China upstarts spur Lucent talks The Wall Street Journal Asia via Factiva; March 27, 2006

China upstarts spur Lucent talks
The Wall Street Journal Asia via Factiva; March 27, 2006

One key factor fueling the merger talks between France's leading
telecommunications-equipment maker and its longtime U.S. rival is a looming
competitive threat: China.

In a plan made public late Thursday, Alcatel SA of Paris is pursuing a more
than $13 billion merger with Lucent Technologies Inc., whose roots stretch
back to Alexander Graham Bell's first telephone. The two came close to merging
five years ago but talks fell apart.

Now, there is renewed urgency for a deal. Chinese upstarts such as Huawei
Technologies Co. and ZTE Corp. are beginning to enter their turf with
less-expensive products, threatening to seize market share, take jobs and set
industry standards for the huge Chinese market.

Alcatel, Lucent and its main competitors -- Telefon AB L.M. Ericsson, Nokia
Corp. and Nortel Networks Corp. -- make technology that is largely invisible
to consumers but underlies many of the services they use: telecommunications
networks transmitting voice, video and Internet traffic.

Both Lucent and Alcatel hope the fast-changing global telecommunications
landscape will keep their deal from becoming a political football. A slew of
other recent deals, including Dubai Ports World's plan to take over some
operations at give big U.S. ports and a possible purchase of Unocal Corp. by
China's Cnooc Ltd., fell apart over U.S. opposition. Lucent may be an
especially sensitive target, because its research arm, Bell Labs, develops
defense and homeland-security technology. So far there hasn't been any uproar
in Washington over the prospect of a deal.

Across the Atlantic, France has become increasingly prickly about mergers
affecting its home-grown companies. The proposed Alcatel-Lucent deal would
likely cost thousands of jobs, as the companies try to slash costs.

The planned transaction comes amid a massive consolidation of the U.S.
telecommunications industry, which is still struggling to recover from a
collapse that began in 2001. About $200 billion of deals have been announced
in the past two years. Most recently, AT&T Inc. announced plans to buy
BellSouth Corp. for $67 billion. Other transactions have included Verizon
Communications Inc.'s acquisition of MCI Inc., and the earlier purchase of
AT&T Corp. by the former SBC Communications Inc., which took the AT&T name.

For Alcatel and Lucent, the deal makes sense because of the shrinking of the
U.S. and European client pool and the prospect of stronger Chinese
competition.

Last year, for instance, BT Group PLC of the U.K. signaled that Huawei had
arrived on the global stage by awarding it a sizeable piece of its
multibillion-dollar project to upgrade its infrastructure. Huawei, based in
the southern Chinese city of Shenzhen, started by concentrating its export
strategy on developing countries, partly to avoid competing with the
industry's giants as it built up its expertise, touting deals in Thailand,
Indonesia and Bulgaria.

The pressures Lucent and Alcatel face in such markets was visible at an
industry trade show in New Delhi last week. Just inside the main entrance, the
first sight for many attendees was the giant booth of China's ZTE, where it
demonstrated equipment for next-generation cellphone networks, wireless
broadband and video cellphones.

For ZTE and Huawei, India is a second big opportunity to prove themselves
against global competitors. Both companies played starring roles in the rapid
buildup of China's wireless networks in the past six years.

Meanwhile, China is expected to start awarding licenses for so-called
third-generation, or 3G, networks in the next six months in order to give its
own state-owned phone companies time to prepare services for the 2008 Olympics
in Beijing. China already is the largest mobile-phone market, and the upgrade
may form the world's biggest high-speed wireless network.

To be sure, Chinese vendors including Huawei currently account for a fraction
of the world market. They hold about 5% of the wireless market, including new
contracts within China, and about 10% of the market for optical equipment such
as switches, according to analyst Paul Sagawa of Sanford Bernstein.

"The biggest impediment to Huawei on a global stage is the lack of a service
and support infrastructure," Mr. Sagawa says. "Carriers don't want to have to
rely on engineers in Beijing to solve problems. They want people on the
ground."

Once a highflying industry leader, Lucent now stands to represent something
far different: the globalization of technology markets, where a few huge
players supply gear to everyone from Polish wireless companies to Brazilian
cable-television companies.

In this transition, Lucent, once the most widely held stock in America, would
enter a new era. As envisioned, the combined company will be registered as a
French company, have its executive offices in Paris and its operational
offices in New Jersey, according to people familiar with the matter. It would
trade on European markets, with its American depositary receipts still trading
on the New York Stock Exchange. All told, Alcatel would hold about 60% of a
newly combined entity.

Lucent would continue to hold power, too. Current Chief Executive Patricia
Russo would become the company's chief executive, with Alcatel's Mike Quigley
retaining his No. 2 spot.

Alcatel's Serge Tchuruk would be company chairman, and the two sides would
share equal representation on the board.

The two sides have had a preliminary agreement in place for about two weeks,
said a person familiar with the matter. A final announcement could come this
week, this person said, though the timing could slip. One item still on the
agenda: the new firm's name. The two companies are more likely to choose an
entirely new moniker than keep their existing names.

Lucent and Alcatel declined to comment.

Integrating two bureaucratic organizations -- Lucent has 30,000 employees and
Alcatel about 56,000 -- would be a difficult task for any manager. Language
differences and time-zone changes make that harder.

Industry observers have long expected equipment makers to follow the wave of
mergers among operators that has marked the telecommunications industry in
recent years.

Consolidation among operators in domestic markets is just one factor pushing
equipment makers into each other's arms. New equipment makers have arrived on
the scene as developing countries are becoming major markets for advanced
technology. European and American companies don't have deep-rooted business
connections to lock out the newcomers in those markets. Indeed, some countries
see a political, as well as economic, advantage in working with manufacturers
from other developing countries, such as China.

For Lucent, a deal with Alcatel would reinsert it in a larger company after a
roller-coster decade on its own. Spun off from the old AT&T in 1996, Lucent
ultimately slashed close to 80% of its peak work force through spinoffs,
buyouts and layoffs. Ms. Russo, a former Eastman Kodak Co. executive, became
chairwoman and chief executive of Lucent in 2002, and was credited with
navigating the turmoil.

She tried to focus the company more on its customers, to use its scientists to
help solve their problems and to devise new business lines for the company,
and to expand into emerging markets, especially China. Lucent recently won
bids to provide Internet-based network systems for television, telephone and
high-speed data traffic that are expected to produce significant sales in
2007.

Lucent was profitable in 2004 and 2005, although most of that was paper profit
from credits in the company's overfunded pension plans, not profit from
operations.

It was in part delays in signing contracts to build China's next-generation
networks that led Lucent to a loss in its first fiscal quarter of 2006, which
began in October.

Any merger would mark a big boost for Alcatel and cap Mr. Tchuruk's decade at
its helm. If successful, the move would stake Alcatel's future on increasing
its market in the U.S. Lucent is strong in the wireless technology, called
CDMA, used by big U.S. mobile-phone providers such as Verizon Wireless and
Sprint Nextel Corp. Geographical reach in the U.S. was one of the main reasons
Alcatel had sought a deal with Lucent five years ago.

The Marseilles-born son of Armenian immigrants, Mr. Tchuruk guided Alcatel
through the technology bubble, and subsequent implosion, by streamlining
operations and refocusing on telecommunications. He reduced Alcatel's work
force about 70%, or 40,000 employees, through job cuts and by selling off its
mobile-handset division and engineering units.

Slowly, Alcatel emerged as a global leader in DSL technology, which updates
regular telephone lines to carry high-speed Internet and other digital
services. The company won major contracts with phone companies, which needed
to revamp their lines to offer new services such as digital TV to compete with
cable companies raiding their turf.

Even as Mr. Tchuruk had stabilized the business, signs of problems began
emerging last year, analysts say. The company lost some contracts, issued
profit warnings and experienced volatile swings. Alcatel also faced looming
strategic choices: Should it focus investment on its dominant fixed-line
business, or try to bolster its relatively weak wireless business through
acquisitions?

Some analysts wonder why Mr. Tchuruk is plunging the company into a risky deal
when Alcatel just now seems to have gotten its own house in order. "It would
take a herculean feat to put two companies together," said Richard Windsor, an
analyst at Nomura Securities. "You likely end up with a value-destroying
merger."

Large buyers of telecommunications equipment signaled their support over the
prospect of a deal. William Smith, chief technology officer of BellSouth, says
"there is an onslaught of new Chinese technology" that poses a threat to
companies such as Lucent and Alcatel. By pooling research resources, the
telecommunications industry could see the development of more new
technologies, he adds. "You haven't seen any Nobel Prizes out of those
organizations recently," he said.