Lucent Technologies: A Risky Call

It looks like a terrible time to invest in Lucent Technologies. The stock fell 6.0% on Tuesday, to $2.19, after the telecommunications-equipment giant disclosed that revenues for the current fiscal year would be lower than expected. Lucent said it expects sales of $2.04 billion for the quarter that ended June 30; analysts, on average, had previously been forecasting $2.34 billion. It's the second time this year the Murray Hill, N.J., company warned of a sales slowdown. The culprits this time around were lower sales of wireless equipment to North America and an overall sales drop in China.

Despite the dampened prospects, Citigroup analyst B. Alexander Henderson upgraded the stock to buy from hold. The reason for his bullishness has as much to do with French telecom-gear producer Alcatel as it does with Lucent.

In April, Lucent (symbol LU) said it would merge with Alcatel in an all-stock deal. Lucent shareholders will receive a 0.1952 share of Alcatel for every one share of Lucent. The American depositary receipts of Paris-based Alcatel (ALA) closed Tuesday at $11.71, down 4.8% after Lucent's sales warning. If the merger where to happen today, Lucent investors would receive Alcatel stock worth about $2.30 per Lucent share. That's a 5% premium over Lucent's current price.

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But Henderson thinks Alcatel ADRs are worth $17 based on the potential of the combined company to achieve the scale necessary to thrive in a fiercely competitive industry. If Alcatel shares were to hit that target, Lucent investors would receive Alcatel stock worth about $3.30 per Lucent share -- a 50% gain from today's price (but nowhere near the $84 that Lucent shares fetched in 1999).

This type of investing, known as merger arbitrage, is risky. The success of a merger investment depends on whether the deal is completed. If a deal fails to close, the stock of the takeover target can plunge. On Monday, Lucent and Alcatel announced that they plan to consummate the deal by the end of the year. Lucent shareholders can only hope that's true.