Last week, China Mobile awarded several companies contracts for the job of upgrading its network infrastructure to be suitable with the 4G networks. Out of the $3.2 billion pie, Nokia (NOK) received a tiny slice of $320 million even though it should have received a much bigger contract. It looks like Nokia became a victim of politic games in China.
Typically, when China Mobile offers contracts like this, each company offers its bid and the lowest bidders gain most of the contract as long as they have strong reputations. Historically, Chinese companies like ZTE and Huawei always have the lowest bids because they are heavily subsidized by the Chinese government and their costs are much lower than other companies. Last month, Nokia surprised everyone by bidding the lowest amounts for the upgrading of the 207,000 basal stations and 550,000 carriers. Nokia's bid was as low as $5,460 per carrier. The bids of ZTE and Huawei were closer to $5,800 and the bid of Ericsson was close to $10,000 per carrier.
Since Nokia was the lowest bidder, it should have received the biggest chunk of the contract, however, the size of Nokia's contract was much smaller than the contracts of ZTE and Huawei and it was just as large as the contract of Ericsson. Not only did Nokia make the lowest bid, but the company also has a lot of experience, patents, expertise and technology to get a much bigger contract than it did in this case. Nokia has already completed several projects very similar to this particular project and the company's customers continue to rate most of its work very highly. NSN has very successful partnerships in more than 100 countries across the world and it's very rare (if ever) to find a partner who is unsatisfied with the company's work.
Obviously, politics were playing a big role in the decision of China Mobile (CHL) and Nokia received a much smaller contract than it should have. After all, what's the point of implementing a bidding process if companies' bids were going to be completely ignored and the contracts were going to be based of nationality of companies anyway? China Mobile said that it had to award some contracts to Chinese companies to keep things "balanced" regardless of the bid sizes; however, it ended up giving out pretty much everything but tiny bits to Chinese companies and there was very little, if any balance in the way contracts were distributed.
The European Union has been keeping an eye on China for its questionable practices, such as subsidizing the companies based in the country in order to create an uneven competition. I am curious to see if the European Union will be taking any action regarding how Nokia got "screwed" in China. Not only does the Chinese government subsidize Chinese companies, but it also pushes its companies to give contracts to each other regardless of how bids come out.
Recently, Nokia contacted the government of India to warn the country that it is seriously considering moving its operations from India to China due to the difficulties it faces in the former country. Nokia has been dealing with some tax issues in India where the Finnish government also got involved, but there hasn't been a solution for the problem so far. If Nokia considers moving its manufacturing to China, the company's management must have a high opinion of the Chinese government despite all the political games in the country. Nokia's factory in Tamil Nadu state of India employs 8,000 local people and it has produced more than 800 million units of phones in its history.
For multi-national companies like Nokia, it is extremely important to have good relationships with countries it sees as major markets. China and India are two markets where the company has to get along with the government if it wants to be relevant. So far, Nokia's relationship with the Chinese government has been decent and the company's problems with the Indian government are not specific to this company. In fact, there are several multi-national companies like Vodafone (VOD) and Shell (RDS.A) who are having tax issues in India.
In the last year or so, Nokia has been relying on NSN (formerly known as Nokia Siemens Networks, currently known as Nokia Solutions and Networks) for profits as the company's devices and mapping businesses haven't really been profitable. It looks like NSN will get increasingly aggressive about winning contracts across the world despite all the political games going on in different countries. It is difficult to determine how Nokia was able to offer a lower bid than the government-subsidized ZTE and Huawei. Perhaps, Nokia wasn't planning to make much of a profit in this contract.
Recently, Nokia decided to decrease the size and increase the efficiency of NSN by cutting 8,500 jobs and axing projects with lower profit margins. As the business segment focuses on high-margin projects, it is expected to remain as the most profitable part of Nokia. In the last quarter, Nokia Siemens Networks had a double-digit operating margin, which is higher than most of the competition including Ericsson, ZTE and Huawei. Moving forward, it will be interesting to see how NSN performs as a company fully owned by Nokia.
Currently, many countries across the globe are upgrading their network infrastructures in order to take advantage of 4G networks. Most of Asia, Africa and South America, in addition to a significant portion of Europe will be going through infrastructure upgrades and Nokia is expected to gain a lot of contracts in the coming years. I expect Nokia to keep NSN as a subsidy rather than spinning it off as an independent company in the near future as well as in the long term.
Next quarter, Nokia is expected to break even and the company is expected to reach slight profitability in the fourth quarter due to the holiday season when most phone sales are conducted. If the company can post a profit in the year of 2013, this will attract a lot of new investors. If it doesn't happen, many investors might lose faith with the company. I will continue to hold onto my shares for now and I will sell monthly covered calls to improve my returns (and reduce the breakeven price) for the time being.