers were thinking about abandoning it over fears it would soon be bankrupt.
Alcatel-Lucent has since been through 10,000 layoffs, sold about 600 million euros in assets, and done a 1 billion euro capital increase to shore up its finances.
Combes, the former head of Vodafone's European businesses, has also cut about 650 million euro in costs out of a billion promised by 2016, helping the previously battered shares triple since his arrival. A key ratio of non-production related costs to revenue fell to 12.4 percent in the first nine months of last year, compared to 14.9 percent in 2012 and about 12 percent for Ericsson.
Further driving the share rally is the hope harboured by some investors that Alcatel-Lucent could one day sell its wireless business - which is strong in the key U.S. market but loss-making - to Nokia.
The success of the Internet equipment division that Combes prioritised when he took over in April 2013 has meant that even if Alcatel-Lucent effectively exited mobile via such a deal, it would still have an independent future albeit with a narrower focus.
"What was missing from Alcatel-Lucent was an industrial strategy that people could understand, but now we have made some real choices," Combes told Reuters in a recent interview.
In a sign that investors increasingly believe in what Combes is doing at Alcatel, the level of short selling on the shares, or hedge funds betting that shares will fall, has steadily fallen over the past six months.
About 8 percent of Alcatel shares are currently out on loan to hedge funds that have shorted the stock, according to data from Markit, the lowest level in a year, and a sharp drop from 13.6 percent in last July.
Francois Meunier, an analyst at Morgan Stanley with a buy rating on the stock, praised Combes for fixing the company's finances and seeking growth in Internet equipment. But he warned that the company still needed to deliver on its financial targets before chasing too many new customers.
"They have really good products but I'd like them to take the new opportunities slowly to prevent a repeat of past mistakes when the company spread itself too thinly," he said.
Alcatel is not alone in seeking to diversify. Mobile market leader Ericsson hopes to generate 20-25 percent of sales from customers outside the telecom arena by 2020, from about 10 percent today.
NETWORKING
The increasing importance of computing networks to multinational corporations from banks to retailers has opened up new opportunities for telecom gear makers and erased boundaries with Cisco and Juniper Networks (N:JNPR), which have long dominated enterprise networking.
Combes is also targeting big Internet companies like Google and Facebook, which need to build and maintain vast computing networks and datacenters to keep their global services going.
Governments and fire and police departments are among potential niche customers, but Alcatel-Lucent will have to learn new skills in research and development and marketing, executives admit.
Today it earns more than 90 percent of revenue from sales to global telecom operators, in particular a small handful of customers led by Verizon (N:VZ) and AT&T
In Internet equipment, where Alcatel-Lucent is not a recognised name, the number of potential customers may strain his travel schedule.
The company first began selling so-called edge routers in 2004 that connect businesses, governments, universities and individuals to the networks run by phone and cable companies that then transport data traffic to and from the Internet.
Then in 2012, Alcatel-Lucent launched its first core networking product. Core networks refer to the ultra high-speed networks that haul data over the Internet's backbone, interconnecting cities and countries. Last year it overtook Juniper in second place in routers sold to telecom operators.
To help reach new types of customers, Combes signed partnerships with technology company Hewlett Packard (N:HPQ) in December and consulting firm Accenture (N:ACN) in September.
Alcatel also hopes its major telecom customers like Orange and Vodafone can become an indirect sales channel through their businesses selling communications services to corporations.
It has signed as many as 15 non-carrier customers since Combes joined the company, including with satellite company Inmarsat (L:ISA) to bring high-speed Internet to airplanes and with Paris transport network RATP for Wifi in the metro.
Deborah Kish, analyst at market research firm Gartner, said Alcatel-Lucent's focus on routers and optical products, along with newer areas like cloud computing and mini-mobile antennas known as small cells, were the right choice.
"Alcatel-Lucent used to look like a mobile infrastructure company and now it's a routing company basically," she said.