Alcatel-Lucent's research and development strengths and broad customer base make it an attractive takeover candidate for a rival, but it has to clean up its operations before a deal is likely.

With the five existing telecoms gear groups, competition will remain brutal and profits elusive, but another wave of consolidation would ease pressure on pricing and margins and allow more investment in research and development.

Franco-American Alcatel-Lucent has not made a profit since it was created by merger three years ago, but its shares are up 72 percent this year, compared with 45 percent for the DJ Stoxx technology index, on hopes it has turned a corner.

The stock jumped last week on market talk of possible Chinese interest in the group, but any buyer would have a number of hurdles to clear, and the company must first work out how to generate more consistent cash flow and reverse losses.

I can see why predators would jump now; Alcatel-Lucent is improving operations, and as it does so it will get more expensive, said one London-based technology banker, who asked not to be named.

But I still think it's premature to talk about the company as a takeover target.

Top rivals include Nokia-Siemens Networks NSN.UL, Chinese players Huawei HWT.UL and ZTE Corp, Sweden's Ericsson and U.S.-based Cisco Systems.

Most analysts and investors, and some industry executives, believe further consolidation is inevitable.

With today's pricing trends, I would say that a maximum of three global players is possible, said Bengt Nordstrom, chief executive of Swedish telecoms consultancy Northstream.

The newly named CEO of Nokia-Siemens Networks, Rajeev Suri, also said there was room for three major companies in an interview with Reuters on Tuesday.

DEEP POCKETS

Even so, a takeover of Alcatel-Lucent would be difficult, costly and, in the case of a Chinese buyer, face political barriers.

Alcatel-Lucent's market capitalization is 6.3 billion euros ($9.1 billion), and any takeover would require a considerable premium -- 25-30 percent based on recent telecom, media, and technology deals -- to win over management and shareholders.

Alcatel-Lucent carries about 4 billion euros in long-term debt, according to the company, and has large pension obligations from the former Lucent.

For Chinese players Huawei and ZTE, buying Alcatel-Lucent would give them more global reach, deepen their relationships with major operators such as Verizon and Vodafone and strengthen their research and development.

But political sensitivities make Chinese bids unlikely.

The French government would never allow it, said Herve Lassalle, a union leader at Alcatel-Lucent.

The U.S. could also oppose a deal as Lucent's Bell Labs unit does business with the government and military. In 2007, Huawei sought to team up with Bain Capital to buy a 16.5 percent stake in networking firm 3Com Corp, but Washington derailed the deal.

Huawei told Reuters last week it had no plans to buy a stake in Alcatel-Lucent, while a ZTE spokeswoman said she had not heard of any deal.

For Nokia Siemens Networks (NSN), buying Alcatel-Lucent would give it the scale it needs to improve profits while strengthening its position in fourth-generation wireless technology.

But the NSN joint venture is still recovering from its own creation by merger in 2007, only replaced its CEO on Tuesday, and could struggle to finance such a big purchase, the London-based technology banker said.

Siemens, owner of half of the venture, does not want to invest more money in Nokia Siemens, but it might allow its stake to be diluted in the event of an acquisition, according to a person familiar with management's thinking.

PROFIT FOCUS

Mobile market leader Ericsson would have the financial might to make a bid, but little strategic motive.

With the best margins in the telecom gear business, its success stems in large part from a focus on wireless technology. It does not try to be all things to all clients and so has huge market share in mobile and better economies of scale.

Buying Alcatel-Lucent, with its higher cost base and broad portfolio, would only drag down Ericsson's profitability, Nomura Securities technology specialist Richard Windsor said.

Cisco Systems, which has a massive war chest of cash, could also be interested to secure a better foothold in mobile and IP technology. To date, Cisco's strategy has been targeted, smaller acquisitions to add promising technologies to its portfolio. Its appetite for a larger, more complicated deal is unknown.

A Cisco spokeswoman declined to comment on its acquisition strategy.

An Alcatel-Lucent spokesman declined to say whether it would put itself up for sale or had hired bankers to advise it.

Our focus is on turning a profit in 2010 and serving our customers, he said.

($1=.6964 Euro)

(Reporting by Leila Abboud and Marie Mawad in Paris, Tarmo Virki in Helsinki and Victoria Howley in London, editing by Will Waterman)

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