LUCENT TECHNOLOGIES' charmed youth is over. In the four years
since it was spun off from AT&T, it has never known adversity--until
now. Lucent posted 15 straight quarters of upside surprises after
going public in 1996. Its revenue swelled 75% in that time. By
year-end 1999 Lucent's stock price was up elevenfold, and it had
surpassed AT&Tto become America's most widely held stock, with
4.6 million shareholders.
Now the firm that never missed the bull's-eye looks more like the
gang that can't shoot straight. Chief Executive Richard McGinn
sprang a nasty surprise last month: In the December quarter net fell
30% below Wall Street expectations and 20% below a year ago. In
one day the stock lost 28%, or $64 billion, of its value. A week later
the stock fell again on rumors that Lucent is under investigation for
bogus accounting; the company denies it.
Scarier still are the reasons for the December shortfall. Lucent
botched a shift in demand to cutting-edge gear for fiber optics, failing
to recognize telecom companies' hunger for bandwidth and then
reacting too slowly to stop them from defecting to archrival Nortel
Networks. McGinn's bombshell left some investors fretting: Had
Lucent grown so fast that it was out of control? Had it so front-loaded
orders that even bigger disappointments loom?
It simply won't matter. Lucent is well poised to help lead an optical
revolution that will whip information around the globe at a fraction of
today's cost. This infobahn will be powered by photons rather than
electrons. Its vehicles will be digital packets that haul voice, data and
video with equal ease. The traffic signals will be a higher form of
today's Internet Protocol, or IP.
Digital deals like America Online's $165 billion bid for Time Warner
will only stoke demand for more Lucent gear. "There is still no better
time to be in the business," McGinn says.
For 25 years high costs had confined fiber optics to handling
long-haul tasks. Now the near-infinite capacity of these glass tendrils
is spreading from long-distance networks to local nets and, one day,
to corporate desktops and your living room. It will eliminate bandwidth
bottlenecks and deliver unlimited connectivity. Movies and files of
almost any size will be as accessible as voice calls and e-mail are
today. You could check your stocks and watch a digital-TV thriller on
one screen, while your daughter videoconferences with her
grandparents on another.
Lucent already surfs this optical wave--so much so that it is mulling
whether to issue a new tracking stock pegged to its booming optics
business. While Wall Street body-slammed the company for one
lackluster quarter, in that same period sales of Lucent's most
advanced optical gear doubled, and its data network business grew
60%. Lucent owns the U.S. market for wireless equipment, and its
worldwide wireless sales should rise 25% this year.
All told, McGinn sees 17% revenue growth and continued gains in
market share--this, for an outfit with $38 billion in sales last year. "As
the world moves to global networks, we aim to be the plumbers, with
our optics, silicon, software and services," McGinn says.
The ranks are as excited as he is. The payroll includes scores of
multimillionaires, thanks to Lucent stock. Two employees are
billionaires and two more are worth several hundred million dollars
apiece because they sold their companies to Lucent. Yet they stick
around, too (see box, p. 94). What drives them to punch the company
clock?
"It's about restlessness," says McGinn, shoeless and tapping his feet
nervously and nonstop through a two-hour interview. "A corporation is
the sum of the restlessness of its people."
Yet for all its success, Lucent lacks Internet sex appeal. Cisco
makes Internet routers and is just one-third the size of Lucent in
sales. But Cisco's market value is more than double Lucent's. Its
price-earnings multiple is 128, three times Lucent's. The optical wave
could give Lucent a shot at some Cisco sizzle.
For now, Wall Street believes in Cisco chief John Chambers, the Billy
Graham of Internet Protocol, who proselytizes that the entire telecom
world will make a fast conversion to IP, abandoning the "circuit
switch" networks in which Lucent reigns.
Nonsense, McGinn says: "The truth is that IP is not ready for prime
time." He adds: "We have avoided Elmer Gantry excesses and made
a conscious effort not to create an image that is greater than the
substance." He calls Cisco "the bestselling machine since IBM of the
1970s."
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Lucent already surfs the optical wave--so much so that it may issue a
tracking stock pegged to its optical business.
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McGinn is very much the regular guy. A trim, bookish history grad in
a company of engineers, he drives his 10-year-old daughter to school
before work. He is intense, but so unassuming that he flashes his
Lucent ID to security when he shows up each morning. McGinn has
long enjoyed competing in Iron Man events, though now that he's 53,
he jokes he is more of a tin man.
He joined the old AT&T's Illinois Bell as a salesman in 1969 and
worked his way up. By 1993 he was running the Network Systems
group, which would form the core of Lucent. AT&T split into three
companies in 1996, cleaving off Lucent because it was losing sales
from carriers wary of buying from rival AT&T. McGinn seemed a
shoo-in for the top job, but the AT&Tboard tapped a grayhead revered
on Wall Street, former Cummins Engine chief Henry Schacht.
Rich McGinn settled for second fiddle--and set out to orchestrate the
company he one day would run. Lucent (a synonym for luminous)
started life in April 1996 as one of the top 50 U.S. companies in
sales, with a market value of $19 billion (now at $170 billion, even
after the recent stock plunge).
In truth, Lucent is not four years old; it began 128 years ago as
Western Electric--the guys who made phones in nothing but black for
half a century. It evolved into a mishmash of businesses--network
boxes for carriers, PBXs for offices, phones, semiconductors and Bell
Labs. The units had little in common but a reputation: "Great
technology, too late."
Early on, Schacht and McGinn gathered their top executives to tell
them the performance bar was going way up: Sales must rise at
double the old rate, and the earnings growth rate must triple. "Rich
was even-toned but totally lacking in ambiguity about what he
expected," says Patricia Russo, who runs the carrier-equipment
business.
They tied pay and budgets to performance, even for scientists in the
ivory tower. The duo granted 100 options to each of the 131,000
employees, down to the humblest factory worker in Bangkok. The
option package's value is up to $18,000.
Untethered from AT&T, Lucent quickly won billion-dollar orders that
had eluded it. By October 1997 McGinn's patience paid off: Henry
Schacht retired.
McGinn went on a shopping spree. He has spent $32 billion in stock
and cash on 30 acquisitions. The largest: $20 billion for Ascend
Communications, the top maker of ATM switches, which phone
carriers use to link old voice circuits and new data pipelines.
He also focused inward, selling off dull but profitable businesses such
as circuit boards. McGinn had the semiconductor group dump
commodity chips in favor of digital signal processors. Deeply in the
red under AT&T, the chip unit grew 18% last year to $3.6 billion. The
gross profit margin hit 48%.
Lucent is also one of the world's largest builders of wireless phone
systems, with nearly half the U.S. market. It leads in making the
chips in communications gear, supplying rivals Cisco and Nortel.
Overseas, where half the population has yet to use a telephone,
Lucent's sales grew 47% last year to $12.2 billion. China Unicom
recently gave Lucent a billion-dollar contract to design and deploy an
entire network, from the optical backbone to the circuits and wireless
systems that will feed into it. Few rivals can handle such a job.
The optics frenzy will drive new growth. Lucent runs neck and neck
with Nortel as the top supplier of optical gear. True, the real growth in
networking is in the data world, where Cisco thrives, not in voice
communications. And most of Lucent revenues still involve voice. But
optics will drive both voice and data. Worldwide, phone companies
still earn 90% of revenue from voice traffic. Established carriers won't
suddenly junk trillions of dollars' worth of circuit-based equipment,
even if they could afford to do so.
And the truth is that IP networks fall far short of the "five nines," the
99.999% reliability that carriers demand. Plain old telephone service
also is deceptively complex. After decades of development, a
standard phone gives users access to 2,500 services, from 911
service to call forwarding. It will take years to develop IP software that
matches up. That is why, in four years, as little as 10% of phone
systems may be IP-based, Gartner Group says.
Lucent, Cisco and Nortel all keenly focus on the coming shift to
IP-over-optical networking, but they hold divergent views on when and
in what form it will arrive. The physics and economics are too
compelling to sit this one out. Today's long-haul optics use photons,
or light, to carry information at about 1% of what it would cost with
electronic circuits and semiconductors.
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McGinn likens Lucent to a teenager who gets good grades but
sometimes backs into a pole and cracks a taillight.
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But beaming long-haul optical signals used to demand old,
electron-based technology at way-stops. There, packets of photons
are translated into electronic form, magnified, shuffled and redirected,
and then converted back to photons for another long trip. The
conversions entail racks of gear, with some installations the size of a
bus and costing millions. It is why optics has been used mostly to
zap data between cities and under oceans.
Until now. Lucent is out front in developing new tools that skip most
of the electronic steps and will thereby make fiber economical in ever
more local uses. Someday we'll all have "fiber to the forehead," says
Gerald Butters, head of technology strategy. Lucent's 30,000 techies
work on such advances as plastic fiber flexible enough to wire your
home, a new over-the-air laser system for local optical transmission
and routers with mind-boggling capacity.
Today, optical fibers can transport 10 billion bits of data per second
on a single wavelength. In order to explain just how much that is, let's
pause to coin a word for the cumbersome phrase "bits per second":
Let's say, "bips."
So, the fiber pumps out 10 "gigabips" on a wavelength. That's enough
to handle 125,000 voice calls. Each strand of fiber, in turn, can carry
80 wavelengths and typically uses 40, or 400 gigabips in all. That's
enough for 5 million calls and represents a staggering fivefold gain
over just a year ago.
The numbers don't stop there. The typical fiber-optic cable now holds
144 strands of glass, enough to accommodate 57.6 terabips. This
bandwidth could handle 720 million simultaneous calls. The world
does not, of course, need that many people chattering at once, but it
may need millions at once fetching different video Web pages, and
video consumes a lot more bandwidth than phone calls.
Someday, optics may be so cheap and omnipresent that any home
can have its own 45-megabips pipeline, enough bandwidth to run the
entire server network of the Washington Post. "It's about driving
monster capacity," says Wayne Knox, head of advanced photonics
research at Bell Labs.
Lucent sold $6 billion in optical equipment and fiber last year--six
times the sales Cisco will probably make in optics this year, though
Cisco has spent $9.5 billion in recent months buying optical firms.
Lucent makes and installs fiber cables, makes the lasers that send
out bursts of photons and writes the code that manages the
networks.
Plenty of optical products are in the pipeline. Butters, the tech
strategist, is known inside Lucent for "Butters' Law." To wit: As the
number of different-colored light waves on a strand of fiber and the
amount of data being transported at each wavelength expand, fiber's
capacity will double every nine months--twice as fast as chips
advance.
Early last year, BellLabs worked on a way to switch light beams
around a long-distance network without having to translate them into
and back from electron-based forms. Many pizzas and sleeping-bag
parties later, Bell Labs unveiled the LambdaRouter in November. The
elegant box uses chips, micromachines and 256 tiny mirrors to
bounce light waves toward their destinations at up to 10 terabips--10
times the traffic that runs over the entire Internet today. Lucent says
the new router could cut switching costs by up to 60%; Global
Crossing plans to test it.
Another product, due this summer, is OpticAir. It sends laser light
through the sky at 10 gigabips. That will let corporate customers
endow their employees with rich Web access, without a costly fiber
build out.
Lucent also leads in voice-over-IP systems. Two years ago
telecommer Level 3 challenged Lucent and rivals to create software
that could carry phone calls over its IP data network. Four months
later Bell Labs unveiled Softswitch. "They blew us away," says Level
3 Chief Operating Officer Kevin O'Hara. Lucent hopes carriers and
software developers will use Softswitch as a Windows-like platform to
create features like call forwarding.
But Lucent dropped the ball with one key optical product: a hot
10-gigabips switch that uploads data to long-distance optical
networks. Underestimating demand, McGinn and Butters were slow
to roll it out. Nortel grabbed 85% of a booming market. "As a
technologist, this place is heaven, but we'll only dominate optical
networking if we execute better and stop being our own worst
enemy," says Jeong Kim, who helps run Lucent's optics group.
As the tectonic shift to ubiquitous optical networks takes hold, all the
big players may keep buying new properties to push further into the
field. Cisco, thinnest in optics, could pursue Corvis, a maker of
long-distance optical systems, or Optical Networks or Tellium; it
holds small stakes in all three.
McGinn admits he is on the hunt in Lucent's highest-growth
businesses--optics, chips, software and networking. More interesting
still may be the prospects for Lucent spinoffs or tracking stocks,
particularly in optics. One optical rival, JDS Uniphase, a maker of
opto-electronic devices, commands a market value of $70 billion on
sales of just $283 million last year. At Lucent, a similar business had
about the same level of sales; a tracking stock could unlock tens of
billions in value.
No technological revolution gets under way without some pain,
without glitches. "This is not a well-oiled machine," McGinn says. He
likens Lucent more to a teenage driver who pulls down good grades
but "from time to time backs into a pole and cracks a taillight. That's
because we are immature." A telling description of a century-old
company.
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FORBES - February 7, 2000
www.forbes.com
