From blue chip to penny stock
The tragic story of a NASDAQ bellwether (and how it could make you 40% richer in the next six months)

by Briton L. Ryle

Your assessment of the global economy right now depends on whether you’re a pessimist or an optimist.

If you’re in the “glass is half empty” camp, stocks remain overvalued. The consumer is tapped out. There’s no more liquidity to be squeezed out of real estate. Inflation is right around the corner. And the impending war with Iraq will spike oil prices, sending the U.S. economy into another round of recession.

On the other hand, if you’re with the “glass is half full” party, the markets have clearly put in a double bottom. The resilience of the American consumer can be relied upon. Inflation will be held in check by productivity gains and competition. Corporate profits are on the upswing. And Bush’s threats of war are a bargaining chip to get the United Nations to endorse stricter inspection rules for Iraq.

Me, I stand somewhere in the middle. I don’t believe the Bush Administration is savvy enough to use war as a smokescreen as it pursues its true agenda of stricter inspection rules for Hussein’s military complex.

But if the American people, Congress and our allies don’t support our regime-change plans, I don’t think Bush is foolish enough to forge ahead alone.

One thing is clear, however: the potential war with Iraq is the single biggest variable in the global economy today.

Reading the road signs

The markets have been giving off a lot of mixed signals lately. Reading them properly will have a profound effect on how you approach investing over the next six months.

Oil’s up. Gold is up. But stocks are up off their lows. And though weak, the Dow and the NASDAQ have been strong enough to keep the bears at bay. So what gives?

Oil prices are seasonal. You can expect to see spikes in price for the front crude futures contracts in spring and fall as companies move to secure their supplies before the summer and winter months. This fall, the spike is greater, due to all the saber rattling over Iraq.

I know I’ll catch a lot of flack for this, but I believe gold is properly dubbed the “barbarous relic.” Gold bugs are perma-bears. They like hard assets, not stocks (though why gold should have intrinsic value is beyond me).

Do stock investors run to gold when stocks are on the ropes? No. That’s why there’s billions of dollars sitting in money market accounts. And why gold’s not US$400 an ounce right now.

The wheel’s spinning… red or black??

I’m not a big fan of casino gambling. But I have been known to sit at the Texas Hold ’Em table for hours. Playing poker is more like investing than a casino game such as roulette. With poker, you can bide your time until you get a good hand. Still, you have to appreciate the finality of playing black or red on the roulette table.

It’s rare when investing in stocks is more like roulette than poker. But right now, the wheel is spinning. And the little ball is going to fall on either red or black. If it lands on black, cooler heads have prevailed. Bush will agree to let tighter inspections monitor Hussein’s weapons development. And stocks will launch.

As I said before, I don’t believe Bush will pursue war without the support of the American people, Congress and our allies. That’s right, my chips are on black.

In the present environment, I don’t mind taking a chance on the direction of the market. After all, no risk inevitably means no reward. But when it comes to an investment, a conservative approach is warranted. And believe it or not, I think Lucent Technologies (LU:NYSE) is a low risk, high reward investment.

It’s hard to believe Lucent was once considered a blue chip stock. The most widely held stock in America has dropped from US$70 to a buck-seventy in three years. You need look no further to find out what happened to the “wealth effect.”

When IT spending dried up and the telecom shell game was exposed, Lucent suffered greatly. Annual revenues were cut nearly in half. And the company took huge charges for restructuring and inventory write-offs. Not to mention all the bad loans it had to absorb.

The US$1.78 beauty contest

As I write this, Lucent trades for US$1.78. It’s basically a penny stock, even though it has US$5.4 billion in cash. Current market cap is US$6.2 billion. Which means investors are valuing Lucent’s US$12 billion in annual revenues at just US$800 million.

Granted, Lucent is not profitable. So any valuation of revenues is subjective. What’s more, analysts continue to expect revenue shortfalls from Lucent. I’ve seen 2003 revenue estimates as low as US$11 billion. And more layoffs are likely.

Clearly, Lucent’s not out of the woods yet. But when the trees start to thin for the telecom sector, Lucent will be one of the survivors. One of a very few survivors. And that will be worth more than US$1.78.

The million-dollar toe

It’s remarkable, to be sure, but Lucent managed to get cash-flow positive during the third quarter ending June 30, 2002. That’s no small feat for a company as screwed as Lucent was a year ago.

Lucent’s managing its turnaround mainly through cost cutting. Administrative costs have been just about halved since the bubble days. R&D’s been cut, too, but only slightly. The workforce was cut in half, underperforming divisions were cut or sold, plants were closed, and so on.

On the surface, it looks bad. Analysts continue to speculate about more layoffs and revenue shortfalls. But guess what? Insiders are starting to test the waters. And they’re doing more than just dipping a toe in.

The chairman of the board bought one million shares on the open market in August. CEO Patricia Russo picked up 350,000 shares. A couple of other executives also bought stock at the end of August.

But that’s not all. Institutions are also buying. Institutions bought a net 124 million shares in the early summer (more recent information is not yet available).

What’s the upside?

There’s pretty much two sides to a Lucent trade. You either short it because you think it’s going bankrupt, or you buy it to stick in your portfolio for 10 years with the assumption that it will be a US$10 or even a US$20 stock.

Ask my wife and she’ll tell you I have a hard time planning for next week, let alone a decade ahead. So there’s no way I’m giving you a 10-year price target for Lucent. Not that anyone would remember it if I did.

But could Lucent hit US$2.50 or, God forbid, US$3 in the next six months? Sure it could. And it would still be trading below sales and for less than 2x cash. As for downside, it’s a buck seventy-five, fer cryin’ out loud. Unless bankruptcy comes into the picture, it’s hard to see the stock going significantly lower. I’m rating Lucent a speculative buy at US$1.75, with a six-month target of US$2.50.