As Nokia (NYSE:NOK) speeds toward completing its $17.1 billion acquisition of rival Alcatel-Lucent (NYSE: ALU) in the first quarter of 2016, industry analysts say that the two vendors are in strong financial shape after delivering their third-quarter results and are well-positioned to take on Ericsson (NASDAQ: ERIC) and Huawei. However, Nokia and Alcatel-Lucent will likely need to make significant cuts to their combined mobile assets, which will result in job cuts, and rivals will be looking to press their advantages as the companies come together next year.
"Nokia Networks' gross and operating margins remain peer-leading at 39.5% and 9.5%, respectively, even as the company's revenue mix shifts away from developed markets in Europe and North America towards developing markets in the Middle East and Asia," TBR analyst Michael Soper said. "This is largely due to a focused R&D strategy and emphasis on high-margin professional services."
TBR expects Nokia to deliver a 2015 operating margin in the double digits and low-single-digit revenue growth, "as large-scale LTE buildouts in China and, to a lesser extent, India will offset slowing LTE activity in North America."
Meanwhile, TBR analyst Patrick Filkins said that Alcatel-Lucent in the third quarter "delivered improved revenues, gross and operating margin," which were "boosted by currency effects and Shift Plan restructuring. Alcatel-Lucent benefitted from higher software sales in the U.S. and LTE deployments in China, however, contract delays in Alcatel-Lucent's Submarine (ASN) business, drove down revenue at constant currency rates. A large, one-time impairment of goodwill charge, attributed to ASN, negatively affected profits."
Despite some of the positive financial progress the companies have made recently, large cuts are coming, especially in the firm's wireless units. Nokia CEO Rajeev Suri, who will lead the combined company, has already said that "radio is where the heavy lifting will take place in wireless and that's where we need to integrate and there of course will be some struggles during the process."
So where will the cuts come exactly?
Ovum analyst (and FierceWireless contributor) Daryl Schoolar said that he thinks many Nokia macro network products will win out, though of course Alcatel-Lucent gear will still be left in networks and serviced for as long as needed, with Nokia products replacing them over time. The exception is likely to be small cells, Schoolar said, where Alcatel-Lucent has gotten more traction that Nokia.
Soper said the cuts "are likely to come in some of the more obvious areas where all the vendors are somewhat similar. Nokia will have to choose between its own macro cells and small cells, and Alcatel-Lucent's."
Additionally, Soper notes that the services organization, which is being lumped in with Mobile Networks in the new company's structure, "will also have a good deal of overlap. However, because Nokia and Alcatel-Lucent downsized their services organizations during restructuring, the combined unit might be more left alone than we think."
Current Analysis analyst (and FierceWireless contributor) Peter Jarich said while there is not much overlap on areas like transport and routing, where Alcatel-Lucent has strengths, there is a lot more overlap on the companies' work on LTE, network functions virtualization, core networking and packet core.
Jarich said it will be interesting to see the companies grapple with the question of, "Where we can we leverage the best of breed?" Around small cells, Jarich acknowledged that Alcatel-Lucent has some momentum but has been less adept at a "hub and spokes" network system like those provided by Ericsson's Radio Dot System or similar offerings from SpiderCloud.
Jarich also said it will be interesting to see how many jobs the companies wind up cutting in the United States, France and China after making specific pledges to regulators to promote investment in those countries.
Nokia and Alcatel-Lucent are a good complement for each other, with Alcatel-Lucent bringing IP, software, BSS, backhaul and fixed access elements that fill out Nokia's product portfolio, Schoolar said. The companies' overlap in wireless is really only in the United States and China, he noted, and in the U.S, they are both only really selling gear into one major operator, Sprint (NYSE: S).
TBR thinks Nokia Networks and Alcatel-Lucent are already the leading vendors outside of Huawei and ZTE to China Mobile, China Telecom and China Unicom, with larger market shares than Ericsson. "Combined, the two vendors will hold significant market share that will challenge, but not exceed China-based rivals due to the Chinese government's preference to favor domestic vendors," Soper said. "While Nokia's presence within the three operators' accounts is limited to radio access and mobile core infrastructure, Alcatel-Lucent provides them with core routing, optical, and fixed access equipment, in addition to wireless access equipment."
After the deal closes, Soper said that "Nokia will be in a much more advantageous position in the U.S., where Alcatel-Lucent and Ericsson currently dominate." He said he does not think Nokia "has to worry about key Alcatel-Lucent customers defecting to rivals during the integration or portfolio culling process. Tier 1s value scale, continuity and existing relationships highly. Samsung lacks scale, while Huawei isn't allowed to compete for Tier 1 contracts in the U.S."
However, there could be defections ahead, and added that "some of Alcatel-Lucent's Tier 2 or 3 customers could elect to roll out new technologies with Samsung or Huawei. Huawei especially has been forging relationships with smaller U.S. operators."
Jarich sees a more strategic challenge for Nokia and noted that over the last several years Ericsson, through small acquisitions, has positioned itself as more of a software and IT vendor than a singularly-focused vendor catering to telcos. Ericsson is "bulking up in terms of systems integrators," he said, which helps its services business. Nokia and Alcatel-Lucent "don't get any benefit in that space" from the deal, Jarich said.
Nokia sees North America sales slump in Q3, but promises faster cost-savings from Alcatel-Lucent deal
Nokia shareholders are final hurdle to Alcatel-Lucent merger
Nokia wins Chinese antitrust approval for Alcatel-Lucent deal
Nokia's Suri: Wireless integration will require 'heavy lifting' in Alcatel-Lucent deal
Nokia executives will dominate following Alcatel-Lucent merger
Nokia CEO gains French government approval for Alcatel-Lucent deal with R&D commitment