Nokia CEO defends Alcatel-Lucent merger after disappointing earnings report; Infonetics: It’s the "Airbus of telecom"

Nokia Corp. said that its mainstay network business delivered “unsatisfactory profits” during the first quarter. Nokia’s network division saw its quarterly revenue rise 15% over the year to €2.67 billion ($2.94 billion), the unit’s underlying operating profit for the first quarter fell to €85 million from €216 million, Nokia said in a statement.

The network division’s quarterly underlying operating profit margin fell to 3.2% from 9.3% a year earlier and was well below the company’s long-term target of between 8% and 11%.

Nokia also said that its network unit is now expected to post a full-year 2015 underlying operating profit margin around the midpoint of the long-term target between 8% and 11%.

The networking unit’s “unsatisfactory” profitability was due to higher expenses and more revenue coming from lower-margin hardware sales instead of more lucrative software deals, Chief Executive Rajeev Suri said in a telephone conference call.  Suri claimed that every single customer he has spoken to since the Alcatel-Lucent deal was announced has expressed support for the move.

“They see it as a way to ensure there are three strong global competitors and not as a reduction in competition,” Suri said. “It’s a way to protect investments of the past while enabling the innovation of the future,” he added

Suri also sought to address the worry that another merger between two huge equipment makers could run into the same problems as earlier tie-ups.

“It’s not a joint venture but an acquisition and there is clarity in terms of leadership and governance,” he said. “Both the companies have learned from recent transformation and restructuring, and so we can ensure that history does not repeat itself.”

Nokia says it has already appointed an “integration leader” to ensure that integration planning is kept separate from ordinary day-to-day business activities.

Suri also believes that recent technology shifts will aid the merger process. “We’ve been transitioning away from customized hardware and towards open interfaces that can mitigate the pain of expensive swaps,” he said.

“We are confident we can execute as discussed and expect no change in planned cost reductions from the transaction,” said Timo Ihamuotila, Nokia’s CFO.

Suri’s defense of Nokia’s bid for Alcatel-Lucent came just a day after Odey Asset Management, the French company’s second-biggest shareholder, was reported by the Financial Times (subscription required) to have described the deal as “unacceptable.”

The investment group, which owns around 5% of Alcatel-Lucent’s stock, is said to have complained that Nokia’s bid massively undervalues Alcatel-Lucent and is really a merger “dressed up as a takeover.”

Last week, ratings agency Fitch Ratings Ltd. weighed in with its own downbeat assessment of the deal, arguing it would do little to ease competition.

“Other major vendors will use the time it takes for the deal to complete to try and strengthen their own position,” said Fitch in a published statement. “In some markets, such as the US, competition should ease in the longer term, but in others the picture is less clear.”

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In a note to Infonetics clients, Stéphane Téral, Research Director, Mobile Infrastructure and Carrier Economics wrote: 

The problem is that we’ve reached the end of the (mobile infrastructure) cycle—2015 is a peak year (see our November 2014 Service Provider Capex, Revenue, and Capex by Equipment Type market size and forecasts)—and the next one will require scale and scope, including a new type of software-based networking equipment that combines telecoms, media, and IT. Alcatel-Lucent and Nokia both lack end-to-end capabilities as well as the scale of their most direct competitors, Ericsson and Huawei, so they can’t fully embrace the new ICT era that is bringing the likes of Cisco, IBM, Oracle, and HP to their traditional service provider turf. Now was the right time for Europe to create its telecom champion, the same way as the European Aeronautic Defense and Space Company N.V. (EADS) was created in July 2000 (reorganized and renamed Airbus Group in January 2014).”

The Finnish-French tie-up (Nokia-Alcatel-Lucent) recorded sales of €25.9B last year and has a market cap of more than €45B, directly rivaling Ericsson (€25B), which was passed by Huawei last year. Put another way, the Airbus of telecoms will become the world’s second-largest vendor by revenue, neck and neck with Ericsson.”

Regarding the scale and viability of the deal, make no mistake, this definitely is the Airbus of telecoms that is about to take off and fly for the next decade or so. The size of this Airbus is now on par with Ericsson’s and directly comparable with Huawei’s. And finally, this deal will arm the 2 companies with tremendous R&D capabilities (e.g., Bell Labs) to build an arsenal of technologies to fight Huawei.  Now it’s all about execution as usual, so let’s see after the deal is closed in a year.”

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 Anders Bylund wrote:

The core networking division that accounts for 84% of Nokia’s overall sales saw strong sales growth, but its operating profits took a 61% year-over-year haircut. Nokia offered many detailed explanations for this swooning profitability, but it all boils down to one thing: The company just isn’t executing like it used to.

This first-quarter report is actually weaker than it looks, because the Nokia technologies boost won’t last. Will it be enough to scuttle the pending deal? Maybe not, but maybe it would be for the best. Like I said when the merger was announced, Nokia is underpaying for Alcatel-Lucent, but I’m not sure why the Finns want to own it in the first place.

Nothing has changed, except the road to Mergerville suddenly gained a few additional roadblocks. I’m not at all convinced that this deal will happen, and Nokia may have damaged its own operations beyond repair by reaching for this strange combination.”