Nokia has kicked off the integration process to bring rival Alcatel-Lucent to its fold. Will Nokia become a strong alternative to Ericsson, Huawei and Cisco?

Throughout the many years of downsizing and rightsizing operations at Nokia and Alcatel-Lucent, rumors circulated regularly that the two firms would merge. These were quickly dismissed as the painful process of merging the former versions of these companies was fresh in the minds of many, and the balance sheets did not look any better for the combined firms.

Thanks to the strong management of Nokia Networks CEO Rajeev Suri and the success of Alcatel-Lucent CEO Michel Combes, the merger has become feasible, with the prospect of the second-largest solutions supplier in the telecom industry emerging from the combination. However, the move presents major risks for the firms, including merging cultures, portfolios and financial models fast enough to prevent competitors from gaining ground. Mergers — even the best managed — take 24 months or more. During this time, the new Nokia will be vulnerable.

The question remains whether management can transform the two legacy-laden installed bases and portfolios to address the seismic transformation underway in the telecom industry from hardware-focused silos to software-mediated integrated virtualized networks. This transition must be accomplished amid demanding customers, a raft of current and new Information and Communications Technology (ICT) competitors and a skeptical financial investor community, said Michael Soper, telecom analyst at Technology Business Research.

Despite these challenges, TBR believes management can carve a strong top-tier ICT competitor out of the combined entity. First, customers will want the new Nokia to be a credible alternative to Ericsson, Cisco or Huawei. Second, both Nokia with its Liquid Radio and Alcatel-Lucent with its CloudBand and Nuage assets are already converting the focus of their companies to the new architecture. Third, close partnerships with IT and services firms such as HP and Accenture will fill in gaps in the ICT portfolio while the new Nokia retrenches.

Whether Nokia will retain its No. 2 position in cumulative revenue remains to be seen as competitors will take every opportunity to take legacy and new architecture share. The best strategy is for Nokia to act quickly, target the core areas that will generate the greatest future value and cooperate closely with partners. Competitors, meanwhile, should look to areas where portfolio transition will yield opportunities. Customers will ultimately benefit from another strong, large-scale player in ICT.

Nokia will realize cost savings from its acquisition of Alcatel-Lucent

Nokia announced that it will acquire Alcatel-Lucent in an all-stock transaction valuing its French rival at €15.6 billion (or $16.6 billion). The transaction is expected to close in 1H16, provided it passes regulatory scrutiny. The largest obstacle would most likely have been the French government, but Nokia made assurances that it would keep Alcatel-Lucent’s headcount in France at levels agreed to as part of Alcatel-Lucent’s Shift Plan restructuring, while adding R&D employees over the long term.

Additionally, Nokia will establish a €100 million (or $133 million) investment fund to support French startups as well as maintain or establish services hubs, centers of excellence in 5G, small cells, cybersecurity and wireless, and keep Bell Labs in France. Merging the various cultures (Finnish, German, American, French, etc.) will be a challenge and likely take several years. The combined entity will retain the Nokia name, Nokia CEO Rajeev Suri, and Nokia Chairman Risto Siilasmaa.

An unknown number of headcount reductions will take place, but Nokia plans to realize much of the €900 million (or $1.2 billion) in expected cost savings through a combination of lower procurement, real estate, general & administrative (G&A) and IT costs. TBR believes Nokia will eliminate redundancies in areas such as selling, marketing and G&A, while maintaining current R&D investment levels to capitalize on Alcatel-Lucent’s Bell Labs R&D unit, which remains Alcatel-Lucent’s most attractive asset given its patent trove and engineering talent.

Nokia will benefit from increased scale and a more comprehensive portfolio

Nokia’s well-respected executive leadership and recent acquisition and restructuring history suggest that integrating a company the size of Alcatel-Lucent will be difficult but successful. Nokia leveraged its billion-dollar acquisition of Motorola Networks into drastic improvements in product quality and an increase in North American market share. The company’s restructuring was executed swiftly and decisively, ultimately yielding a company focused on mobile broadband with higher gross and operating margins than many peers.

However, restructuring pared down Nokia’s portfolio to the point where it could not offer comprehensive solutions for network operators. Acquiring Alcatel-Lucent gives Nokia the fixed access, IP core routing and optical assets it lacked, as well as strong SDN and cloud offerings in Nuage Networks and CloudBand.

The combined entity’s portfolio overlaps heavily in wireless access; however, Alcatel-Lucent’s small-cell business is in a stronger market position compared to Nokia’s thanks to several Tier 1 agreements in the U.S. Beyond telecom, Alcatel-Lucent expands Nokia’s addressable market to large enterprises. Post-restructuring, Nokia focused exclusively on the mobile broadband opportunity and did little to transform into an ICT vendor. Alcatel-Lucent, through its Nuage Networks subsidiary, is addressing the SDN priorities of large enterprises.

Acquisition represents the best case scenario for Alcatel-Lucent

Alcatel-Lucent CEO Michel Combes engineered an excellent exit strategy for his company. Despite years of restructuring, the company’s long-term survival remained in question. Combes restructured the company’s debt portfolio, pared down product and service portfolios, exited or divested noncore businesses such as Alcatel-Lucent Enterprise and LGS, and trimmed headcount to 52,673 employees at the end of 2014, down from about 64,800 employees in June 2013 when the Shift Plan was implemented. Alcatel-Lucent will continue executing the Shift Plan until the acquisition closes. The company reduced fixed costs by €675 million (or $843 million) since 1Q13, about 70 perent of the way to its goal of €1 billion (or $1.2 billion) in fixed-cost savings outlined in the Shift Plan.

Customers will benefit from an alternative to Ericsson and Huawei

Customers will applaud the merger and the rapid negotiation process. The combined Nokia and Alcatel-Lucent creates a more attractive partner for operators that previously would not have considered the separate entities. The new company will be strong in wireless and IP, creating an end-to-end player that could trump Ericsson and Huawei. In regions where Huawei and ZTE are limited in their ability to compete (North America, Australia) this merger creates a better-funded and more credible supplier as an alternative to Ericsson. Additionally, it serves as an alternative to Ericsson and Huawei in Europe.

Competitors face a more formidable vendor, but one lacking services expertise

Without question, a combined Nokia and Alcatel-Lucent creates a more formidable competitor for Ericsson, Huawei, Cisco, ZTE and Samsung. The combined entity can come to market with an end-to-end communications networking portfolio and leverage the R&D capabilities of two storied companies to continue innovating in next-generation technologies such as cloud, NFV, SDN and 5G.

However, the combined entity lacks scale in key areas, particularly services. Both Nokia and Alcatel-Lucent downsized their services organizations as part of restructuring and only recently pivoted to scaling up resources in C&SI. They are largely leveraging partnerships with HP and Accenture rather than investing internally, which is the opposite approach taken by Ericsson. Both Nokia and Alcatel-Lucent are limiting their addressable markets and hurting margins by leaving the high-value services component to partners in the value chain.

The combined entity lacks a strong presence in some markets. A merger does little to change the regional competitive dynamics in Latin America or the Middle East & Africa (MEA). Ericsson and Huawei dominate the LTE contract count in Latin America, while Huawei and ZTE have a significant installed base of 2G and 3G customers in MEA. Both Nokia and Alcatel-Lucent downsized in emerging markets as part of their restructuring initiatives as contracts in such countries tend to have low-margin profiles.

Vendors will benefit from reduced pricing pressure that will result from lowering the number of significant vendors in the marketplace. Vendors could capitalize on customer turnover as Nokia rationalizes the combined portfolio.

By Michael Soper, telecom analyst at Technology Business Research
[email protected]