Mallinson: Nokia, Alcatel-Lucent and the last of the network equipment mega-mergers

Keith Mallinson

Nokia's integration of Alcatel-Lucent following the proposed acquisition of its rival will be difficult and messy. Some significant rewards will take many years to achieve, if ever.

However, very large research and development demands with economies of scale and scope in 4G, 5G and with fixed-mobile network convergence make this kind of transaction inevitable and indispensable. Bystanders Ericsson and Huawei will probably do at least as well from it as the parties involved, with the reduced network equipment provider competition, while Nokia and Alcatel-Lucent are distracted with many years of merger integration work.

Simplification and rationalisation
Nokia's clean design for the €15.6 billion ($16.7 billion) takeover of Alcatel-Lucent is reassuring. But the implementation will be difficult and distract management from their other strategic goals in 5G and fixed-mobile convergence. Nokia has laid out a simpler-than-expected plan for its biggest-ever acquisition. It has avoided complicated corporate governance structures that have been demanded by the French government and mired previous rationalisation work.

The firms are promising to cut €900 million of yearly operating expenses by 2019 by reducing duplicated products, overlapping real estate and other overhead costs. They aim to slash another €200 million in interest expenses. Nokia's HERE mapping business and Alcatel-Lucent's submarine cable divisions appear to be on the block for sale.

Alcatel-Lucent shareholders are fortunate to have the possibility of a brighter future. However, the heavy costs to shareholders from the merger of Alcatel and Lucent in 2006 serve as a warning to Nokia. The French group has not generated positive free cash flow since 2005 and its market capitalization fell by 80 per cent in the eight years after the deal. Full rationalisation of what were once the four national champions in France, the U.S, Finland and Germany (i.e. Siemens) will take enormous effort by management with integration challenges for many years. The ability to cut jobs looks limited, as Nokia has promised not to retrench in France, where most Alcatel-Lucent employees are based, beyond what has already been agreed to under a three-year restructuring plan.

Yet the combination has appeal with respect to geographic and product market scope.

Long gone are the days when each major developed county had its own selection of national champion network equipment vendors. Markets are largely global, but there remain some geographic wrinkles. Through the proposed acquisition, Nokia would own Alcatel-Lucent's 50 per cent stake in Alcatel-Lucent Shanghai Bell alongside the Chinese state. Over the past year, both Nokia and Alcatel-Lucent have received contracts to supply 4G equipment to China's three main mobile operators.

Huawei is blocked from the U.S. due to worries about national security, which Huawei says are unfounded. This means that the proposed acquisition of Alcatel-Lucent by Nokia would effectively narrow the market to two with Ericsson in mobile RAN equipment, for example. However, this will raise antitrust concerns.

Obtaining competition authority clearance in Europe will likely prove less of a problem, particularly since the deal is being presented as an attempt to create a European champion to challenge overseas rivals such as Huawei.

Convergence and replacement
Nokia CEO Rajeev Suri says the deal is about responding to convergence among telecoms operators, which are increasingly offering combined fixed and mobile services as well as TV offerings. Nokia has concentrated heavily on the mobile Internet recently, so adding Alcatel-Lucent's strong position in fixed broadband will improve what he calls "the scope" to address this. Alcatel-Lucent CEO Michel Combes recently said that "to compete in the future you will need end-to-end solutions across the whole portfolio."

Eliminating duplication and amalgamating technology and staff groups often also takes longer than expected. Unlike many other industries where benefits from consolidation might be rapidly obtained in many ways, in telecommunications network equipment there are limited opportunities to rationalise product portfolios until a clean sheet can be used to create the next generation of technologies.

Ripping out and replacing current-generation technology is very costly and so following mergers, with a few notable exceptions, network equipment providers tend to carry overlapping product lines until long-term R&D yields something entirely new and unified in the next generation technologies that operators will pay for. In one bizarre exception, Alcatel-Lucent ripped-out and replaced 3G equipment at AT&T after favouring the UMTS platform it acquired from Nortel in 2006 over Alcatel's and Lucent's platforms, as Alcatel-Lucent sought to rationalise product lines as quickly as possible. Fortunately, that was relatively early days in AT&T's 3G deployments.

I doubt the parties want to do such wholesale replacements, again, with so much 3G and 4G equipment already in the field now, and possibly not even for 4G products on sale. But it might make them particularly eager to implement 5G and new converged platforms.