Nokia: 5G Costs Hit Q1 Outlook as Shares Crash and Dividend Suspended
We’ve strongly warned for some time that making money in 5G will be extremely difficult until the core IMT 2020 standards (radio and non radio aspects) are complete and widely implemented. Today we heard proof of that from Nokia:
“Some of the risks that we flagged previously related to the initial phase of 5G are now materializing,” Nokia CEO Rajeev Suri said, noting that its third-quarter gross margin was impacted by the “high cost level associated with our first generation 5G products.”
“Competitive intensity has increased in some accounts as some competitors seek to take share in the early stage of 5G,” Nokia said in a statement. Yet the company said it has 48 commercial 5G deals and has launched 15 live (pre-standard) 5G networks. It’s telco customers include Sprint, Verizon, AT&T, and T-Mobile in the U.S.
China has been a disappointment for Nokia, too. Greater China made up 8% of Nokia’s net sales in the third quarter, the company said Thursday. But revenue from the region fell by 21% from the year-earlier period.
Nokia shares had one of their worst days ever on Thursday after the Finnish telecom equipment maker reduced its profit outlook to reflect the costs of developing 5G products. The stock fell by -24% to $3.87 — the largest drop since 1991 — as Nokia also disclosed in its third-quarter earnings release that it would not be paying a dividend for that quarter and the fourth quarter in part to “guarantee Nokia’s ability to increase 5G investments.”
The elimination of Nokia’s dividend contradicted what the company said about dividends on its website to attract investors:
The dividend is the principal method of distributing earnings to shareholders. Over the long term, Nokia targets to deliver an earnings-based growing dividend by distributing approximately 40% to 70% of non-IFRS diluted EPS, taking into account Nokia’s cash position and expected cash flow generation.
Instead of paying a dividend, the company wants to use its cash to increase its 5G investments, strengthen its cash position, and invest in strategic areas such as software. The company expects to start paying dividends again after it reaches a cash balance of 2 billion euros.
Nokia reduced its earnings forecast this year from an operating margin of 9-12 per cent to one of 8.5 per cent, plus or minus one percentage point. For next year, it slashed its estimate of a 12-16 per cent operating margin to 9.5 per cent, plus or minus one percentage point.
It will take much longer than most pundits believe to realize to monetize the potential and make a decent profit from 5G!
AJW Comment: We are at the start of the 5G transition and Nokia appears to be having the usual problems of refining and finding cost efficiencies in its technology in its first iterations. Gross margins were hit by “a high cost level associated with our first generation 5G products” combined with “pricing pressure in early 5G deals” as it has been limited in what it can charge for the next-generation equipment by competition for those key first customer wins. There are also “profitability challenges in China,” where there has been patriotic domestic buying and support of Huawei 5G equipment by the three state owned telcos. Also, the proposed (but not consummated) merger of Sprint and T-Mobile in the U.S. is causing uncertainty on future demand in one of Nokia’s main early markets for 5G where the company largely competes only with Ericsson (as Huawei has been shout out of the U.S. telecom equipment market, except for earlier sales to rural wireless carriers).
Nokia is the world’s second-largest telecom gear maker by market share, but way behind #1 Huawei. Ericsson is #3 (see Positive Note below).
From Nokia’s 3rdQ-2019 earnings statement:
The overall decrease in Nokia gross profit in the first nine months of 2019 was primarily due to lower gross margin in Networks. We experienced relatively high 5G product costs in Networks, as well as elevated levels of deployment services, consistent with being in the initial phase of 5G. This was partially offset by lower costs related to network equipment swaps, net sales growth in both Networks and Nokia Software, as well as higher gross margin in Nokia Software. In the first nine months of 2019, Nokia gross profit benefited from lower incentive accruals.
From the company’s 3rdQ-2019 slide presentation:
Key drivers of Nokia’s outlook-
Net sales and operating margin for Networks and Nokia Software are expected to be influenced by factors including:
• Our expectation that we will perform approximately in-line with our primary addressable market in full year 2019 and full year 2020, as we further prioritize profitability and cash, while continuing to drive growth in our Nokia Software and Nokia Enterprise businesses. (This is an update to earlier commentary to outperform our primary addressable market in full year 2019 and over the longer-term.) On a constant currency basis, we expect our primary addressable market to grow slightly in full year 2019, and for growth to continue in full year 2020;
• Competitive intensity has increased in some accounts as some competitors seek to take share in the early stage of 5G, which is particularly impacting Mobile Access. (This is an update to earlier commentary that competitive intensity could increase);
• Additional 5G investments focused on accelerating our product road maps and cost competitiveness. Investment areas include System on Chip based 5G hardware, including diversifying and strengthening the related supplier base (new commentary);
• Additional digitalization investments focused on driving automation and productivity, including further simplification of IT tools and operational processes (new commentary);
• Temporary capital expenditure constraints in North America related to customer merger activity, as well as other potential mergers or acquisitions by our customers (This is an update to earlier commentary for potential mergers or acquisitions by our customers);
• The timing of completions and acceptances of certain projects, particularly related to 5G. Based on the evolving readiness of the 5G ecosystem and the staggered nature of 5G rollouts in lead countries, we expect full year 2019 will have seasonality characterized by a particularly weak first quarter, a strong second quarter, a solid third quarter and an expected strong fourth quarter (This is an update to earlier commentary for an expected soft third quarter and an expected particularly strong fourth quarter);
• Some customers are reassessing their vendors in light of security concerns, creating near-term pressure to invest in order to secure long-term benefits;
• Our expectation that we will improve our R&D productivity and reduce support function costs through the successful execution of our cost savings program;
• Our product and regional mix, including the impact of the high cost level associated with our first generation 5G products (This is an update to our earlier commentary, providing additional details); and
• Macroeconomic, industry and competitive dynamics.
On a positive note: “As I look to the future, it is clear to me that Nokia has some unique advantages,” Suri said, citing “a powerful, end-to-end portfolio that allows us to benefit from 5G investments across all network domains.”
Nokia’s dismal earnings report contrasts with that of rival Ericsson which last week beat quarterly earnings expectations and lifted its market forecast for this year and its sales target for 2020. The Swedish firm said demand for (pre-standard) 5G networks was robust: “5G is taking off faster than earlier anticipated,” CEO Börje Ekholm said in an earnings statement. The Swedish telecom equipment company said it had signed 27 commercial 5G contracts.
Some analysts had thought that Nokia would benefit from the pressure on Huawei. But the disappointing results published Thursday were driven primarily by weakness in the division responsible for rolling out 5G.
“The report was a major disappointment … outlook was cut across the board reflecting the company’s continuing stumbles as the new cycle of network market is starting to take off,” Inderes analyst Mikael Rautanen said in a note to clients.
“This is all very disappointing,” said Lee Simpson, an analyst at Jefferies. “There is something almost embarrassingly irrelevant about the Nokia story now.”
“He has been in the position now for over five years and is still struggling to put in place a sustainable, comprehensive set of results and targets,” sad Neil Campling of Mirabaud Securities.
4 thoughts on “Nokia: 5G Costs Hit Q1 Outlook as Shares Crash and Dividend Suspended”
Shares of Nokia Corp. fell again Friday, putting them on track for their worst two-day performance in 19 years, after the Finland-based network infrastructure company issued a profit warning and said it would stop paying a dividend as it grappled with implementing new 5G networks.
With a new burst of infrastructure spending by the big telecoms carriers, mobile networks should be a bright spot for equipment makers. Yet they’re Nokia’s biggest problem. Revenue from this business grew just 4.4% in the three months through September. Sales at Ericsson’s networks arm (which includes more than just mobile products) rose 9% in the same period.
Nordea Bank analyst Sami Sarkamies reckons Nokia simply lags behind Ericsson technologically. That makes Nokia’s equipment more expensive to produce. With the company still having to try to compete with Ericsson on price, this erodes profitability.
Of the 32 analysts surveyed by FactSet, 6 have downgraded Nokia since the profit warning, while 17 have cut their stock price targets.
MKM Partners Michael Genovese wrote in a note to clients: “We are disappointed by Nokia’s execution in the 5G hardware and 5G software markets so far. However, we think the guidance has now likely been set low enough that the next revision is more likely to be up.”
Ericsson, Nokia, Huawei may suffer badly with Indian telcos set to curtail capex
They added that with balance sheets of the two telcos likely to be further weakened, existing tenancies and future growth of telecom tower companies like Bharti Infratel could be at risk as well.
Telecom gear makers such as Europe’s Ericsson and Nokia, and China’s Huawei could be staring at significant growth challenges with the Supreme Court’s ruling on adjusted gross revenue (AGR) likely to force their main clients Vodafone Idea Ltd. (VIL) and Bharti Airtel to curtail capex plans, say analysts.
With the balance sheets of the two telcos likely to be further weakened, existing tenancies and future growth of telecom tower companies like Bharti Infratel could be at risk as well, they said.
Rajiv Sharma, the co-head of research at SBICap Securities, said all vendors would be affected except Samsung (the Korean company sells equipment only to Reliance Jio Infocomm in India, and the country’s newest telecom operator isn’t affected by the judgement) because telcos’ capital expenditure plan would take a back seat.
“A sharp cut in the capex deployments over the next 12-18 months at the least is expected, and it could be prolonged. VIL will find it hard to do meaningful capex if they were to pay, and Airtel will also be selective,” Sharma added.
Nokia has hired 350 employees for research and development in Finland this year as it tries to fix a 5G chip problem that could derail its mobile business, the company confirmed in an email to Light Reading.
Following reports in the Finnish press, the equipment vendor said it had been recruiting mainly for system-on-a-chip development but declined to provide staff numbers for its overall R&D function.
The update comes after Nokia’s share price fell 27% last week when the company revealed that its use of certain components in 5G products had squeezed third-quarter profits, with the gross margin at its networks business falling five percentage points compared with the year-earlier period.
CEO Rajeev Suri had hoped the use of field programmable gate arrays (FGPAs) — chips that can be reconfigured after the design stage — would provide flexibility and give Nokia a 5G time-to-market advantage over competitors Ericsson and Huawei.
But FGPAs are more expensive than alternative application-specific integrated circuits (ASICs), meaning Nokia’s 5G products are less profitable than rival gear. Suri also said Nokia had also been let down by one of its FGPA component suppliers, which one analyst on the earnings call appeared to identify as Intel.
Its problems have forced Nokia to lower its outlook and pause dividends while it pumps extra funding into 5G R&D.
Nokia cut overall R&D expenses by 6% last year, to about €4.62 billion ($5.14 billion), and has spent €3.34 billion ($3.71 billion) in the first nine months of 2019, about 3% less than in the year-earlier period.
“It’s fair to say that 5G happened quicker than we and others thought,” said Kristian Pullola, Nokia’s chief financial officer, when asked during an interview with Light Reading last week if the firm was guilty of underinvesting in 5G. “We have had pressure in R&D to get to the situation we are in now and that happened in parallel with product migration work related to the Alcatel-Lucent merger.”
Nokia bought rival Alcatel-Lucent in a €15.6 billion ($17.3 billion, at today’s exchange rate) deal at the start of 2016 and said its decision to use FPGAs was prompted by that move and the integration challenges that came with it.
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While it has not indicated exactly how much it plans to spend on R&D next year, it has been forced to reduce cost-saving targets by €200 million ($222 million). Nokia was previously hoping to cut annual costs by €700 million ($778 million) in 2020, compared with 2018, but is now aiming for a €500 million ($556 million) reduction.
Unlike rival Ericsson, Nokia does not disclose details of headcount in its quarterly earnings statements, but its annual reports indicate that average staff numbers increased from 101,731 employees in 2017 to 103,083 last year.
Ericsson finished 2018 with 95,359 employees after shedding 5,376 that year. Its headcount has fallen by more than 15,500 employees since current CEO Börje Ekholm took charge of the business at the start of 2017.
ZTE, a Chinese 5G competitor, appears to have made even sharper cuts in recent years, with overall headcount falling from 84,622 employees in 2015 to 68,240 last year.
Nokia’s Rajeev Suri is the worst CEO among the companies I follow, by far. No focus, no strategic vision, destroying shareholder value fast. Its mind boggling that the board still allows him to stay
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