February 12, 2016 / 1:06 PM / 4 years ago

Nokia Alcatel merger story draws investors, even as growth fades

FRANKFURT (Reuters) - Nokia’s (NOKIA.HE) best days of growth may be behind it for the foreseeable future, but what keeps investors on board one of Europe’s biggest technology stocks is the progress it is making to deliver more consistent profits and shareholder returns. It came as little surprise when Nokia warned on Thursday its core mobile business could decline during 2016 as China, its most vibrant market, has largely finished upgrading networks. Nonetheless, many analysts predict rising margins after Nokia closed its 15.6 billion euro ($17.6 billion) acquisition of Alcatel Lucent ALUA.PA, allowing the combined firm to cull many overlapping operations and products.

Michel Combes (L), Telecom equipment maker Alcatel-Lucent Chief Executive Officer, shakes hands with Nokia's President and Chief Executive Rajeev Suri (R) before a news conference in Paris April 15, 2015. REUTERS/Charles Platiau

In its last separate report, Alcatel Lucent produced strong results on Thursday, taking the sting out of Nokia’s own cautious outlook.

“Under good management, which I believe Nokia has, the operating margin of Alcatel’s side of the business could almost double over the next two to three years,” Liberum analyst Janardan Menon said.

Alcatel operating margins around 7 percent could expand to nearly 13 percent by 2018, Menon predicts - a view shared by many analysts.

“My bullishness on the stock is entirely driven by Alcatel Lucent,” said Menon, who recommends investors buy Nokia stock, which he says should appreciate roughly 50 percent over time.

Thomson Reuters StarMine data shows Nokia can increase earnings at a compound annual growth rate of 10.6 percent over the next five years, which suggests the stock should be worth 7.61 euros, a 46 percent increase from current levels. The market is pricing in earnings growth of just 4.5 percent.

Nokia’s merger with Alcatel, well-timed in retrospect, given its own declining growth, puts wireless and fixed-line network products under one roof to help it compete with bigger rivals Ericsson (ERICb.ST) of Sweden and Huawei [HWT.UL] of China.


Alcatel thrusts Nokia into some faster growing markets for data network gear, software and services that can command higher margins. Ericsson has resisted a big merger of its own and has instead partnered with Cisco Systems (CSCO.O).

Nokia says it will eventually wring out 900 million euros of savings from the combination with Alcatel. Many analysts believe that Nokia will find even more cost reductions. Its management put off until May providing guidance beyond the current quarter and any further savings it expects from the merger this year.

The contrarian view is that big mergers in the mobile industry over the past 20 years have failed to deliver many of the promised synergies. Alcatel-Lucent and Nokia’s purchase of Siemens networks a decade ago are classic examples.

“These mergers have quite a bad track record,” said analyst Mikael Rautanen, of Inderes Equity Research. He sees a lack of clarity on how cost savings will be achieved with the Nokia-Alcatel deal. He recommends investors reduce holdings in Nokia.

Cognizant of the history, Nokia and Alcatel managements haggled for years to work out a deal that lets them move quickly to combine the companies and develop an integrated product strategy for 5G, the next generation of networks due after 2018.

Alcatel has completed a nearly three-year turnaround plan that led it to generate its first year of positive cash flow in a decade. Alcatel’s wireless business and duplicate sales and marketing functions are likely to bear the brunt of future cuts.

Reporting by Eric Auchard; editing by Adrian Croft

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