Nokia-Alcatel Lucent Deal Progressing Well As It Gets Department Of Justice Clearance

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Earlier this month, Nokia (NYSE:NOK) announced that the U.S. Department of Justice has granted early termination of the U.S. antitrust waiting period, thus allowing its merger with Alcatel-Lucent to proceed. [1] The 15.6 billion Euro ($16.6 billion) all-stock deal, subject to approval by Nokia’s stockholders, is expected to close in the first half of 2016. Though the company still needs approval from other regulators (mainly the FCC), the Department of Justice clearance should set a precedent for other bodies. Following the acquisition, Nokia Corporation (the combined entity) will become the second largest mobile equipment manufacture in the world with an estimated market share of 35%, just behind its Swedish counterpart Ericsson, which holds about 40% of the market.

Nokia had initially extended an offer for Alcatel-Lucent’s wireless business, which the latter rejected. This turned out to be a blessing in disguise for Nokia, which eventually decided to buy the entire company, stating that the merger held substantial operational and financial benefits. ((Press release, Nokia, April 15 2015)) [2] In addition to positioning it among the top players in the telecom gear market, the acquisition will help Nokia expand its product portfolio in the domains of optical transmission and Internet Protocol (routers and switches), which are essential components in building a complete network. Financial benefits of the deal for Nokia include cost synergies, a decline in interest expenses, tax benefits and high cash balance of the combined entity.

Our $7.50 price estimate for Nokia is about in line with the current market price.

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Operational Benefits For Nokia

Alcatel-Lucent is among the strongest players in the U.S. wireless equipment market, with long standing contracts with carriers such as Verizon and AT&T. A merger with Alcatel-Lucent will provide Nokia a very strong base in the U.S. to build upon. The importance of the U.S. market for Nokia stems from the fact that U.S. carriers tend to invest a huge amount in network infrastructure. The U.S. invests more in its networks than any other country in the world – over $35 billion to be precise. [3] Interestingly, the U.S. accounts for over 50% of global LTE connections, which is an indication of the competitive nature of the market. And competition prompts telecom companies to continue investing in their infrastructure.

Nokia is also looking to take advantage of Alcatel-Lucent’s technological prowess. Alcatel-Lucent’s small cells technology is becoming popular in the U.S. and has already found acceptance among clients including Verizon and AT&T. Since the telecom industry mainly earns its profits on volumes, technology that can help reduce expenses is bound to draw attention. With the Alcatel-Lucent deal, Nokia gets a head start in this arena.

Moreover, Nokia will have a comprehensive networking product line (wireless and wireline) along with advanced research capabilities for development of future technologies such as software-defined networking and cloud computing. This can give it an edge over market leader Ericsson, whose portfolio is currently limited to wireless networking equipment and services. Also, the deal places Nokia strongly in the global service provider router market, as Alcatel-Lucent holds the second highest market share after Cisco.

Financial Benefits For Nokia

Nokia has stated that, owing to its overlapping and complementary portfolios with Alcatel-Lucent, it should be able to report operating cost synergies of EUR 900 million by 2019 and approximately EUR 200 million in interest expense reductions by 2017. Also, both companies will benefit considerably from their strong R&D departments, which cumulatively employ over 40,000 employees and had investments of EUR 4.7 billion last year. The similar and complementary nature of the companies’ product portfolios should enable more effective utilization of R&D resources, which will likely bring down R&D expenses as a percentage of revenue from the current 17-18% levels.

The agreement to acquire Alcatel-Lucent is an all-share deal which means that there will be no cash payout to the shareholders. This essentially implies that the 15.6 billion Euro ($16.6 billion) deal will not be overly taxing for Nokia. In addition, the combined entity will have net cash of EUR 5.3 billion, which should help Nokia improve its credit rating.

Terms Of The Deal

As per the terms of the deal, Nokia will offer 0.55 shares of the new company in exchange for each ordinary share and each American Depository Share of Alcatel-Lucent. Post-closure, this will provide Alcatel-Lucent shareholders 33.5% ownership in the combined entity, with the remaining 66.5% owned by Nokia shareholders. The deal is still subject to Nokia’s shareholders’ approval and full acceptance of the tender offer. The deal is surprisingly simple, with no complicated corporate governance structures, which seems to be playing an important role in convincing Nokia’s shareholders that this deal is likely to be handled better than its earlier joint venture with Siemens.

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Notes:
  1. U.S. Department of Justice Permits Nokia and Alcatel-Lucent to Proceed with Proposed Combination, Nokia, Jun 17 2015 []
  2. Nokia buys Alcatel to take on Ericsson in telecom equipment, Reuters, April 15 2015 []
  3. U.S. Investments in Wireless Leads the World, The Wireless Association []