The Mir space station isn't the only thing set to crash and burn this week.
As Mir prepares to deorbit, Agere Systems will roll itself onto the IPO launchpad. But the Lucent (LU) spin-off faces a host of problems that make it a poor investment, in our view.
Like Mir's Mother Russia, Agere's parent is a mere shadow of its former self. The grossly mismanaged Lucent suffers from a litany of woes--mass layoffs, frequent earnings warnings, and an inquiry by the Securities and Exchange Commission. The telecom firm, which generated 21.3% of Agere's revenue in the last fiscal year, now hopes that spinning off Agere will stop further slides in its stock price and credit rating.
Agere's main business line is integrated circuits, a market where it competes with PMC-Sierra (PMCS) and Texas Instruments (TXN). The remaining 25% of Agere's sales come from optoelectronic components, a market dominated by the likes of JDS Uniphase (JDSU) and Corning (GLW).
If the spin-off is successful, Lucent will boost its financial health by offloading $2.5 billion of debt onto Agere's balance sheet. Agere hopes to have an easier time winning Lucent's competitors as customers once it gains independence. But Agere's weakening business gives IPO investors less reason to be sanguine. In the quarter ended December 31, its revenue dropped 8.5% from the September quarter, and it was much less profitable than its major rivals. Agere's gross margin was 42%, compared with 49% for Texas Instruments, while its operating margin was a razor-thin 2%, vs. 20% for TI. At a time when most of its competitors were generating plenty of cash, Agere burned through $99 million last quarter. And the outlook is deteriorating: The company has warned that both revenue and operating income will decline for the current quarter.
At the $13 per share midpoint of its offering range, Agere is valued at 3.4 times sales. That's comparable with rivals like Corning and Texas Instruments, but those market leaders are at least making money. Apart from Agere's deteriorating business, we have to question the awful timing of this deal. Communication chipmakers are among the hardest-hit in this technology meltdown, victims of an inventory glut; if Agere were to wait for the storm to blow over before going public, it could probably raise a lot more money. Launching the second-largest domestic offering on record in the throes of a bear market looks like a recipe for disaster, one that we think investors should avoid.