Nokia (NYSE:NOK) played down the possibility of a merger with Juniper (NYSE:JNPR) on Sunday, announcing that it is only looking to deepen its sales partnership with the U.S. company in order to bolster its network-infrastructure arm, Nokia Solutions and Networks (NSN). Speaking at the Mobile World Congress in Barcelona, NSN Chief Executive Rajeev Suri said that he is working to expand an existing collaboration deal with Juniper into something more substantial. The comments came amid rumors that the company is considering acquiring Juniper in order to better compete in the U.S. market. Ever since Nokia decided to sell its handset business and license its patents for 10 years to Microsoft for $7.4 billion, speculation has been rife that the company will use the cash to play an active role in consolidating the network equipment industry. Earlier, there was speculation that Nokia was planning to buy the wireless equipment unit of Alcatel-Lucent (ALU). While Suri didn’t deny the possibility of an acquisition in the future, we expect any M&A attempt to be more low-key in nature than what rumors seem to have suggested so far.
With a market capitalization of about $14 billion, Juniper would have made for an expensive merger given the lack of operating synergies with Nokia and the considerable premium that Juniper’s shareholders would have demanded for such a deal. While Nokia builds wireless infrastructure for 2G/3G/4G networks, Juniper’s network expertise primarily lies in IP routers and switches. Acquiring Juniper would have given Nokia a complimentary product portfolio to market and helped it secure more end-to-end network deals with carriers, especially in the U.S. However, Nokia would have also had a harder time integrating operations and realizing margin gains due to the lack of effective cost-optimization opportunities across different product portfolios with little overlap. It would have therefore been risky for Nokia to pay a premium for Juniper, which we believe is being priced close to its fair value currently. On the back of a restructuring and capital allocation program, Juniper’s shares have risen almost 25% since the start of the year and are currently trading close to our $28 price estimate for the stock (see Juniper Valued Fairly At $28 On Restructuring Plans And Capital Return Program).
With revenues stagnating in the overall mobile infrastructure market and China favoring local players in recent LTE contract wins, Nokia is increasing its focus on the U.S. market. Historically a laggard in the region, which accounted for less than 10% of NSN’s revenues until 2012, the company has seen its U.S. sales mix improve gradually on the back of recent contract wins at T-Mobile (TMUS) and US Cellular. Last year, NSN’s revenues grew year-on-year by about 3% in North America – the only region where the company saw positive growth as it avoided less profitable deals elsewhere. With Chinese manufacturers such as Huawei and ZTE (OTCPK:ZTCOY) blacklisted in the U.S. due to security concerns, the North American market has become a very lucrative opportunity for NSN to pursue in the coming years.
There has also been a spate of recent consolidation in the U.S. market that has worked in NSN’s favor. Long-time NSN customer Softbank’s acquisition of a 78% stake in Sprint (S) helped NSN displace Ericsson (OTC:ERIAF) in a recently signed LTE deployment contract with the U.S. carrier, which plans to use the spectrum acquired from Clearwire (CLWR) and Softbank’s (OTCPK:SFTBY) cash to bolster data capacity in densely populated areas. Sprint is building out a faster 4G TD-LTE network covering around 100 million PoPs by the end of the year in a bid to catch up with rivals Verizon (VZ) and AT&T (T). Even T-Mobile’s recent merger with MetroPCS should help NSN gain market share in the country. T-Mobile currently sources its equipment from Ericsson and NSN, while MetroPCS does the same from Ericsson and Samsung (OTC:SSNLF). As the carriers look to consolidate suppliers, NSN has an opportunity to displace Samsung owing to its relationship with the bigger T-Mobile.
Juniper Partnership Could Help NSN Penetrate U.S. Market
However, despite the recent momentum, NSN generated less than 12% of its revenues from North America last year; so the good showing in this region has so far had a muted overall impact. Additionally, the tapering down of T-Mobile’s LTE roll-out is likely to offset most of the revenue gains that NSN will realize from the Sprint win in the near term. Consequently, we believe that NSN needs to sign larger contracts with its existing clients or break into the top two carriers in the country in order to be able to penetrate the U.S. market better.
This is where pursuing a bigger partnership with Juniper could help NSN, as Juniper derives more than 50% of its revenues from the Americas. The top two wireless carriers in the U.S., Verizon and AT&T, have been major customers for Juniper for some time. Service providers are Juniper’s biggest revenue generators, accounting for almost two-thirds of its total revenues. Expanding its relationship with Juniper should therefore give Nokia a broader base of U.S. carriers to market to and improve its sales mix of higher-margin products. Nokia has realised impressive margin gains in recent years on the back of a restructuring program that helped cut superfluous expenses and made it more focused on mobile broadband. However, last quarter’s 320 basis point drop in NSN’s operating margins put in question NSN’s ability to hold on to these gains in the coming years. This was partly due to lower network activity in the U.S. as T-Mobile’s LTE roll-out neared completion last quarter, which caused NSN’s U.S. sales to decline year-over-year by 38%. Wider exposure to U.S. carriers will serve to decrease the lumpiness that NSN is seeing in its U.S. sales and help it better defend overall margins.
Disclosure: No positions.