What Nokia and Alcatel Lucent’s Merger Means for Investors
Nokia (NOK) is a company that is making impressive moves to grow its business and tap growth in fast growing market for connectivity. As a part of its plan, Nokia has acquired Alcatel Lucent (ALU) for almost $17 billion, and the deal was recently green-lighted by the European Commission. In my opinion, Alcatel has made a smart move by acquiring Nokia as this will allow it to compete it more effectively against the likes of Ericsson and low-cost Chinese powerhouse Huawei.
The merits of the deal
Alcatel Lucent is already benefiting from its Shift plan that has been a significant driver of profitability of late. As a part of this plan, the sales of its next generation products grew 25% at actual and 9% at constant exchange rates during the last twelve months. In fact, the company sees growth of 15% in its next generation technology products, which is quite impressive. Also, its shift plan is driving its bottom line performance. For instance, Alcatel recorded cumulative fixed costs savings of $825 million in the second quarter 2015.
On the other hand, Nokia looks well-positioned with strong network software sales and HERE maps gaining. CEO Rajeev Suri said in a statement, "Software sales were up significantly; core networking sales improved; we saw a reduced impact of strategic entry deals; Global Services had one of its best quarters in the history of the company; and costs remained well under control."
Nokia reported €3.21 billion in revenue in the second quarter of 2015. This represents revenue growth of 9.2% year-over-year. In fact, Nokia expects its network sales to grow between 8% and 11%, and HERE revenue to grow between 9% and 12% this fiscal year. More importantly, the combined revenue for both these companies for fiscal 2014 was quite strong as compared to its peers. Nokia and Alcatel Lucent together reported about €26 billion in revenues last year, while Ericsson and Huawei posted revenues of €24bn and €43 billion, respectively.
Tapping end market growth
As per a report by GSMA for Mobile Economy, the Asia Pacific region now accounts for half of the world’s mobile subscribers and will remain one of the world’s fastest growing mobile markets through 2020 and beyond. This creates a good opportunity for Alcatel and Nokia to enhance their market share in the Asia Pacific.
Also, the Mobile Economy Asia Pacific report expects the number of Asia Pacific subscribers to grow at CAGR of 5.5% until 2020, reaching 2.4 billion. Only the sub-Saharan African region is expected to grow at a faster rate during the period. Total mobile connections in Asia Pacific stood at 3.4 billion at the end of 2013 and are forecast to increase to 4.8 billion by 2020. There were only 1.7 billion unique mobile subscribers in the Asia Pacific region at the end of 2013, accounting for half of the 3.4 billion global subscriber bases.
More importantly, according to GSMA, there are only over two thirds of Chinese mobile internet subscribers who have access to internet services via mobile broadband networks, either 3G or 4G. This means the remaining internet subscribers are using 2G networks, creating room for Alcatel and Nokia to take advantage of this opportunity.
Strong growth of next generation technologies will be a catalyst
Alcatel-Lucent is experiencing good sales momentum for its next generation technologies. Its 7950 XRS series continues to gain traction in the market. In fact, during the second quarter, Alcatel won five new contracts, taking its tally to 44 since the start of the year. Also, its virtual routing platform as well as new carrier SDN platform is enhancing its top line performance. Alcatel Lucent won eight new customers for its virtual routing platform during the quarter.
More importantly, for the first time, Alcatel saw its free cash flow grow by €270 million due to strong sales of next generation technologies. Also, Alcatel-Lucent's operating margin increased by 100 basis points to 5.1%. So, growth in the free cash flow as well as operating margin is a positive indicator.
Together, Nokia and Alcatel will be able to tap the opportunity in the end market more effectively. This is the reason why investors should remain invested in these stocks as the combined entity could do well in the long run.