Nokia Looks To Defend Margins With Increasing U.S. Focus Amid LTE Transition

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Nokia’s (NYSE:NOK) networks business is seeing its revenues drop alarmingly as it transitions to become a specialist  in mobile broadband and lets go of less profitable contracts. In the first three quarters this year, Nokia Solutions and Networks (NSN) has generated net sales of $8.2 billion – about 16% less than what it posted during the same period last year. In fact, the decline has been gaining pace, with the most recently completed quarter, Q3, seeing NSN’s revenues fall by 26% year-over-year. However, NSN’s focus on profitability has helped more than offset the impact as its margins have improved amid a restructuring program that has seen heavy job cuts and divestments of non-core operations. NSN’s underlying non-IFRS operating margins in the first three quarters this year have improved by 700 basis points over the same period last year to more than 9%.

What should help NSN defend its profit margins in the coming quarters is its growing presence in the more lucrative U.S. market, where it has historically been a laggard. North America has accounted for less than 10% of NSN’s revenues in the past, but the mix is improving gradually with recent contract wins at T-Mobile and US Cellular. Last quarter, NSN saw its revenues increase y-o-y by 5% in North America – the only region that saw positive growth as the company avoided less profitable deals elsewhere. However, despite the recent deals, NSN generated less than 12% of its revenues from North America; so the good showing in this region has so far had a muted overall impact.

See our complete analysis for Nokia stock here

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Deals With T-Mobile and Sprint

Going forward, however, we expect NSN to gain ground in the North American market, where Chinese manufacturers such as Huawei and ZTE have been blacklisted amid security concerns. Also, unlike other developed markets such as Europe, carriers in the U.S. are more actively transitioning to LTE in response to rising competition and to support the surging demand for mobile data. There has also been a recent spate of consolidations in the U.S. market that has worked in NSN’s favor. Long-time NSN customer Softbank’s recent acquisition of a 78% stake in Sprint helped NSN displace Ericsson in a recently signed LTE deployment contract with Sprint, which plans to use its recently acquired spectrum from Clearwire and Softbank’s cash to bolster data capacity in densely populated areas. The carrier is building out a faster 4G TD-LTE network covering around 100 million PoPs by the end of next year in a bid to catch up with the bigger rivals, Verizon and AT&T.

Even T-Mobile’s recent merger with MetroPCS should help NSN increase its U.S. market share. 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.

LTE transition in China

The transition to 4G LTE is actually having a more wide-ranging impact on NSN than listed above, with carriers outside the U.S. also gradually making the transition to 4G LTE. China, especially, is a potentially big market for network vendors with the country planning to hand out LTE licenses either by the end of this year or early next year. In preparation, Chinese carriers have already given out multi-billion dollar LTE deployment contracts. While local Chinese vendors accounted for the bulk of the contracts, NSN managed to land the biggest share among foreign vendors of a $3.3 billion LTE contract with China Mobile, the largest wireless carrier in China. NSN will supply about 11% of the initial LTE gear according to the contract, along with another single-digit share from selling through resellers.

The increasing focus on the U.S. market, together with the LTE transition in China, should help NSN offset the impact to the top line from the unprofitable contract exits. The increasing mix of LTE revenues, and the ongoing restructuring – which is expected to be completed by the end of the year and save about Euro 1.5 billion in operating costs compared to 2011 – should help NSN hold on to the impressive margin gains it has made in the past few years. With NSN becoming the most valuable business for Nokia following the Microsoft deal, a solid margin performance in this division is central to the new Nokia’s future prospects.

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