Nokia (NYSE:NOK) has completed its $2.2 billion takeover of Siemens’ 50% stake in their telecom infrastructure joint venture, and renamed it. The erstwhile Nokia Siemens Networks will now be called Nokia Solutions and Networks, thereby dropping ‘Siemens’ from the name but retaining the NSN moniker for all branding and marketing purposes.
The deal, which Nokia had announced last month, values Siemens 50% stake in the venture at 1.7 billion Euros – 1.2 billion Euros of which will be paid in upfront cash by Nokia (financed by bank loans) and the rest a year later. The purchase price is more than 65% lower than our estimate of NSN’s fair value given its ongoing turnaround that is improving margins, generating cash and has put it in a very strong position in the 4G LTE world. How cheap the deal is for Nokia can also be gauged from the fact that NSN generated over 1.4 billion Euros in free cash flow during 2012 itself.
The extremely low valuation for the stake shows Siemens’ desperation at getting rid of a non-core asset which wasn’t aligned with its long-term goals, and its inability to find another buyer for quite some time now. Siemens might however have found it tough to find a private equity buyer willing to pay for its 50% non-controlling stake leaving it with few options but to sell to Nokia for a clear exit.
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As for Nokia, the deal may load Nokia’s balance sheet with more debt and lower its net cash position, but it also gives it a business that is turning around and has been generating a lot of cash in recent quarters. It also reduces the risks attached to its core device business where the company has been bleeding market share amid a slow transition to Windows Phone.
As per our estimates, NSN contributes over 35% to Nokia’s value currently and will become a much larger value contributor once the deal closes. Our current $4.85 price estimate for Nokia does not incorporate the NSN acquisition, and is about 15-20% ahead of the current market price.
NSN focuses on LTE transition
Over the past year, Nokia Siemens Networks has increasingly shown signs of turning the corner as a result of an ongoing restructuring that has not only helped improve its operating margins but also restored focus on its wireless business. As a result, NSN has fast emerged as the leader in the ongoing 4G LTE transition around the world and is taking share away from competitors. As of the third quarter of last year, NSN had succeeded in increasing its market share to about 20% share of the wireless infrastructure industry, only 2% behind #2 player, Huawei.  It now expects to reclaim its #2 spot behind Ericsson by the end of 2013. Most of these gains should come on 4G LTE – a market NSN managed to capture almost 22% of in Q3 2012, up from 13% the previous year.
In the U.S. especially, where Chinese manufacturers such as Huawei and ZTE have been officially blacklisted amid security concerns, NSN will be looking to build on its recent LTE wins at T-Mobile and US Cellular and do well in a region where it has historically been a laggard. The ongoing consolidation in the U.S. wireless market presents a big opportunity to NSN in this regard. NSN has a strong relationship with Softbank in Japan which it can leverage to win more contracts at Sprint, which is now 78% owned by Softbank. Even T-Mobile’s recent merger with MetroPCS is likely to work in NSN’s favor. T-Mobile currently sources its equipment from Ericsson and NSN, while MetroPCS does the same from Ericsson and Samsung. As the carriers look to consolidate suppliers, NSN has an opportunity to displace Samsung owing to its relationship with the bigger T-Mobile.
Restructuring has greatly improved profitability
Apart from revenue share gains, NSN is also benefiting from the streamlining of operations and the ongoing job cuts. In a bid to become leaner and more focused, NSN has sold off many non-core assets such as its wireline and optical networking business, and is increasingly focused at becoming a pure-play mobile broadband specialist. As a result of the reshuffle, NSN has performed really well recently, returning to operating profitability in Q4 2012, and managing to turn a small profit in each of the the next two quarters as well. The division recently posted its fifth consecutive quarter of underlying profitability (non-IFRS), beating the higher end of Nokia’s operating margin guidance and growing by 11 percentage points over the year-ago quarter.
The restructuring is in fact going so well for the company that it now expects to achieve a total of 1.5 billion Euros in yearly savings as compared to 2011 by the end of this year – up by 50% from its earlier estimate. The extra 500 million Euros in savings is likely to come from an additional 8,500 job cuts that Nokia seems to be planning for this year, as reported by Bloomberg earlier this week. While the downsizing will impact revenues, as was seen in the 17% y-o-y drop in NSN sales in the recently concluded Q2, profitability should continue to improve further.
From a cash flow perspective, NSN is proving invaluable to Nokia as it negotiates a tough turnaround in its mobile phone business. While the networks venture has been less consistent in turning profits, it has generated cash for the last seven quarters now. At a time when Nokia is conserving cash by suspending dividend payouts and leasing its headquarters instead of owning it, NSN is proving highly valuable with its steady cash flows despite not being a core asset. In the first of the year, NSN has already generated over 240 million Euros in free cash flow, while the overall Nokia Group could manage negative cash flows of 250 million Euros.Notes:
- Nokia Siemens gains market share in telecom equipment: Dell’Oro, November 13th, 2012 [↩]