The networking industry has been growing at an extremely low rate over the last few years. In fact, the participants have produced declining revenues. As a result, the need for consolidation has been present in the industry over the period. There have been rumors that two of the largest players in the industry, Alcatel-Lucent (ALU) and Nokia (NYSE:NOK), might merge. These rumors have resurfaced.
According to a German source, Nokia and Alcatel-Lucent are in talks for a merger or a close cooperation agreement. The rumor resulted in an increase of about 8% in ALU and a gain of about 3% for NOK on Thursday.
A merger makes sense for both companies. Nokia holds a strong position in the LTE segment, while ALU has established a strong position in the ultra-fast broadband and IP networking segments. A combination of the assets could result in an incredibly strong entity focused on the high-growth areas of the networking industry. At the moment, Ericsson (NASDAQ:ERIC) is ahead of both ALU and NOK in terms of overall business and the market presence.
Both ALU and NOK are going through different phases of restructuring. Nokia sold its handset business to Microsoft (NASDAQ:MSFT) for $7 billion and the company is looking to strengthen its networking business. Alcatel-Lucent is at the tail end of its restructuring plan and the company is expecting to be profitable during the next year. If we look at the individual performance and the execution of the strategy, both these companies pass with flying colors.
Alcatel-Lucent continues to execute "The Shift Plan" (explained in detail here) - the company is on track to achieve almost all the major goals of the restructuring plan - and will soon return to profitability. Nokia sold the segment that dragged earnings and cash flow, getting a good price for it in the process.
To see how an ALU-NOK merger makes sense, consider data from the recent Ericsson mobility report, which shows the trend in fixed-line and mobile subscriptions and data usage.
At the moment, total mobile subscriptions stand at 7.1 billion and are expected to reach 9.5 billion by 2020. Currently, LTE accounts for a small portion of total subscriptions, which is understandable as the 4G and LTE roll out is still underway in most of the developing world. However, by 2020, the majority of growth in mobile subscriptions will come from LTE. Nokia stands to benefit from this growth as the company has a strong position in this segment. On the other hand, growth in fixed broadband subscriptions is expected to remain flat over the next 5-6 years. Mobile broadband subscriptions, however, are expected to see a sharp rise.
Global monthly mobile traffic currently stands at close to 5 ExaBytes and is expected to reach over 25 ExaBytes over the next 5-6 years. Almost all the growth will come from data usage, as voice is expected to remain flat.
While a merger might make sense, there are some issues that might prove troublesome for both companies.
The first issue comes from the French government. It might not be in favor of job cuts at ALU that could come as a result of the merger. Consolidation will certainly result in some redundant positions and the combined entity will have to let some employees go.
The second issue is more company specific. ALU and Nokia might have to get rid of some business segments, as not all the units will be complementary. Both companies will have to trim their operations and focus on the core areas. Despite these issues, I believe the expected benefits of the merger outweigh the drawbacks and both companies can benefit from the merger, if it happens.
The Bottom Line
Alcatel-Lucent is executing its strategy well and the company will certainly become an attractive partner for other players in the industry. Nokia and Alcatel-Lucent is a good match as Nokia has ample cash reserves and ALU is growing extremely well in the ultra-fast broadband and IP networking areas. Furthermore, ALU has an incredibly strong position in China and India - two of the largest markets for mobile networking companies. The merger makes sense. However, both these companies have reportedly been in talks in the past and it is not certain a merger will happen. Nokia and ALU will also have to keep in mind the hurdles and the regulatory issues they might face from the government, particularly in France.
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