Why the Nokia, Alcatel-Lucent mega-merger is significant

  • Deal puts Nokia’s market share at No 2; expands its presence into US, China
  • Still considerable hurdles to overcome, including integration, culture and tech

Why the Nokia, Alcatel-Lucent mega-merger is significant

NEWS ANALYSIS: THE telco world got a mild shock when news broke on April 15 that Finnish mobile equipment manufacturer Nokia Corp had agreed to buy Franco-American vendor Alcatel-Lucent SA in an all-stock deal valued at US$16.6 billion. 

Mild because speculation was already rife about the move when The Wall Street Journal got its teeth on the story a day earlier on April 14, as did Reuters.
 
Both media outlets then said that talks were at the advanced stage, with The Journal reporting a “full combination” of both companies’ business, in which Nokia would offer a share exchange for control of Alcatel-Lucent. Reuters pointed out that the full announcement could come “very quickly.”
 
It was first reported that Nokia would only purchase Alcatel-Lucent’s wireless assets. However, the takeover ended up being bigger than that, with CNBC reporting that Alcatel-Lucent chief executive officer (CEO) Michel Combes claimed to have convinced Nokia to buy the whole company instead.
 
On April 15, the CEOs of the two companies emerged smiling while announcing the deal after meeting French President François Hollande.
 
Industry watchers noted that the sale of such an iconic national asset to a foreign entity needed tacit political approval, after Paris had earlier promised to take a harder stance against foreign buyouts, The Guardian reported.
 
Why the Nokia, Alcatel-Lucent mega-merger is significantAs part of the deal, Nokia pledged to keep France as “a vibrant centre of the combined company” and not to cut jobs beyond what Alcatel-Lucent had already planned, especially protecting research and development sites at Villarceaux and Lannion, Reuters reported.
 
“This is not a joint venture, so there will be no governance issues,” Nokia CEO Rajeev Suri (pic) said on a call with investors, according to Reuters. “We will take a no-politics, no-nonsense approach to running the business, and have learned from past mistakes.”
 
If the deal receives regulatory approval, the Finnish-French tie-up would create a firm with more than 100,000 employees and nearly €26 billion (US$27.7 billion) in revenue, rivalling Sweden’s Ericsson AB, the market leader, as well as China’s fast-rising Huawei Technologies Co.
 
According to Reuters, Nokia will give Alcatel-Lucent shareholders 0.55 shares in the combined company for each of their old shares, resulting in 33.5% of the entity being in Alcatel’s hands and Nokia having 66.5%, if the public exchange offer is fully taken up.
 
The deal will be finalised in the first half of 2016 and is expected to result in €900 million (US$952 million) of operating cost savings by the end of 2019, the two companies said.

The combined company will be called Nokia and led by Nokia’s Rajeev, and chaired by its current chairman Risto Siilasmaa.
 
According to Bloomberg,  the deal is comparable with the US$13.4-billion deal in 2006 that created today’s Alcatel-Lucent, and would top Nokia’s previous record acquisition of map provider Navteq Corp for about US$8 billion in 2008. It would also be the biggest-ever deal made by a Finnish company.
 
What is it ‘really’ about?
Why the Nokia, Alcatel-Lucent mega-merger is significant
The deal is significant for a couple of reasons. Firstly, while not necessarily a general trend, the return of such telco mega-mergers – eschewed by the market for some time now – is a sign of the need for vendors to find strategic synergies amongst themselves in a bid to combat growing competition in an increasingly low-margin networking equipment business.
 
Historically speaking, large unions between telco vendors have not gone well. When Alcatel first merged with Lucent Technologies Inc in 2006, the two companies were supposed to have created a ‘mega-company’ that was to take the telco world by storm.
 
The same can be said of Nokia when it merged with German powerhouse Siemens AG in 2005, creating an entity known as Nokia Siemens Networks (NSN).
 
The 2007 tie-up between Nokia and Siemens and the creation of Alcatel-Lucent were in part conjured by the four companies separately – all of which were not considered clear leaders in the business at that time – as a strategy to gain greater scale so that they could compete with the likes of Ericsson and upstart Huawei.
 
However, that strategy did not pan out, as the two companies struggled with various issues including the inability to merge their product lines and integrate their respective business cultures.
 
NSN accumulated an operating loss of €5 billion (US$6.8 billion) by the end of 2010, forcing Nokia and Siemens to inject a further €1 billion (US$1.4 billion) of fresh capital into the venture in 2011, according to The Wall Street Journal.
 
Similarly, the Financial Times reported that even four years after the merger, Alcatel-Lucent found it hard to turn a profit.
 
Secondly, there aren’t many telco vendors – save Ericsson and Huawei – that can provide it all from an end-to-end telco infrastructure and services perspective in this day and age, which is the reason why a merger such as this makes sense.
 
In the early days, the mobile telco business was relatively straightforward, and all vendors needed to do was to keep supplying their gear and maintenance contracts to operators worldwide. Operators then also depended on voice as the major earner, and to a lesser extent, SMS and other value-added services.
 
But today, the mobile telco game is much more complicated as operators struggle to keep up with over-the-top players; optimising data connectivity; managing a myriad of apps and services; and keeping abreast of innovations such as network functions virtualisation (NFV) and software-defined networking (SDN).
 
Thus, the vendor without the economies of scale, state-of-the-art innovation, and financial muscle to outgun its competitor’s pricing is going to end up losing not only the battle but also the war.
 
Put simply, the coming together of these two old foes is more than just a marriage of convenience or a defensive move – it is about taking the fight to the competition.

Next: What analysts have to say

Analysts weigh in

Why the Nokia, Alcatel-Lucent mega-merger is significant

Overall, the deal has spawned mixed views with some analysts lauding it, and others, including a former employee, warning that it may be risky move for Nokia.
 
The plus points for Nokia are in three areas.
 
The first is market share. Various estimates put the combination of Nokia’s and Alcatel-Lucent’s telco equipment market share just slightly ahead of Huawei, making the new entity the No 2 vendor behind Ericsson, which is currently the leader.
 
This augers well for Nokia, as it will immediately gain scale to compete with Ericsson and Huawei, particularly in the United States and China, where Alcatel-Lucent had recent wins in 3G (Third Generation) and Long-Term Evolution (LTE) contracts.
 
Next, the two companies have been cutting costs quite aggressively, something that could benefit the combined entity once it works out how best to use its human and financial resources.
 
But perhaps most significantly, Nokia’s move to acquire Alcatel-Lucent has more affinity and strategic direction than it did when it merged with Siemens.
 
In a research note, Ovum’s Mark Newman said that when one considers the strengths and weaknesses of Nokia and Alcatel-Lucent and their product portfolios, a merger of the two businesses seems logical.
 
The chief research officer of the London-based research firm said that Nokia is a mobile-only equipment vendor, while Alcatel-Lucent’s strengths are in the fixed network business, especially in core and optical network, as well as IP (Internet Protocol) routing.
 
“It [Alcatel-Lucent] has long struggled in the wireless business, and its attempts to become a leading player in LTE have failed,” Newman said.
 
“Alcatel-Lucent has also been active in SDN/ NFV with CloudBand and Nuage, and aggressive with small cells – areas in which Nokia is perceived to be lagging behind the competition,” he added.
 
Two financial institutions quoted by CNBC gave the deal the thumbs-up, with Citigroup Inc saying that it believed that “Alcatel-Lucent's and Nokia's wireless businesses are a great strategic fit since the latter is as strong in the United States as NSN was in Europe and Japan [at one time], and that both have strong positions in China.”
 
Credit Suisse Group in a research note said, “We believe that such a potential deal would allow Nokia to significantly improve its presence in the United States with AT&T and Verizon, where Ericsson and Alcatel-Lucent are key suppliers.”
 
Nordnet brokerage strategist Jukka Oksaharju said that Nokia’s Rajeev has a good track record in corporate turnarounds, including what he did earlier with NSN.
 
“There is no reason to doubt that this deal too wouldn’t increase shareholder value ... . We know that there are risks related to France and the cost cuts, but I believe that Nokia has calculated a margin of safety to the deal price,” Oksaharju told Reuters.
 
Other challenges
 
Why the Nokia, Alcatel-Lucent mega-merger is significantStill, Ovum’s Newman (pic) warned that there are still very real risks associated with such a move, as a full merger would plunge both businesses back into a period of introspection and restructuring.
 
Moreover, rationalising two product lines would be difficult, and such moves could create significant duplication in areas such as mobile broadband and small cells.
 
Also a challenge would be maintaining two different product portfolios and servicing existing customers, which could counteract the benefits of increased scale, he added.
 
Other detractors of the deal include Juha-Pekka Helminen, Nokia’s former strategy director, whom the Financial Times quoted as saying on Twitter that “Doing merger with Alcatel [is] crazy … Alcatel-Lucent is and will be a mess [plus the] French government.”
 
Mathias Lundberg, an equity analyst at Swedbank, told MarketWatch that while the bid on Alcatel-Lucent is strategically correct in the long term, it is still highly risky.
 
“We are hesitant [about] its potential for value creation; the true picture will only emerge in a couple of years ... . If Nokia succeeds in this endeavour, a really strong actor will emerge.
 
“However ... many similar ventures have resulted in less stellar performance. Having recently been in a turnaround, perhaps the Nokia team can do a better execution than history would suggest.”
 
Meanwhile, UBS analyst Gareth Jenkins said that other than political and regulatory issues, he believed the two biggest risks to deal with in the execution (not completion) are the cultural difficulties of combining a Finnish-German-French-US corporate entity.
 
“Strong management will be required, and fortunately there are plenty of high-quality managers across the businesses to choose from.”
 
Newman added, “For both Nokia and Alcatel-Lucent, the big challenge facing their businesses is the shift in value from hardware to software, and the convergence of IT and telecoms technology.
 
“Both companies are still firmly anchored in network hardware. A merger of the two businesses will give them more scale but it will not create the software culture to compete in the IT-centric future.”
 
Related Stories:
 
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Say 'hello' to the new Nokia
 
Microsoft’s big bet on Nokia hinges on execution: Analysts
 
Reengineering NSN back to the black
 
Accenture and Alcatel-Lucent team up in ultra-broadband enterprise play
 
 
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