financialanalysised2

subject: A SURVEY OF FINANCIAL STRUCTURES AND
STRATEGIES OF EQUIPMENT SUPPLIERS IN
THE TELECOMMUNICATIONS SECTOR
Ed. 2
November 22 , 2001
from: Bertrand Sallé
+33 695389797
Executive Summary
This study compares different Telecommunications vendors and highlights the key
strengths and issues that these vendors are facing in the Telecom market.
The surveyed companies are Alcatel, Ciena, Cisco, Foundry, Lucent, Nokia and
Nortel.
Typical financial analysis steps were made: Analysis of the cost structure and cash
flows, then of the sales vs. the break-even and the profitability and finally the
balance sheet, the working capital and the debt structure.
It is noteworthy to mention that the study includes data during transition into a
"boom" as well as into a "bust" cycle. It gives the rare opportunity to compare how
resilient different corporate strategies are in the face of hard times. These findings
probably have applicability to other high tech industries.
Key findings:
1- In the telecommunications industry, a business model built around low margins
(#35%) not only can be profitable; it also resists better to market downturns.
2- New entrants have built their business models around very small capital
requirements. They manage to make huge profits with lower volumes than their
competitors, making barriers to entry built around volume strategy and capital
requirements irrelevant.
3- Among the root causes of the difficulties for many of the surveyed vendors, one is
that break-even points grew in parallel to revenues for several years, instead of
increasing safety margins.
4- Firms need to question how they set the discount rate for their most risky
projects, including acquisitions.
Summary of main outcomes from the survey
Financial strategies of the firms in this survey significantly impact their
successes and difficulties, especially during downturns:
The surveyed companies can roughly be divided into three groups in terms of
their market and pricing strategies. The first group includes Ciena, Cisco and
Foundry. Until 2001, it sold with high margins (>50%). The second group
comprises Alcatel and Nokia. It had much lower margins (<35%). The last group
includes Lucent and Nortel and sold with # 40 to 50% gross margins.

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In the recent downturn, two of the strategies have proven more resilient: the
strategy of the group that sells high margins products, and the strategy of the
group that has low gross margin practices and tight expense control. The group
of vendors with gross margins in between (~50% in 2000) has been the most
severely hurt. Overall, it is the group of vendors with low gross margin cultures
that has resisted the best.
In the Telecom market, this study shows that a business model of 35% gross
margins not only is viable, it also leads to better practices to stay profitable in
difficult market conditions, and to invade upper (e.g. higher margin) markets
with better costs. To be successfully implemented, the low margin model
requires a strong culture of cost management on all fronts of the sales and
delivery process. It also requires a strong corporate finance culture at the middle
management level.
In sum, the lesson is either to be in the high margin business, or to organize for
low cost- low margins. Companies must avoid to get stuck in between.
During the recent downturn of the Telecommunications market, companies that
stayed profitable are the ones that had the highest sales/ break-even ratio.
Financial engineering practices have evolved; the newer practices show
promise of being as important (and possibly more important) than
technological innovation in the success of high tech companies.
Foundry has built a new type of cost structure that, combined with its capital
structure, gives a competitive advantage and a ROIC that's much more
attractive than older competitors, and also more competitive than recent
companies such as Cisco. New entrants take advantage of a split in the R&D
value chain to enter the market with minimal investment into development
(they focus their development efforts solely on the few strategic pieces of their
product lines that are required).
Companies that subcontract production still have a high number (15%) of
manufacturing specialists.
Several companies have enormous amounts of cash. This will help them survive
during the ongoing market difficulties. These companies will also benefit when
other companies back off some from their markets or consolidate.
Risk management practices.
High amounts of cash in the balance sheet hedges the company risk. However, it
dilutes the returns, and can lead to more risk being taken by the management.
The discount rate used to value an acquisition must better take into account the
technical risk as well as the business and the cultural risk.
The study therefore argues that a "risk spread" must be added to most risky
projects.
Companies often end-up selling some of their businesses, just like Venture
Capitalists do.
Miscellaneous
Right now, a key market issue is inventory management to prevent inventory
write-downs in a rather unpredictable market.

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Key highlights per company:
Ciena: strong product line and financial strategy. Needs to assess Capital
Expenditures and its ratio of manufacturing staff.
Cisco: commanding share of the Internet market, it needs to reconsider some of
its SG&A expenses, prune its portfolio and get back on track at inventory
management.
Foundry: Strong structure of the income statement and surprisingly low
investments in assets and R&D. Needs to bring its SG&A expenses back to
normal, and to bring its capital structure to where it was one year ago.
Lucent: Strong position with some key customers, pursuing the new financial
model seems like the right thing to do (e.g. structure the company for 35% gross
margins). Research is a key component to its recovery strategy that can succeed
if implemented with the new cost structure in mind.
Nortel: has a commanding share in 10 Gbit/s optical market, needs to revise
what its break-even really is, as well as what it will really take to get where it
wants.
Alcatel: strong cost control culture. Needs to assess its vendor financing and get
its inventories under control.
Nokia: Best-In-Class business model: high profits on top of high margins and low
capital. Must keep executing and take advantage of the ongoing downturn to
invade competitor's turf (Terminals and Infrastructure) even further. Use the
strong financial position to build strategic advantages.

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TABLE OF CONTENT
1 PURPOSE OF THIS REPORT 5
2 METHODOLOGY 5
2.1 ACCOUNTING PRACTICES 6
2.2 FINANCIAL ADJUSTMENTS 6
2.3 NUMBERS THAT HAVE BEEN ESTIMATED 7
2.4 OTHER NUMBERS AND DEFINITIONS 8
3 TELECOMMUNICATIONS BUSINESS: SECTOR OVERVIEW 10
3.1 END USER NEEDS 10
3.2 THE VALUE CHAIN. 10
3.3 THE TELECOMMUNICATIONS BOOM 11
3.4 AND ITS DOWNTURN 12
3.5 OUTLOOK 13
4 COMPARATIVE ANALYSES 14
4.1 OPERATIONS 14
4.2 CASH-FLOWS 24
4.3 BALANCE SHEETS 26
4.4 EMPLOYEES 32
5 ANALYSIS PER COMPANY 35
5.1 ALCATEL 35
5.2 CIENA 38
5.3 CISCO 42
5.4 FOUNDRY NETWORKS 45
5.5 LUCENT 48
5.6 13. NOKIA 51
5.7 NORTEL 55
6 LESSONS LEARNED 58
ANNEX 1.1. - REFERENCES. 61
ANNEX 1.2. GLOSSARY OF TERMS AND ABBREVIATIONS 62
ANNEX 1.3. FIGURES 64

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Introductory note: Both the financial and the telecommunications world use many
abbreviations and acronyms. Because most readers will be experts from either side,
Annex 1.2 tries to define the acronyms and abbreviations.
1 Purpose of this report
This report has several goals.
Its first goal is to benchmark the financial engineering and structure of a set of
Telecommunications equipment vendors ("Financial engineering" means the
approaches and processes used to turn the company operations into a financial
success). The underlying idea is to compare key business parameters such as the
ratio of R&D, G&A, costs of sales, inventories, working capital, etc... needed by
these companies to operate.
The second goal is, by analyzing competing companies, to:
• Show how financial engineering practices differ inside the business sector,
• Assess what the financial models tell us about strategic options taken by
competitors addressing the market,
• Identify competitors that have a strength of execution or have built a competitive
advantage around their financial model,
• Identify and validate forces within the sector that derive from a financial
strategy. Examples of these forces are the ability to create barriers to entry by
requesting the use of high asset intensities. Another example is a balance sheet
model that enables triple digit growth using cash from operations only.
• show how the financial engineering discipline can be just as important to
competitive success as technological prowess
Using the information, we expect to derive action items that can be taken into
account by leadership teams when they design or evolve their business.
The third goal of this document is for the financial curriculum required for a
Master's degree done at the HEC school of management.
2 Methodology
The analysis was conducted using the (annual) 10-K and 20-F reports, together with
the (quarterly) 10-Q reports available from the SEC web site. The focus was on
results from operations, Balance sheets and Cash Flows. Financial analyses were
supplemented by informal interviews with customers and operations personnel.
The following companies were analyzed:
• Large companies: Alcatel, Nortel, and Lucent. These companies have been
operating over several decades.

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• More recent large companies: Cisco, Nokia. These companies have started their
current operations about a decade ago.
• "Young" companies: Ciena, Foundry Networks. Have IPO less than 5 years ago
(Ciena: 1997; Foundry: 1999)
Financial information was adjusted (e.g. presented with a different accounting
practice) as explained below.
2.1 Accounting practices
Most firms produce their reported and pro-forma results using the following US
GAAP:
• Cost of sales include Inventory write-downs and vendor financing,
• SG&A include acquisition expense and may include amortization of Goodwill,
• EBITDA is not reported
2.2 Financial adjustments
2.2.1 One-time costs and profits
The period over which the analysis has been conducted includes all of the following
kind of events: A transition into a period of hyper-growth, followed by a large
downturn, many IPOs, acquisitions and spin-offs. This gives the rare opportunity to
compare how resilient different corporate strategies are in the face of growth and in
the face of hard times.
All these one time events which occurred during the observation period could make
it difficult to draw any reliable and useful conclusion. Therefore a special effort is
made to separate out (1) regular operations, allowing us to judge the ongoing
business, and (2) one time events, such as provisions, restructuring, etc.
Therefore, one time costs, profits and charges were isolated from regular operations.
This doesn't mean they don't deliver useful information about the health and
performance of the firms;it simply means they will be analyzed separately in this
report.
Another adjustment was to isolate Minority Interests and Share of Net Income of
Equity affiliates from the continuing operations.
To summarize, the adjustments made relate to:
• Acquisition expenses,
• Gains and losses on sale of investments,
• Income from discontinued operations,
• Effects of accounting changes,
• Provisions for restructuring,

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• Provisions for inventory (when they are outside of standard allowances). These
provisions are usually charged to costs,
• Provisions for vendor financing losses. Most often included in costs,
• Asset write-downs,
• Share of Net Income (NI) of equity affiliates,
• Minority Interests,
• Amortization of Goodwill,
• Tax adjustments related to one-time items.
2.2.2 Other financial adjustments within continuing operations
Lease expenses and commitments are the plants and equipment that the firm has
committed to lease over long periods in a non-cancelable manner.
Lease expenses for a reported period are split in two parts. The first part
corresponds to the Rental expense on capital operating leases paid to run the
firm. This first part is added to amortization. The second part represents the
interests due on the non-cancelable lease commitments. This later part is added
to interests.
Lease commitments due within one year have been added to Short Term Debt
and to fixed assets.
Other long-term lease commitments have been added to long term debt and to
fixed assets.
Software amortization, depreciation and lease expenses have been separated from
EBIT, and accounted separately in order to provide with an estimated EBITDA.
CAPEX: It is argued that the changes in leases commitments represent a capital
expenditure since they are somehow related to expenses for Property & Equipment.
The line of reasoning is that non-cancelable leases are an investment paid by debt.
On the other hand, changes in lease commitments are cash neutral because
compensated by the grant of a debt in the same amount.
To summarize:
Capex = Reported Capex + Changes in lease commitments
Note: from a cash-flow standpoint, lease payments are added to the amortization
and therefore impact Free Cash Flows to the Firm (FCFF), they also are added to
debt reimbursements, which makes it cash neutral. Changes in lease commitments
increase both Capex and debt, which makes them cash neutral too.
2.3 Numbers that have been estimated
Some numbers have been deducted, which included a partial estimation. Although
this does not enable a perfectly accurate measurement, they match reality closely
enough to enable reasonable comparisons across the industry.

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The estimated numbers are:
• Wages and salaries: Only a few foreign companies (Nokia and Alcatel) disclose
the amounts spent on wages and benefits. In one case (Lucent), a reliable order
of magnitude was implicitly deducted (Lucent canceled Fiscal Year 2000 bonuses
and disclosed the related savings). All the observed companies disclose the
number of employees. All the companies disclose the number of R&D staff. Some
(Cisco, Ciena, Foundry) give the number of their employees for manufacturing,
sales, G&A, etc.
• EBITDA: deducted as
EBITDA = EBIT + Depreciation + SW amortization + leases.
• Cost of Sales: Costs of sales - inventory write downs - depreciation - SW
amortization - leases.
• EBIT break-even: was estimated by considering
(Costs of sales after adjustments - Estimated Mfg. personnel costs)
This estimate constitutes the variable portion of sales, while other costs are fixed.
This estimation is especially important to evaluate the ability of a firm to stay
profitable in a downturn. Although perfect accuracy cannot be reached here, a very
close match was observed between the disclosed EBIT values and the estimate
(except for extremely high losses such as Nortel in 6/01). Other issues exist, such as
the variable portion of SG&A (large amounts spent by Foundry and Cisco on
distribution channels or at worldwide advertisement campaigns). By assuming that
Costs Of Sales after adjustments are variable, we tend to give a more favorable
picture than reality.
2.4 Other numbers and definitions
The following have been calculated from the numbers after adjustments:
• NOPAT (Net Operating Profit After Tax)
NOPAT= adjusted EBIT x (1-0.35).
If EBIT < 0, then NOPAT = adjusted EBIT
The NOPAT enables to compare the performance, outside of the debt structure and
any particular tax adjustment.
• WCR (Working Capital Requirements)
WCR = Current assets - Cash - Short term investments
- Accounts Receivable - payroll & benefits liabilities - Deferred revenues
- tax payable - other current assets excluding Short Term Debt.
Working Capital Requirements measure the Capital used in the daily operations. It
differs from the Working Capital (Current Assets - Current Liabilities) because it
excludes Short Term Debt, the Cash position and the short-term investments. It
was necessary to use WCR rather than WC because some firms (Cisco, Foundry and
Ciena) have tremendous amounts of Cash and treasury bonds. Should these
amounts be included, it would (1) significantly distort the amount of Capital that is

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really needed to operate those firms, and (2) give an inaccurate view on the Returns
the firms give on the capital they employ. The point is that the money invested in
Treasury bonds influences the Gearing (See annex 1.2 for definition) rather than the
operating results.
• Financial debt
Financial debt = Debt maturing within one year (STD) + Long Term Debt
+ deferred Income Tax + non-cancelable leases + other liabilities
- cash - investments.
• Interest bearing liabilities
Interest bearing liabilities = STD + LTD + non cancelable leases.
• IC (Invested Capital)
Can be calculated either from the liabilities standpoint as the capital invested in the
firm's operations:
IC = Equity + financial debt + Minority Interests
+ Liabilities from discontinued operations,
Or can be calculated from the assets standpoint as:
IC = Goodwill + fixed assets + discontinued current assets + WCR
IC measures the Capital needed to operate the firm. It excludes the cash
investments that do not directly contribute to the operations. Pension liabilities and
prepaid pension costs were not considered as part of the Capital used to operate the
firms, only the difference between them was accounted as a liability.
• Free Cash Flow To The Firm
FCFF= NOPAT + amortization - Capex - Change (WCR)
is a normalized representation of what the Firm could expect to generate in terms of
cash, in the absence of one-time items.
• STD (Short Term Debt)
STD = Debt Maturing within 1 year + lease payments committed within 1 year
• LTD (Long Term Debt)
LTD = Long Term Debt + Deferred Income Tax + Other Liabilities
+ non-cancelable lease payments due
- lease payments committed within 1 year.
• Gearing
Gearing = Financial debt/ Equity
Increment return generated by gearing =
(ROIC - (Interests*(1-Tax Rate))/Financial debt) * Gearing
The gearing helps measure the impact of the financial structure (the debt to equity
ratio)

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Figure 3.2.1: The Telecommunications business value chain.
The end-users rely on service providers, which supply the basic communication
functions.
Service providers route and transport the digital information on networks. Most
service providers also are network providers: they own some of the network.
However, more and more new operators own less of the network: For example,
"Virtual Wireless Operators" have no real network, CLECs often do not supply
the "last mile" connection to the end-user nor any long distance portions of the
network.
Equipment suppliers provide with some or all of the gears needed that make
such networks run. A critical aspect is the network management, e.g. the ability
for the network and service provider to operate and maintain its services. Until
recently, AT&T integrated an equipment supplier with a network provider
supplier, which it spun off (Lucent).
To develop the equipment, some key components such as lasers, ASICs,
demodulators, SW protocols, etc. are needed. Until recently, the leading
equipment suppliers also integrated the development of such components. New
firms (JDS Uniphase, PMC Sierra) have entered, and existing suppliers have
spun off some or all of their component branch (Alcatel O from Alcatel, Agere
from Lucent).
Design and tool makers create the tools needed to actually design and develop
the by-products used by the rest of the chain. Such companies include RADvision
(a supplier of protocol stacks) or Rational (a provider of R&D tools). These
companies service the Telecommunications sector and may supply other sectors
as well.
3.3 The telecommunications boom
1999 was a special year for the Telecommunications industry a combination of
things happened that created demand:
Wireless subscribers reached amounts similar to wireline, and were growing by
two-fold or more per year,
Data traffic "crossed" voice traffic in the US, and was to do so in the rest of the
world within a year or so. While voice traffic had been growing at 10 to 20% per
Year, the slope of the overall network capacity required suddenly changed to
about 100%.
Network
Providers
Service
Providers
Equipment
suppliers
ComponentsDesign &
Eng. tools

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The Internet passed a critical point. It had clearly become a mass media market.
Lots of Internet companies were launched to capture the new business
opportunities.
In sum, all these events combined to create a bandwidth shortage, and a routing
shortage in the transport parts as well as the access parts of the network. The
existing networks were used to their full capacity. The shortage also related to a
cost factor: Optical fibers acted as a bottleneck because installing them is lengthy
and costly. Dense Wavelength Division Multiplexing (DWDM)- the ability to
combine several communication links on a single wavelength-appeared as a solution
to this problem. DWDM allowed transmission of an order of magnitude more
information over existing fiber, eliminating the expense of installing new fiber.
These factors created a snowball effect in the value chain:
Traditional Service providers needed to accelerate investments to catch up with
the demand and the new (planned) growth.
New service providers appeared to capture the market opportunities, and invest
heavily (CAPEX was 100 to 200% their sales).
Equipment suppliers were working full steam to meet the demand. Moreover,
the network infrastructures needed to cope with the demand required different
kind of equipment. New entrants appeared to make the new equipment.
Etc.
Meanwhile, the demand for wireless access skyrocketed as well. Because the outlook
seemed so bright, Telecom companies fought to bid in auctions for third generation
wireless spectrum. In doing so, they augmented their CAPEX even more.
Figure 3.3.1: Network providers' and operators' CAPEX.
CAPEX, as % of sales
0%
20%
40%
60%
80%
100%
120%
140%
160%
1996 1997 1998 1999 2000 2001 2002
PTT's
US Wireless
CLECs
Next Gen Long Haul
RBOCs/NAR Nationals
3.4 And its downturn
Two years later, demand does materialize, but not as quickly as projected. Many
Internet companies go broke, which reduces the traffic,
Many new Telecom companies fail, which reduces investments further,

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DWDM has increased the available transport capacity faster than the demand
has grown,
Etc. - it rippled back in the other direction.
3.5 Outlook
It is quite difficult finding anyone willing to try to forecast the future of the industry
these days. However, a few things can be inferred:
Transport networks:
There is a large oversupply of bandwidth. Because of DWDM, increasing the
capacity is simplified to adding wavelength to existing equipment. The demand for
equipment exists, but is reduced. There most likely will be a pause in investments.
Figure 3.5.1: US backbone traffic.
US Backbone traffic
(Exabytes = Billions of Billions)
1.4 1.7 2.1 2.6 2.9 3.3
0.7 1.6 3.3
6.3
10.5
0.3
2000 2001 2002 2003 2004 2005
IP
Voice/ non-IP1.7
13.8
9.2
5.9
3.72.4
Afterwards, network growth will be about 50% Y/Y. The network capacity growth
will be slower than the Telecom equipment's capacity growth (which doubles every
12 to 18 months). Therefore, any shortage in transport capacity should not result in
the same difficulties to get resolved.
Wireless networks
While many countries have more wireless voice subscribers than wireline
subscribers, the future will widely depend on wireless data, and its adoption, which
in turn depends on the availability of data oriented services (e.g. features that
require the exchange of data).

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Figure 3.5.2: WorldWide Wireless penetration.
10%
13% 15% 16% 18% 20%
2000 2001 2002 2003 2004 2005
WW Wireless penetration
Data
Doubling of the network capacity affects the routers and switches more thanthe
transport layers. (Router complexity grows as the square of their capacity).
Moreover, the current oversupply of bandwidth leaves less room than it does for
optical.
Figure 3.5.3: WorldWide Broadband penetration.
WW Broadband (penetration, in millions)
12 22 35
52
68
84
2000 2001 2002 2003 2004 2005
Therefore, routers and Internet gear might be the first to grow again in volume, if
the internet starts growing again. A key strategic question ishow much have the
prices eroded in the meantime?.
4 Comparative analyses
4.1 Operations
4.1.1 Sales (See Annex 3.1)
At this level, sales figures do not tell much, but a few things stand out.

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4.1.2.1 Gross margins
During the high growth period ('99 and '00), the industry roughly kept its costs of
sales unchanged. In other words, all the companies, even the ones that doubled
their revenues, passed the economies of scale to their customers.
Figure 4.1.3: Cost of sales - FY2000 vs. last Quarter.
Cost of sales
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
ALCATEL CIENA CISCO FOUNDRY LUCENT NOKIA NORTEL
FY00
6/01
During the recent ('01) revenue crunch, all the companies have taken an average 5
to 10% hit on their gross margins. Because the preceding revenue growth had not
resulted in margin improvements, the vendors now are struggling with significantly
reduced margins that put them in the No-Profit Zone ([Sly-99], p57).
Looking at the cost structures during the '99-'00 period, we can highlight 3 sub-
groups of vendors:
• The high-margins group (Cisco, Foundry) displayed 60 to 65% gross margins.
This group has maintained slightly positive margins during year '01. Within this
group, about 25-30% is spent at SG&A. Most of this higher spending is related to
the distribution channels. Cisco spends lots of money to build its brand and its
"Cisco Powered Network" label. Foundry, on the other hand, spends its SG&A at
building its sales infrastructure.
• The low-margin group (Nokia, Alcatel) operates with a business model that
leaves 30 to 35% gross margins before adjustments (35 to 40% after
adjustments). Still, Nokia managed to retain more than 12% in Net Margins.
This group seems to keep afloat during the ongoing downturn.
• In between, companies like Lucent & Nortel operated with 50% gross margins.
These companies have posted huge losses during the last quarters.
Interestingly, the companies at both extremes (high and low margins) are the ones
that resisted the market downturn the best while those in the middle have suffered
the most. There is a theory ([Sly-99], p77) that, during a market downturn, two
groups of vendors resist better: the one with acceptable quality at lowest price and
the one with differentiated performance (unique benefits, design or brand) at
premium price, superior focused product (niche). The companies in the middle suffer
the most. In this case, the theory seems to hold.

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In sum, the identification of these three categories is so important that it will serves
as an organizing theme for the rest of this analysis. The three groups of companies
will be:
The Medium Margins group (40-50% gross margin in the 99-00 period): Lucent
and Nortel,
The High Margins group (>50% gross margin in the 99-00 period): Ciena, Cisco
and Foundry,
The Low Margins group (<35% gross margin in the 99-00 period): Alcatel and
Nokia.
4.1.2.2 R&D
Cisco, contrary to its reputation of being a marketing & sales company, is the
company that pours the most money into R&D (15%, not including IPR&D).
Foundry, on the other hand, is the company that spends the least on R&D. This is
quite interesting when one notes it built a complete product line of routers, in a
market segment that several major players would like to be in, with less than 40
Headcount in development.
4.1.2.3 Depreciation and leases
The numbers contradict some established opinions. One of these opinions is that
Cisco and Foundry need less capital because they lease most of their properties,
plants and factories. The numbers, on the other hand, tend to show that Nortel is
the highest user of leases (2.5% of its revenues), followed by Cisco and Lucent, who
both spend roughly 1.5% of their revenues on leases. When looking at the
combination of amortization and leases, Lucent and Ciena are the highest spenders
(6.5% and 9% respectively), while Alcatel and Nokia (the low-margin group) spend
about 4%.
Foundry once again stands out as the lowest spender (1%, including leases). This,
together with the low R&D figures also explains how Foundry managed to get very
high net margins by combining high gross margins with low R&D expenses and
very little depreciation and leases.
4.1.2.4 What does a low margin model look like?
While the sector is struggling to restructure, Lucent claimed that it would move
toward a business model of $20 billion revenues and 35% gross margin on a pro-
forma basis. This is essentially moving to the low-margin players'category (Nokia
and Alcatel).
Let's look at what it means to play in this field by comparing Lucent and Nokia.
(Note: the 35% gross margins on a pro-forma basis translate into 40% when
adjusted with Depreciation and Leases)

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Figure 4.1.4: Low margins model: Lucent vs. Nokia.
Cost element
Lucent current
(6/01)
Lucent Target
(announced)
Current vs
Target
Target vs
Nokia Nokia
Gross Margin w/o depreciation
& one time events 26% 41% 15% -1% 42%
R&D 14% 12% -2% 1% 11%
SG&A 24% 13% -11% 1% 12%
Depreciation & leases 9% 6% -3% 2% 4%
Interests 2% 2% 0% 2% 0%
One time costs, incl. GW 43% 4% -39% 0% 4%
Net margin -65% 4% 0% 0% 12%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Lucent current (6/01) Lucent Target (announced) Nokia
Gross Margin w/o
depreciation & one
time events
R&D
SG&A
Depreciation &
leases
Interests
From the above, we can conclude that the plan, even if it succeeds, does not provide
with the Return on Capital that shareholders will require (#13%) on the # $20B
assets of Lucent after the latest restructuring. A comparison with Nokia helps to
identify the remaining improvement opportunities.
4.1.2.5 One time costs & GW
Although they do not reflect a company's status on an ongoing basis, one-time costs
help rate the level a risk taken on the past investments of a given company. When
they bring money in, it means that units were sold for a profit and had created
value. When money is lost, it means that cash from operations and financing that
was invested in the past was invested at a discount rate not commensurate to both
the project and market risks of the sector.
The high losses posted came from several main areas:
• Goodwill has been depreciated because it related to companies that were
acquired by exchanging shares. Once the underlying shares lost 80-90% of their

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value, or when the acquired company and its products are discontinued, it is fair
to adjust Goodwill accordingly,
• Vendor financing has created huge losses for some companies. Vendor financing
will be discussed later to highlight how some companies have managed their
credit risks in the past,
• Inventory write-downs,
• Asset write-downs.
4.1.2.6 A word on vendor financing
During the course of 2001, major telecommunications suppliers have accounted a
$2.8B loss in vendor financing. In a private discussion with Prof. D. Thambakis
from Cambridge University, we noted two key issues:
• First, by providing credit to their customers, vendors created an abnormal risk
concentration (e.g. non-diversified risk concentrated in only one sector).
• Secondly, the vendor financing credit might not have been priced to include a
suitable risk spread (the additional interest rate that accounts the probability of
default).
In sum, a more rigorous vendor financing process would have been to:
• Set up strict vendor finance policies. Ciena has done so and doesn't even bid on
tenders issued by most risky operators if they include vendor finance,
• Price offers to include the credit risk into the cost of sales (credit risk can amount
as high as 8 to 10% for junk rated operators such as KPN),
• Buy credit insurance from specialized companies that diversify their credit risks
across several industries, using the price overhead discussed above. In buying
this insurance, a key benefit for firms is that they also get the support from
credit risk professionals to do the credit pricing.
4.1.3 Estimated break-even points (See Annex 3.4)
The Break-even / sales ratio is an especially important tool to estimate the level of
risk that a company will fail to stay bellow its break-even. If a company is below
break-even, it gives a measure of how hard it will be to get back to profitability.

of 64 Ed. 2
Figure 4.1.5 Break-even/ Sales: FY2000 vs. last Quarter.
Est Break-even/ Sales
0.0%
50.0%
100.0%
150.0%
200.0%
250.0%
300.0%
FY2000 6/01
ALCATEL
CIENA
CISCO
FOUNDRY
LUCENT
NOKIA
nortel
Average
(For every company, a graph showing the level and sales and the estimated break-
even is given in the annexes.)
Analysis of the sales/break-even ratios clearly shows the following phenomenon:
• First, during the expansion ('99-'00) period, the break-even remained roughly
stable, showing that the companies were increasing their fixed costs in amounts
proportionate to their sales. In doing so, they were increasing their levels of risk.
• Although it is in the Low-Margin group, Nokia managed to have a break-even
point that was and has remained very far from the sales.
• When the market suddenly plummeted, not only did sales go down, but the
break-even for the high and intermediate margin groups significantly increased
because they squeezed their cost margin,
• Those companies that kept their Break-even/ Sales ratio in the 50-60% range
stayed profitable,
• The low-margin category of vendors seems to resist better because, all in all, the
variable portion of their costs was higher and their sales prices were probably
under tighter control.
In sum,
Low margin group is best because of the pricing culture, the high margin group
is next best because there was more buffer on prices, and the medium margin get
squeezed the hardest.
The recent events seem to recommend building companies that are as scaleable
as possible. It is a key factor because it enables a company to sustain high
growth periods without needing large capital increases. It is also key because it
enables the company to rapidly shift the break-even point.
Having sales prices and COGS under tight control seems to be one of the key
cultural success factors for operating in the low-margin category.

of 64 Ed. 2
4.1.4 Profitability & ROIC (See Annex 3.5)
Figure 4.1.6: Profitability (2000).
Profitability
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
140.0%
NOPAT/sales ROIC ROE
ALCATEL
CIENA
CISCO
FOUNDRY
LUCENT
NOKIA
NORTEL
4.1.4.1 NOPAT/ Sales
During the sector's growth period (99-00):
• The high gross margin group (Cisco, Foundry) comes with NOPAT in line with
the gross margins: 17% for Cisco, and a record 20-25 % for Foundry. Foundry's
huge NOPAT comes from a combination of high margins, together with very
frugal R&D expenses (7%) and minimal Depreciation and leases (1%).
• At the other extreme, Nokia managed to combine low gross margins with a high
NOPAT of 12%, thanks to low expenses on all fronts. Nokia seems to combine a
strong culture of expense control, together with strict sales policy (probably there
is an examination of profit and loss for every contract).
• Alcatel, on the other hand, didn't manage to retain as much value as Nokia, due
to the higher SG&A and the high amortization. There is a strong culture of
expense control (was indicated by side interviews).
• Nortel and Lucent retain 9 to 11% of NOPAT.
Figure 4.1.7 NOPAT/ Sales: FY2000 vs. last Quarter.
NOPAT/ Sales
-40.0%
-30.0%
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
FY00
6/01

of 64 Ed. 2
Growth through acquisitions, this strategy creates more risks of doing dilutive
acquisitions (although Cisco has a very strong competitive advantage in its
approach to acquisitions).
Higher profitability hurdles for the strategic bets to go through. According to
Christensen, the need for growth also translates into a tendency to over-invest,
and to target mainstream markets with technologies that are ready only for the
downward markets at the time of the initial investment.
Christensen ([chr-99], p103) also gives an analysis of why companies that are
younger (e.g. Ciena and Foundry) keep better NOPAT (e.g. than Cisco, Lucent and
Nortel, the other members of the high and medium margin groups). According to
Christensen, this is because they have to succeed in downstream markets, together
with lower margins and/ or volumes, the new/ pre-IPO entrants opportunistically
build large competitive advantages through much tighter cost structures and capital
costs. (They have to make it with what they got from the last funding round). This
establishes a cost-conscious culture that sustains the company for some time.
4.1.4.3 Gearing.
There are two categories:
About half of the observed companies (e.g. Ciena, Cisco, and Foundry) have negative
gearing because they have huge amounts of cash and investments in reserve: this
Cash amount is as much as 4 to 11 months of sales. While these companies cashed
out lots of money from their operations, this cash now produces much more modest
revenues (a few percent). On the one hand, it reduces returns, especially when the
cash in question has been invested in a portfolio that replicated the NASDAQ (Cisco
had $3 Billion there), or in treasury bonds. On the other hand, this cash hedges the
risks when difficult market conditions appear. Moreover, it will take a long time
before these companies run out of cash, giving them breathing room while the
market consolidates.
At the other extreme, Nortel and Lucent are in a situation where ROIC suddenly
went below their cost of debt, resulting in negative gearing.

of 64 Ed. 2
4.2 Cash-flows (See annex 3.6.)
Figure 4.2.1 - Cash Flows (2000)
Cash Flows
-0.30
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
Cash ops/1$ rev. CAPEX Free Cash/1$ financing/ 1$
ALCATEL
CIENA
CISCO
FOUNDRY
LUCENT
NOKIA
NORTEL
Figure 4.2.2 - Cash Flows: FY2000 vs. last Quarter.
Free Cash
-0.30
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
0.50
FY00
6/01
Surprisingly, it is Ciena that raises attention when looking at Cash Flows. While all
of the other tables give a positive outlook on Ciena, this one doesn't. With the
highest CAPEX in the sector (15%), Ciena has consistently, over the last years and
quarters, produced much less cash than needed for its investments. If we add the
additional cash required by a growing Working Capital Requirement, Ciena over
and over had to raise money from the market. We can therefore worry that it might
be harder to do so in the current market conditions. We will need to observe what
will happen to its $800M cash and investments at hand. In order to make a final

of 64 Ed. 2
judgment, one should look at what Ciena's investments exactly are. As a matter of
fact, the extremely high-tech segment it is in (Dense WDM and Long-Haul optical
transmissions) typically requires high investments to stay at the leading edge.
Figure 4.2.3 - Cash from operations: FY2000 vs. last Quarter.
Cash From Operations
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
0.50
FY00
6/01
Alcatel is in a similar situation as Ciena. Over a long period, it has continued using
more cash than it produces from its operations.
Figure 4.2.4 - Cash from financing: FY2000 vs. last Quarter.
Financing
-1.00
-0.80
-0.60
-0.40
-0.20
0.00
0.20
0.40
FY00
6/01
Finally, Lucent and Nortel both are consuming lots of Cash from their operations.
They have stayed afloat so far because (1) they have reduced their WCR by 4 and 3
billions respectively, and because (Lucent) sold or discontinued some of its
operations. The next few quarters will be critical for them because Cash
opportunities out of the WCR will stop. As a matter of fact, in 8/01, Lucent has
raised $1.9B in convertibles at 8% and Nortel has raised $1.8B in convertibles (at
#4%).

of 64 Ed. 2
4.3 Balance sheets
4.3.1 Capital structures (See Annex 3.7.)
Figure 4.3.1 Capital structures (2000)
Capital Structures
-300.0%
-250.0%
-200.0%
-150.0%
-100.0%
-50.0%
0.0%
50.0%
100.0%
150.0%
WCR/IC Fixed Assets/IC Goodwill/IC Financial debt (LT
debt+ ST debt + other
liabilities - cash)/IC
ALCATEL
CIENA
CISCO
FOUNDRY
LUCENT
NOKIA
NORTEL
4.3.1.1 Financial debts
The most noticeable thing in the balance sheets is the important amounts of cash
that several companies (Ciena, Cisco, and Foundry) accumulated during the high
growth period. As seen before, Ciena got the cash through financing. Foundry,
although it raised 40% of its cash at the time of its IPO, got most of the money from
operations. Finally, Nokia doesn't have as much cash, but it served its shareholders
Euros 1.3B, 1B, 0.6B in dividends in 2001, 2000 and 1999 respectively.
At the other extreme, Nortel and Alcatel have experienced a 100% increase of their
financial debt, and, together with Lucent, a significant portion is due within short
term.

of 64 Ed. 2
Figure 4.3.2 Financial debt: FY2000 vs. last Quarter.
Financial debt/ IC
-250.0%
-200.0%
-150.0%
-100.0%
-50.0%
0.0%
50.0%
100.0%
FY00
6/01
4.3.1.2 Fixed assets
Foundry surprises once again here: its fixed assets (after the adjustment with non-
cancelable lease commitments) amount to about 5% of its sales, which is far better
(2 to 10 times) than all the other companies in this survey.
Relative to the total amounts of Capital Employed, Cisco has 70% in fixed assets (a
40% increase Y/Y). This raises questions about how cautiously money gets invested
at Cisco. Do the fixed asset promise the same amount of returns, or do they just
dilute? Up until so far, they seem to be on a dilutive trend.
4.3.1.3 Goodwill
While Cisco has the reputation of making lots of acquisitions, its goodwill is much
lower ($4.6B) than Alcatel ($6.7B at 3/01) Lucent ($9.6B at 9/00) and Nortel ($19.8B
at 3/01).
This is in large part due to Cisco's acquisition strategy. Cisco's policy regarding
acquisitions is:
• Scout for companies that will be candidate targets well before they release their
first product,
• Acquire the company if and only if due diligence shows that the staff can easily
be integrated,
• If the acquisition is decided, do so before product launch, so that the brand name
doesn't need to be changed in the customer's mind,
• Estimate the company's fair value with a 40 to 45% discount rate, in view of both
the product risk and the risk associated with the acquisition,
• Amortize the goodwill over 3 to 5 years. (before the latest SFAS142)

of 64 Ed. 2
Figure 4.3.4 Working Capital Requirements vs. Invested Capital: FY2000 vs.
last Quarter.
WCR/IC
-20.0%
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
FY00
6/01
4.3.2 Working Capital Requirements (See Annex 3.8)
Figure 4.3.5 Working Capital Requirements (2000).
Working Capital
0
50
100
150
200
250
300
350
A/R DOS Inv. DOS Csh con. Days WCR/ days
ALCATEL
CIENA
CISCO
FOUNDRY
LUCENT
NOKIA
NORTEL
4.3.2.1 Accounts receivable
It seems like the rules differ between the sub-segments. While the markets
addressed by Cisco and Foundry seem to be working with 30 days of accounts
receivable, the companies which are addressing large established telephone
company operators seem to operate closer to 90 days. Once again, this seems is
highly variable and depends on the power of the buyers or the segment (Enterprise
vs. ILEC) being addressed.

of 64 Ed. 2
On the one hand, longer A/R delays should be favorable to the established suppliers,
because it can act as a barrier to entry for new companies. On the other hand, when
the established suppliers are struggling for cash and the new entrants have lots of
cash at hand, it has just the opposite effect.
4.3.2.2 Inventories
Figure 4.3.6 Inventories - FY2000 vs. last Quarter.
Inventories (DOS)
0
20
40
60
80
100
120
140
160
180
FY00
6/01
Despite the recent downturn of the telecommunications market, only Nokia
managed its inventory as well as it was doing in the past, keeping it to a flat 40 to
45 days.
Nortel also kept its inventories relatively stable (about 90 days), and Lucent, after a
peak at 170 days, brought the inventory back down to 120 days, from 100 before the
market changes.
At the other extreme, Cisco and Foundry nearly doubled their inventories.
Moreover, Cisco inventories are at 96 days of sales vs. 53 one year ago, despite a $ 2
billion write-down in its inventory.
Alcatel has also reached peaks in its inventories (156 days!);, there are some
chances to observe future write-downs there.

of 64 Ed. 2
4.3.2.3 Working Capital Requirements
Figure 4.3.7 WCR - FY2000 vs. last Quarter.
WCR (DOS)
-50
0
50
100
150
200
FY00
6/01
It is surprising to note that Cisco maintains a Working Capital Requirement that is
close to zero, or negative. The only indication of cause found was the amounts of
deferred revenues related to advance cash payments. ($3 billion as of 7/01).
4.3.3 Debt (See Annex 3.9)
ALCATEL 12/97 12/98 12/99 12/00 3/00 6/00 9/00 12/00 3/01 6/01
Quick ratio (current assets/Current liabilities)1.29 1.55 1.42 1.49 1.46 1.52 1.48 1.49 1.53 1.52
Free Cash Flow/ interests 11.84 6.80 (7.87) (31.45) (0.42) (4.56) (6.54) (25.68)
financial debt/ Equity 0.98 0.21 0.33 0.34 0.27 0.36 0.37 0.31 0.32 0.63
CIENA 10/97 10/98 10/99 10/00 4/00 7/00 10/00 1/01 4/01 7/01
Free Cash Flow/ interests 3.31 3.05 16.96 9.02 27.90 8.55 2.06 15.92
financial debt/ Equity (0.54) (0.39) (0.27) (0.14) (0.19) (0.18) (0.14) (0.15) (0.13) (0.20)
CISCO 7/98 7/99 7/00 7/01 4/00 7/00 10/00 1/01 4/01 7/01
Free Cash Flow/ interests (8.23) (3.35) (3.32) 1.68 (3.16) 3.48 (10.96) (2.09)
FOUNDRY 12/97 12/98 12/99 12/00 3/00 6/00 9/00 12/00 3/01 6/01
Quick ratio (current assets/Current liabilities)2.32 6.66 7.36 5.34 5.58 4.47 7.36 7.34 10.25
Free Cash Flow/ interests 28.46 (5.98) (1.58) (1.63) (5.30) 7.68 (1.99) 4.04
financial debt/ Equity (1.67) (0.82) (0.70) (0.84) (0.79) (0.79) (0.70) (0.71) (0.68)
LUCENT 9/97 9/98 9/99 9/00 3/00 6/00 9/00 12/00 3/01 6/01
Free Cash Flow/ interests 3.38 (6.41) (0.54) 14.45 12.71 (2.06) 0.69 11.94
NOKIA 12/97 12/98 12/99 12/00 3/00 6/00 9/00 12/00 3/01 6/01
Free Cash Flow/ interests 24.71 35.41 (23.01) 1.14 (24.98) (14.46) (53.38) 27.51
NORTEL 12/97 12/98 12/99 12/00 3/00 6/00 9/00 12/00 3/01 6/01
Free Cash Flow/ interests 7.00 7.17 (8.95) 16.22 (284) 27.48 (47.77) 29.48
Most of the younger companies aren't concerned about debt. As a matter of fact,
several of them have so much cash on hand that the shareholders should worry
about the risk associated with the cash not being wisely invested instead.

of 64 Ed. 2
The companies with relevant debt levels are the large, older companies: Alcatel,
Lucent and Nortel. We note that all of these companies have a debt issue.
• First, Quick ratios (current assets/ Current liabilities) for these companies are
low. In particular, Nortel's Current Assets are only slightly higher than its
current liabilities.
• Secondly, the cash used in operations has not left what was required for the
payment of the interest. The companies have been forced to cut the burn rate
(expense control, huge layoffs) and capture as much cash as they could (reduce in
WCR, spin-offs, sells, convertible offerings). Investors should be cautious because
some of these sources have almost dried out at this time (Nortel's quick ratio is
1.16).
• Finally, until these firms get cash positive again, there is risk that they will not
have enough energy after the cost cuts and restructuring to get back on track.
Instead, they may go into a vicious cycle (de-investing and staff cuts lead to
lower revenue, which in turn do not break-even, which requires more cuts, etc.)
In sum, it is already known that Lucent and Nortel have been struggling with debt.
In view of the large amounts of short-term debt due by Alcatel, we can predict a
similar problem shortly.
4.4 Employees
Figure 4.4.1 Employees per company
ALCATEL 12/97 12/98 12/99 12/00 R&D
Employees 118102 118272 115712 131598 28000
Rev/ employee 213 160 177 212 21%
CIENA 10/97 10/98 10/99 10/00 R&D Mfg & inst SG&A
Employees 841 1382 1928 2775 527 1645 603
Rev/ employee 491 368 250 309 19% 59% 22%
CISCO 7/98 7/99 7/00 7/01 R&D Mfg & inst SG&A
Employees 14623 21000 34000 38000 13000 7000 18000
Rev/ employee 581 580 557 587 34% 18% 47%
FOUNDRY 12/97 12/98 12/99 12/00 R&D Mfg & inst SG&A
Employees #DIV/0! 120 222 572 89 75 408
Rev/ employee 142 601 659 16% 13% 71%
LUCENT 9/97 9/98 9/99 9/00 R&D
Employees 104000 112000 123000 126000 29400
Rev/ employee 207 218 249 268 23%
NOKIA 12/97 12/98 12/99 12/00 R&D
Employees 36647 44543 55260 60289 19304
Rev/ employee 215 266 318 448 32%
NORTEL 12/97 12/98 12/99 12/00 R&D
Employees 68,341 71,296 76,712 94,500 27200
Rev/ employee 213 226 256 296 29%

of 64 Ed. 2
4.4.1 Revenue per headcount
A set of companies manages to produce very high revenue per headcount: Once
again, Foundry leads with 660 K$ per headcount, followed by Cisco (587) and Nokia
(448).
Reasons for the highest revenue per headcount include:
• Outsourcing of all or parts of the production. (This may depend on the sector the
company is in). Ciena, because it is in the Optical equipment sector, has elected
not to outsource.
• Partnership strategies with other companies that distribute the products. Cisco
has a large network of partners that distribute and support its products.
Foundry has formed several alliances with major companies (HP, Lucent) who
integrate its products in their offers.
• More standardized products and offers. (This statement derives from discussions
with operators.) In practice, products from these vendors are as close as possible
to "plug-and-play" devices. The consequences are (1) less sales overhead:
standard product descriptions and responses to proposals support sales. For
example, minimal time is being spent at producing detailed point to point
responses to requests for proposals. (2) less technical support is needed during
the installation.
The "standard products" approach isn't just reserved to Internet products and
networks. One could say that non-metro Optical networks, especially DWDM,
require more engineering. Discussions with Ciena's customers tended to prove just
the opposite: Ciena provides customers with just adequate (minimal) support
during the bidding process, and Ciena's products are accompanied with minimal
installation and network engineering support. However, this strategy works
because the products are simple and straightforward to install and operate.
The same concept applies to Wireless networks: customers reported that Nokia's
product tend to be extremely robust, easy to install and to maintain. This enables
Nokia to have very limited installation costs.
At the other end of the revenue per headcount, Alcatel, Nortel and Lucent have a
legacy of strong customer support, services and engineering. Here are some of the
consequences:
• Major carriers (like ATT, France Telecom) have a bidding process that tends to
require significant amounts of time and staff expertise for the vendor to proceed.
It seems like, under the pressure of the new entrants, this is changing - which
will not be good for the large, established vendors.
• Service organizations are a significant source of revenue for this group of
companies. It reduces the revenue per headcount, but it is quite profitable.
• The services provided are somewhat equivalent to subcontracting for the
customer. The drawback is that it hedges the staff risk toward the vendor when
a market downturn occurs - witness the effects on Lucent and Nortel. To
mitigate this, Cisco, externalizes this risk with its partner program.
According to G. Moore ([Moo-99]), a strategy is to design the services out, e.g. to
design the services out when designing the product concepts. By this, Moore means

of 64 Ed. 2
5 Analysis per company
5.1 Alcatel (See annex 2.1)
5.1.1 Company Overview.
Alcatel is one of France's largest industrial companies, it supplies high-tech
equipment for the global telecommunications industry. The company (formerly
Alcatel Alstom) is organized into three operating units. Its Telecom segment makes
equipment for telecommunications networks. Its cable and Components division
makes telecommunication cables, power cables, and batteries. Alcatel's Engineering
and Systems unit provides project-management services. The company also owns a
24% stake in Alstom (a former joint venture with GEC, gone public), which makes
power-generation equipment, ocean liners, and high-speed trains.
Figure 5.1.1 Business per segment - Alcatel
FY 2000 Net Sales by Business Segment
Networking
36%
Optics
21%
E-Business
15%
Telecom Components
11%
Others & Eliminations
3%
Nexans (Energy Cables)
14%
Key target markets:
DSL access market,
ATM/IP switching: Building on top of the Newbridge acquisition,
Optical: Hopes to catch-up on DWDM, and to trial 40 Gigabit technology,
Expects Europe to outpace the US market for 2001.
Key recent events:
Faces a sudden halt in submarine cables: 360Networks (a company that provides
international transmission networks) multi-$B deal not only bit the dust, but
poses a huge vendor financing issue. A restructuring of the unit has been
announced,
Announced significant outsourcing steps for its plants,

of 64 Ed. 2
CEO S. Tchuruck announced the meeting of the 2001 forecasts to be "a
challenge"
Failed to merge with Lucent in 5/01.
5.1.2 Costs and Cash Flows.
Figure 5.1.2 Costs and cash flows - Alcatel
Cost Structure
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
3/00 6/00 9/00 12/00 3/01 6/01
Cost of sales
%
R&D %
S,G&A %
Depr &
Leases%
Interests
One time-
costs & GW
Cash Flows
(0.30)
(0.20)
(0.10)
0.00
0.10
0.20
0.30
3/00 6/00 9/00 12/00 3/01 6/01
Cash
ops/1$ rev.
CAPEX
Free
Cash/1$
financing/
1$
We can see from the income statement that Alcatel has structured its business
model for a lower margins/ tighter cost control approach.
Discussions with former Alcatel employees confirmed that the firm started its move
toward this model as early as 1992. In order to move the model, a cultural shift was
progressively implemented by systematically pushing toward (1) low COGS, (2) low
expenses cross the board, and (3) an overall management of the complete sales costs
(E&I, Maintenance, etc.). To succeed, Alcatel has implemented a strong corporate
finance culture.
The cash flows indicate that the company has been consuming significant amounts
of cash. Until the end of 2000, a key cause was vendor financing. An Alcatel
customer reported to me that A/R amount up to 450 days, with a recent increase to
620 days. This recent increase, together with the inventory increases is a key cause
for the huge amounts of cash burned.
5.1.3 Profitability.
Figure 5.1.3 - Sales and profitability - Alcatel
Profitability
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
6/00 9/00 12/00 3/01 6/01
NOPAT/s
ales
ROIC
ROA
Quarterly Sales
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
3/00 6/00 9/00 12/00 3/01 6/01
Net sales
Operating
Income
(EBIT)
Est Profit
break-even
Est Fixed
cost

of 64 Ed. 2
While the cost structure indicates a low cost model, the estimated break-even shows
that the company is less scaleable and therefore more sensitive to volume changes.
If we add the more constraining regulations in Europe, which makes restructuring
the staffing level a slower process, we can assume that Alcatel has become much
more vulnerable than the profitability trend could show.
With the difficulties of some key customers (360 networks, downturn in submarine
cables division), it is reasonable to expect that sales will fall below the profitability
threshold.
In that respect, the recent announcement that large parts of the manufacturing will
be outsourced (except some strategic parts in optical) is a significant step to make
costs more variable. Alcatel's ability to retain enough manufacturing expertise
internally will need attention if it is to remain as a strong manufacturing partner
(perhaps they should plan 15% of staff, like Cisco). Investors should watch the
outsourcing contracts. Is there a minimal load committed before penalties?
5.1.4 Capital.
Figure 5.1.4 - Balance sheet and working capital - Alcatel
Working Capital
0
50
100
150
200
250
3/00 6/00 9/00 12/00 3/01 6/01
A/R DOS
Inv. DOS
Csh con.
Days
WCR/
days
A/P DOS
Balance sheet
0
5,000
10,000
15,000
20,000
25,000
30,000
12 /97 12 /98 12 /99 12 /00 6 /01
Liab./disc. Ops
Equity
Minority int.
LTD
STD
Disc. Ops
Goodwill
Fixed Assets
WCR
Investments
Cash
Working Capital has very significantly increased. Moving forward, an aggressive
management of working capital can provide the cash needed for restructuring
further. This puts Alcatel in a slightly better short-term position than Lucent and
Nortel, which both have already squeezed as much as they could out of their
working capital.
However, inventories have reached an alarming level, and the analyst should check
what happens to these inventories.
5.1.5 Strategic implications for Alcatel.
Outlook:
The next 6-9 months will be gloomy for Alcatel: the submarine cash cow has
become a huge cause for losses.
Expect significant inventory, vendor financing and Goodwill write-downs.

of 64 Ed. 2
Due to the high debt level, expect some sales of non-strategic assets.
Moving forward:
Alcatel already has a strong cost control culture; they need to capitalize on that
strength.
Alcatel will need to resolve its scalability issue and lower its break-even (this
includes, but is not limited to pushing more costs toward variable costs),
Due to vendor financing, a portion of Alcatel's money is at risk right now.
Moreover, the interest rates applied to its vendor are reportedly extremely low.
These need review, and the risk spread should be adjusted to the customers'
updated risk level. Another option is to investigate how these risks could be
hedged.
Inventories need to be brought under control.
To get back to value creation, Alcatel will, like Nortel and Lucent, need to prune
its portfolio of products and customers until the market gets better.
5.2 Ciena (See Annex 2.2.)
Ciena makes dense wavelength division multiplexing (DWDM) systems for use with
long-distance fiber optic telecommunications networks. CIENA's MultiWave DWDM
systems (MultiWave 1600, 4000 and Sentry) allow optical fibers to carry 16 to 100
times more data and voice information on existing cables without requiring more
lines. MultiWave systems include optical transmission terminals, optical amplifiers,
and network management software (WaveWatcher).
CIENA also makes O-E-O and O-O switches; their CoreDirector product switches
traffic inside the networks.
The company's customers include Sprint, MCI worldCom, Teleway Japan, Telecom
Development.
In January 2001, CIENA acquired Cyras. The Cyras product was renamed
MultiWaveMetro; MultiWaveMetro is a platform that combines multiple functions
(digital cross connects, add/drop, ATM, frame relay, etc.).
CIENA is labeled as a pure player within the optical market. Key target markets:
Long and short haul DWDM market,
Optical switches
Transport and Metro networks.
Key recent events:
Verizon canceled its contract with Tellabs in the NY area. Initially, Tellalbs won
the contract over Ciena because Verizon pushed hard on price. Afterwards,
Tellabs proved to be unable to deliver on its promises. As commented by an

of 64 Ed. 2
The real issue is the amount of CAPEX. Ciena is having, Quarter after quarter, a
15% rate of Capital Expenditure. This, together with the increases in Working
Capital, has required Ciena to get cash from the market. In 1/01, Ciena raised 1.6
B$, half in stock, and the other half in 3.75% convertible bonds. It leaves Ciena with
enough cash at hand for a long while. But, since customer spending has paused,
analysts should check whether the amounts of CAPEX are consumed on an ongoing
basis (which would be a matter of concern), or if they are invested in growth (which
can be delayed).
Figure 5.2.2 - Sales and profitability - Ciena
Profitability
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
7/00 10/00 1/01 4/01 7/01
NOPAT/s
ales
ROIC
ROA
Quarterly Sales
0
50
100
150
200
250
300
350
400
450
500
4/00 7/00 10/00 1/01 4/01 7/01
Net sales
Operating
Income
(EBIT)
Est Profit
break-even
Est Fixed
cost
Looking at sales and how far they are from the break-even, we see a healthy
margin. Ciena can take a large hit on sales before it stops making profit. Moreover,
we see that the economies of scale achieved from growth have been used to raise the
safety margin from the break-even and increase Ciena's flexibility on revenues.
It doesn't come as a surprise, therefore, that the NOPAT is good. However, because
of the Cyras acquisition (Goodwill), ROIC has been slashed by 40%. Worse, because
of the goodwill and the $1.4B$ Ciena has at hand in cash and treasury bonds, ROA
has been cut by 3 (not including the impact of goodwill amortization).
The strategic question for the investor is whether Ciena will be able to leverage the
Cyras acquisition quickly. This is a serious concern - according to CIR
(OpticalWatch 5/01) the metro DWDM market isn't likely to explode for at least
another two years.,. Even if the Cyras box is leveraged into other markets by
combining offers with the Core Director product, the acquisition most likely has
been dilutive.

of 64 Ed. 2
5.2.4 Capital.
Figure 5.2.3 Balance sheet and working capital - Ciena
Working Capital
0
20
40
60
80
100
120
140
160
180
200
4/00 7/00 10/00 1/01 4/01 7/01
A/R DOS
Inv. DOS
Csh con.
Days
W CR/
days
A/P DOS
Balance sheet
0
1,000
2,000
3,000
4,000
5,000
6,000
10 /97 10 /98 10 /99 10 /00 7 /01
Liab./disc. Ops
Equity
Minority int.
LTD
STD
Disc. Ops
Goodwill
Fixed Assets
WCR
Investments
Cash
Observing the balance sheet is surprising: In just 8 months, the assets have been
multiplied by 5, mostly because of the Cyras acquisition (more than $2B in shares),
and because of the huge financing money raised from stock and convertibles. From
the shareholder standpoint, it is far from obvious that this strategy has protected
the share value and reduced the risk.
Looking at the Accounts Receivable, we can see another area where Ciena is
executing well: keeping them close to 60 days in the kind of markets (ILEC and
CLEC) it is operating is a good performance. Moreover, customers assert that Ciena
has a rigorous vendor financing evaluation process and policy. Ciena doesn't even
bid for a customer that has a default risk higher than it requires.
5.2.5 Strategic implications for Ciena.
Outlook:
The tough times ahead for optical vendors are both a threat and an opportunity.
It is a threat because most optical networks are by far underutilized. In Europe,
for example, many DWDM networks use only 8 to 16 wavelengths (1/10th to
1/4th of the capacity). Therefore, it is likely that the market won't grow for a
year or two.
It is an opportunity because, by catching a significant share of the market, Ciena
already has many products in the network. This will provide opportunity for
recurring sales to activate the additional wavelengths.
It is an opportunity because, overall, Ciena has more than a year of its revenue
in cash and investments. Meanwhile, several competitors are backing off (Cisco,
Tellabs) which should put Ciena in an easier competitive position.
Moving forward:
Ciena needs to keep executing its healthy financial strategy: it has a
commanding share in some markets (DWDM and O-E-O switches), and it needs

of 64 Ed. 2
to keep selecting customers and projects according to whether or not they fit in
(1) its pricing strategy, and (2) its strict vendor financing policy.
Ciena must start to structure its products and cost structures for when the
DWDM and OEO markets will start maturing (e.g., moving to a cost model
capable of dealing with 40% margins).
CAPEX must be brought under control,
The manufacturing processes need review to understand and justify why 60% of
the staff is in manufacturing and installation.
5.3 Cisco (See Annex 2.3.)
Cisco is the leading supplier of products that link LANs (Local Area Networks) and
WANs (Wide Area Networks). It has 85% of the markets for routers (which tell
messages where to go) and 35% of the market for LAN switches. Its other products
include dial-up-access servers and network-management software. Cisco is using
acquisitions to broaden its product line and is licensing products to widen the
influence of its Cisco Internetwork Operating System (Cisco IOS) software in hopes
of making it an industry standard. Strategic relationships with the industry's
biggest players, including Microsoft and Intel, and with Telecom giants (GTE, US
West) are boosting Cisco's influence on the data networking industry.
Figure 5.3.1 Revenue Mix (2000) - Cisco
2000 Revenue Mix
68%
25%
9%
5%
Americas
EMEA
Asia/Pacific
Japan
Key target markets:
A dominant player in the enterprise market (e.g. the companies that build their
own internal network, by distinction from the service provider companies), Cisco
also has a large share in the operator's market (CLEC and ILEC) for routers and
Internet gear.
The metro network and the related infrastructure products,
Voice Over IP.
Note: the Optical market (DWDM, switches) was a target market for Cisco until
recently, but Cisco is backing off.

of 64 Ed. 2
Recent events:
Cisco gave a positive outlook on its ability to reach the consensus for the current
quarter. Market signs seem to show that, contrary to markets such as optical,
the router market still is at a strong level.
Strong signs seem to show that Cisco is going back to its main Internet territory
in order to restore to a better profitability.
Figure 5.3.2 Costs and cash flows - Cisco
Cost Structure
-10%
0%
10%
20%
30%
40%
50%
60%
70%
4/00 7/00 10/00 1/01 4/01 7/01
Cost of sales
%
R&D %
S,G&A %
Depr &
Leases%
Interests
One time-
costs & GW
Cash Flows
(1.00)
(0.80)
(0.60)
(0.40)
(0.20)
0.00
0.20
0.40
0.60
0.80
1.00
4/00 7/00 10/00 1/01 4/01 7/01
Cash
ops/1$ rev.
CAPEX
Free
Cash/1$
financing/
1$
Thanks to its dominant share of the IP business, Cisco is able to experience the
benefits of being a Gorilla. ([Moo-99], p33) "The pragmatists (customers) give the
market leader an extraordinary set of advantages, which they deny to all other
competitors. It gives the leader the right to charge more money. In addition, market
leaders enjoy lower cost of sales (learning curve). Not only does it spend less money
at marketing, it sometimes gets paid for others to adopt it".
In that respect, Cisco's expenses at SG&A (25%) contradict G. Moore's assertion. A
significant portion is used by the distribution channels. From a strategy standpoint,
one can question why it keeps spending 25 to 30% at marketing and other
worldwide advertisement campaigns. Cisco's brand is already established; they are
labeled as the leader. Now that costs are getting squeezed, this is an area of savings
to get back to profitability.
Figure 5.3.3 Sales and profitability - Cisco
Profitability
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
7/00 10/00 1/01 4/01 7/01
NOPAT/s
ales
ROIC
ROA
Quarterly Sales
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
4/00 7/00 10/00 1/01 4/01 7/01
Net sales
Operating
Income
(EBIT)
Est Profit
break-even
Est Fixed
cost

of 64 Ed. 2
5.3.5 Strategic implications for Cisco.
Outlook
The router market should restart growing earlier than others. While the optical
market has oversupplied the needs for bandwidth and delivers product with
higher performances than what's really needed, this isn't the case for routers.
Market downturns usually favor market leaders because fewer customers can
afford the risk of buying from companies with unproven future.
Moving Forward, Cisco should:
Spend less on SG&A: Cisco is the customer's first choice by default ("you can't
get fired because you bought your IP gear from Cisco")
Get back to profits by pruning the portfolio, taking the weakest products out, and
by returning to more rigorous cost control,
Get back on track with inventory management,
Handle the cash better: invest it wisely on highly promising projects and
companies, or give it back to shareholders,
Take advantage of the market downturn to be the first to consolidate. Either
make a bold move, buying a company or division commensurate to your appetite
in the optical market, or forget about that market.
5.4 Foundry Networks (See Annex 2.4.)
Foundry Networks, Inc. (NASDAQ: FDRY) is a next-generation networking
company. It provides end-to-end Global Ethernet and intelligent traffic-
management solutions. Products include Internet routers, Layer 2/3 LAN switches,
and Layer 4-7 web switches with integrated Internet traffic and content
management. It has more than 3,300 customers worldwide, including the world's
leading enterprises (such as China Telecom), Internet-based businesses, Metro Area
and Internet service providers and other institutions (US government).
Key markets:
Foundry can be labeled as a pure player in the LAN routers and switches
market.
Key recent events
Already had a partnership with HP. Announced a partnership with Lucent to
distribute its products in combination with Lucent's Metropolis product line.

of 64 Ed. 2
Figure 5.4.1 Costs and cash flows - Foundry
Cost Structure
-10%
0%
10%
20%
30%
40%
50%
3/00 6/00 9/00 12/00 3/01 6/01
Cost of sales
%
R&D %
S,G&A %
Depr &
Leases%
Interests
One time-
costs & GW
Cash Flows
(0.20)
(0.10)
0.00
0.10
0.20
0.30
0.40
3/00 6/00 9/00 12/00 3/01 6/01
Cash
ops/1$ rev.
CAPEX
Free
Cash/1$
financing/
1$
Foundry's income statement is different from all the other observed companies in
this report. While the gross margin and the SG&A are in line with Cisco's, the key
differences are the amounts of R&D expenses (8%) and the amortization (less than
1.5%).
The consequence is that Foundry could, unlike Cisco, move below a 40% Gross
margin and still be profitable, provided it reduced its SG&A expenses. In other
words, Foundry is a very scaleable company, cashing in lots of money as soon as the
market is doing well, yet still capable of doing well when things are more difficult.
In the more recent downturn, the cost structure has remained good, except SG&A,
which need to be better managed. In addition, the Working Capital increase results
in a negative Free Cash Flow. This doesn't seem to be a big deal anyway, when
considering the large amounts of cash at hand.
But the real question is: How can Foundry, with less than 40 R&D headcount, build
a full product line of Ethernet, Gigabit Ethernet and 10-Gigabit Ethernet routers?
Many world leading firms would like to have this product line. Foundry seems to
have optimized its contribution by taking as much advantage as it could from all the
available components, optical modules, etc. that have been produced by the many
vendors. In short, the value chain has exploded in many small parts, and Foundry is
taking full advantage of it. This may represent a new model for product
development in the telecommunications sector; a key question is if the model is
sustainable in the face of radical technology advances.

of 64 Ed. 2
Figure 5.4.2 Sales and profitability - Foundry
Profitability
0.00%
50.00%
100.00%
150.00%
200.00%
250.00%
6/00 9/00 12/00 3/01 6/01
NOPAT/s
ales
ROIC
ROA
Quarterly Sales
0
20
40
60
80
100
120
3/00 6/00 9/00 12/00 3/01 6/01
Net sales
Operating
Income
(EBIT)
Est Profit
break-even
Est Fixed
cost
With the highest NOPAT of this survey in Fiscal Year 2000, Foundry takes full
advantage from its unique cost structure. Even better, the amounts of IC are so lean
that it built a 131% ROIC in 2000! Once again, this results from a culture of tight
capital expense control.
Is this the result of the tough pre-IPO times when Foundry had to make it with
its latest round of cash or die? Even their leases are extremely small.
Is this the result of acting like an assembler of components where everything is
developed elsewhere except the strategic ASICs?
Moving forward, the ROIC has landed back on earth. This landing is a consequence
of the much smaller NOPAT, as well as the much higher amounts of Invested
Capital, mostly the Working Capital. The questions for the analyst to answer are:
Is this due to a more capital-intensive sales process when using its partners as a
sales channel (Foundry routers also are distributed by HP and Lucent, which can
only mean a positive outlook on future sales)?, or,
Is this the result of management's lack of attention now that there is so much
cash available?
5.4.4 Capital.
Figure 5.4.3 Balance sheet and working capital - Foundry
Working Capital
0
20
40
60
80
100
120
140
160
180
200
3/00 6/00 9/00 12/00 3/01 6/01
A/R DOS
Inv. DOS
Csh con.
Days
WCR/
days
A/P DOS
Balance sheet
(50)
0
50
100
150
200
250
300
350
400
12 /97 12 /98 12 /99 12 /00 6 /01
Liab./disc. Ops
Equity
Minority int.
LTD
STD
Disc. Ops
Goodwill
Fixed Assets
WCR
Investments
Cash

of 64 Ed. 2
The balance sheet comes as a confirmation of the surprisingly smaller than average
IC: WCR is under 100 days, and fixed assets (after the inclusion of non-cancelable
leases) are only 1/15th of the sales! Foundry seems to be a good example of how
Venture capitalists can now engineer the best start-ups from a financial viewpoint
as well as from a product line strategy viewpoint. In other words, these new
entrants have a competitive advantage in their financial engineering and can, if
they remain well managed, create threats to other companies that won't consider
the restructuring of their capital structures.
5.4.5 Strategic implications for Foundry.
Outlook:
With the oversupply of equipment, there is a risk that customers will prefer
more established suppliers (e.g. Cisco),
Foundry has to trade attempts to grow vs. the need to stay profitable in the
ongoing downturn.
Moving forward
Foundry should remain a profitable company, if it brings SG&A expenses back to
normal. This can be done either by reducing the expenses or by increasing the
sales, depending on the market.
The capital structure needs to be kept as low as it is now. It can be improved by
aggressively working on inventories.
Foundry must identify ways to put its cash at work in ways that bring enough
returns and do not fundamentally change the invested capital structure.
5.5 Lucent (See Annex 2.5.)
Lucent has the following main units:
Integrated Network Solutions: Delivers wireline solutions (switching, data and
optical) to long distance carriers, incumbent local service providers, PTTs,
emerging service providers and backbone builders.
Mobility Solutions: Delivers wireless solutions to established wireless service
providers and emerging service providers.
Worldwide Services: Lucent's Worldwide Services is delivering a broad portfolio
of network design and consulting services to service providers and enterprises.
Bell Labs is the research branch of Lucent. It enjoys a worldwide reputation as a
leader in developing and bringing to market new communications technologies and
scientific breakthroughs.
Revenue is distributed between US (61%) and non-US (39%)

of 64 Ed. 2
3 Telecommunications Business: Sector Overview
The telecommunications sector has been the subject for much controversy over the
last 3 years. At first, itwas, with the Internet, the next big thing. Quite too often
now, it now gets the headlines to report layoffs and bankruptcies. What happened?
3.1 End user needs
From a 30,000 feet view, the basic end-user needs are:
to exchange digital information between one or several other end-users. This
information can be voice, data or video, and can be exchanged through a
communication cable (wireline), or over the air (wireless).
In general, the end-users needs are fulfilled by "service providers" (Telephone
Companies, Internet service providers, etc.).
To do so, the service provider uses "Telecommunication Networks" which typically
are comprised of:
An access part aimed to collect and aggregate the end-user's information either
through a wireline or a wireless media.
A transport network that sends aggregated information toward its destination.
The complete telecommunications network is actually many interlinked networks,
each with different underlying technologies and equipment. For example, there are:
Voice networks that collect and route (switch) information. Key technologies are
Line ports (wireline) or Base Stations (Wireless). They are combined with
signaling networks, which carry the information related to the communication
(destination, billing information, etc.)
Data networks that collect data and route (switch) it. Key technologies will be
LAN and WAN networks, and the associated routers.
Transport networks that aggregate multiple connections to send them between
routers and switches. Key technologies are Optical transport, routers and
multiplexing.
3.2 The value chain.
The value chain in the sector can be described as follows:
(Note: The value chain describes all the steps taken within the sector to create the
value that the end-user ultimately pays for).

of 64 Ed. 2
The problem is real: Lucent's sales are well below its break-even. The real question
becomes, after all the cost control measures, can Lucent break-even at $20B of Y/Y
sales?
Considering all the restructuring efforts and the headcount remaining, a rough
estimate shows that it might be possible to break-even at $20B - but only IF the
portfolio changes have kept the most profitable product lines and dumped all the
others. This must be done while still providing a cohesive set to build the networks
required by the customers. Meanwhile, the debt expenses are there to push the
break-even upward.
Moving forward, Lucent has announced a new business model that will be built for
profitability out of a 35% gross margin (40% after adjustments). As explained in §
3.2.5., the model will leave with at best 4% net profit and about as much ROIC. Will
this be acceptable to shareholders even with a 10% yearly growth?
Moreover, the most challenging issue in this model is to actually execute the
cultural shift that's needed to achieve such tight financial control. It took 4 years for
Alcatel to do it. Will Lucent have enough time?
Several initiatives are going on to change the cost culture by getting to excellence at
E&I and maintenance. Lucent competitors Ciena, Nokia and Cisco already have
excellent reputations at E&I. Moreover, they have a strong practice of lowering the
costs associated to the sale by (1) excellent documentation support, (2) plug-and-
play approaches that reduces the need for specific work on tenders and (3) low
installation costs and very limited needs for customer-specific reconfigurations or
fixes.
5.5.4 Capital.
Figure 5.5.3 Balance sheet and working capital - Lucent
Working Capital
0
50
100
150
200
250
300
3/00 6/00 9/00 12/00 3/01 6/01
A/R DOS
Inv. DOS
Csh con.
Days
W CR/
days
A/P DOS
Balance sheet
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
09 /97 09 /98 09 /99 09 /00 6 /01
Liab./disc. Ops
Equity
Minority int.
LTD
STD
Disc. Ops
Goodwill
Fixed Assets
WCR
Investments
Cash
From a balance sheet standpoint, we can:
Materialize the amounts of Short and Long Term debt and understand why
banks are so cautious on the covenants associated with the lending of their
money. In particular, Short Term Debt is higher than the cash.
Measure how far Lucent is from Foundry on its fixed assets.

of 64 Ed. 2
Finally, the analyst should notice that the strong working capital efforts, if they are
visible on the balance sheet, are not as significant when looking at the A/R and
Inventories expressed in Days of Sales. This is due to the fact that sales have been
reduced by significant amounts.
5.5.5 Strategic implications for Lucent.
Pursuing the new financial model seems like the right thing to do,
Costs and the ability to control them must be controlled on all its elements,
including E&I, maintenance, as well as the sales process. This will require "plug
and play" approaches, even if this comes at the expense of the Lucent Service
organization.
5.6 13. Nokia (See Annex 2.6.)
5.6.1 13.1. Company Overview.
Nokia is the world's top mobile phone maker (a title for which it vied with rivals
Ericson and Motorola). The company's strength is in the fast growing market of
digital cell phones. It operates three divisions: telecommunications (radio access,
network, information networking, and fixed-access systems), mobile phones (cellular
phones), and other operations (PC and workstations monitors, multimedia digital
satellite and cable network systems, electronic control and display units, and mobile
phone battery chargers). Nokia has manufacturing operations in 12 countries and
sells its products in more than 130 countries.
Figure 5.6.1 Revenue distribution
Revenue distribution 2000
7,714
21,887
854
(79)
Telecommu
nications
Mobile
Phones
Other
Elimination
s
Revenue per region (2000)
2%
18%
17%
10%
53%
Finland
Rest of Europe
Americas
Asia/Pacific
Other countries
Key target markets and objectives:
The 2.5 GPRS and Edge market, and the 3G UMTS. (Mobile wireless data
terminals and infrastructure).
To continue expanding the mobile phone market share towards its goal of 40%
To increase share in infrastructure,
To become a major player in the US.

of 64 Ed. 2
Figure 5.6.2 Market shares
Nokia
12%
11%
Other
Ericsson
30%
Motorola
12%
Nortel
Lucent
10%
Alcatel
3%
22%
Wireless: Worldwide Market Share 2001E
Source: CSFB estimates January ‘01
Nokia
22%
Ericsson
38%
Motorola
12%
Nortel
8%
Alcatel
5%
Lucent
3%
Siemens
12%
GSM Market Share 2001E
Key recent events:
Nokia has been awarded 26 UMTS contracts (Ericson: 29), a 26.4% market
share.
It expects 35% share of the W-CDMA 3G but doesn't expect 3G vendor financing
to be a material issue, thanks to a strong balance sheet.
Nokia had won, together with Lucent, a $1B contract with AT&T wireless over 4
years. Lucent backed out of the contract, which further broadens Nokia's
opportunity both with AT&T and with other RBOC (RBOC often imitate one
another).
In 2000, Nokia launched a $500M venture fund to invest in "leading edge"
wireless technology companies.
Nokia announced that UMTS terminals would not be available in mass
production in 2002. This will impact Operator's willingness to rollout UMTS
quickly.
Figure 5.6.3 Costs and cash flows - Nokia
Cost Structure
-10%
0%
10%
20%
30%
40%
50%
60%
70%
3/00 6/00 9/00 12/00 3/01 6/01
Cost of sales
%
R&D %
S,G&A %
Depr &
Leases%
Interests
One time-
costs & GW
Cash Flows
(0.30)
(0.20)
(0.10)
0.00
0.10
0.20
0.30
0.40
0.50
3/00 6/00 9/00 12/00 3/01 6/01
Cash
ops/1$ rev.
CAPEX
Free
Cash/1$
financing/
1$
Nokia, is arguably the best in class among all the companies observed:
The cost structure is built for low margins,
Amortization and CAPEX are low,

of 64 Ed. 2
There is a very substantial margin to the break-even point in sales.
The company has a commanding share in its market, and is capable of saying no
to customers that aren't promising safe vendor financing, or that destroy value
for it.
This strategy hasn't come overnight: several years ago, Nokia started in the Low
Cost business, occupying the vacuum left by Ericson's willingness to be in the upper
segments of the terminal and infrastructure segments.
Ultimately, when the lower cost technologies developed by Nokia successfully
crossed over into what the upper markets were demanding, Nokia made further
steps in its strategy to invade from down-market and force others (Ericson) into up-
market retreats ([Chr-00], p 135)
5.6.3 13.3. Profitability.
Figure 5.6.4 Sales and profitability - Nokia
Profitability
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
6/00 9/00 12/00 3/01 6/01
NOPAT/s
ales
ROIC
ROA
Quarterly Sales
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
3/00 6/00 9/00 12/00 3/01 6/01
Net sales
Operating
Income
(EBIT)
Est Profit
break-even
Est Fixed
cost
The bottom line comes on the profitability: Despite a 20% decline in sales, the
break-even point has remained very stable. Moreover, the good NOPAT combines
with well managed Invested Capital to generate an ROIC that remains close to
40%. The decrease in profitability was half due to amounts of R&D and SG&A that
decreased slower than revenues and half due to a significant increase in IC.
In 3/01, Nokia and SCI agreed to expand an existing outsourcing agreement to
include narrowband and 3G wireless base stations. This doubles an existing
outsourcing of 60% of its infrastructure and 10% of handsets. This will further
decrease Nokia's break-even and fixed costs.

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