5G pressures drive Nokia to slash profit forecast and suspend dividends

While Ericsson and Huawei reported solid quarterly results (see Wireless Watch October 23 2019), Nokia lost €6bn ($6.7bn) of its market value when it slashed its profit outlook and suspended its dividend, blaming the impact of 5G costs on its margin.

In the third quarter, Nokia actually reported sales growth – up 4% year-on-year, or 1% at constant currency, to €5.7bn. The firm said it expected a good revenue performance in the current Q4, but said it was lowering its outlook for full year 2019 and also for full year 2020 because of “margin pressure and additional investment needs”. It has suspended dividend payments to help meet the increased investment demands for 5G and to strengthen its battered cash position.

In the quarter, Nokia reversed a year-ago net loss of €127m to make an €87m profit, on sales of €5.68bn. The Networks business saw sales up 4% year-on-year to €4.4bn, while the smaller Software unit enjoyed the highest annual growth, up 9% to €677m. Revenue from the Technologies unit grew by 2% to €358m.

The high points of the quarter in revenue terms came from Nokia’s Software, Enterprise and IP Routing units, not directly from its central Networks division, though this now claims 48 5G contracts and 15 live deployments.

But the strength of the other, smaller units reflects some good strategic decisions by Nokia, relative to Ericsson – to build up a new customer base in the enterprise, via operators or directly if necessary; and to expand the software platforms to be decoupled from the networks where appropriate. Both these approaches will help to deliver a broad and deep 5G business in the medium term.

But in the short term, for vendors as for operators, 5G impact is about delivering big deployments as cost-effectively as possible, and here, Nokia has been less successful than its main rivals. Its operating margin fell – by five percentage points in the Networks division – and it does not see any improvement in the near to medium term. For full year 2019, it has downgraded its margin outlook by two percentage points, and for 2020, by 5.5 points compared to previous guidance. It is now looking for non-IFRS operating margin of around 8.5% in 2019, and 9.5% in 2020, but insists it can improve that figure to between 12% and 14% in the 3-5 year timeframe.

All this is hitting its cash position, which in turns limits its ability to invest in new technology and sales activities. It now has just €344m in cash, about the amount it paid in dividends last quarter, and the figure is down by €160m compared to the end of Q2. That pattern would see Nokia running out of cash within two quarters, hence the suspension of the dividend until the company improves its cash pile to at least €2bn.

While Ericsson has credited 5G with its modest turnaround of the past couple of years, for Nokia, 5G is currently the problem. CEO Rajeev Suri said on the analyst call to discuss the results: “Some of the risks that we flagged previously, related to the initial phase of 5G, are now materializing. In particular, our Q3 gross margin was impacted by product mix; a high cost level associated with our first generation 5G products; profitability challenges in China; pricing pressure in early 5G deals; and uncertainty related to the announced operator merger in North America.”

His remedy, which he claims will “progressively mitigate these issues over the course of next year”, includes increased investment in 5G to accelerate the availability of next generation technologies and encourage faster uptake by operators. In some cases, this will mean playing catch-up – Nokia’s cloud-native core, for instance, is said to be less market-ready than those of some competitors, especially core specialists, while it is behind Ericsson in supporting dynamic spectrum sharing (DSS – see separate item). In others, it will be building on developments, such as orchestration and advanced midhaul, where it has an advantage.

Suri said there would be parallel efforts to accelerate product roadmaps while also driving product cost reductions for customers. But if Nokia is to engage in a 5G price war – partly in response to very affordable offers reported from Ericsson and Huawei to secure market share – it will need to improve its own cost economics. It says that will be partly achieved by greater scale as 5G products mature, and also by “the digitalization of internal processes to improve overall productivity”.

But CFO Kristian Pullola told LightReading he was less willing than some vendors to sacrifice profits for market share, especially with the margins already under such pressure. He also hinted that, as critics say, Nokia under-invested in 5G R&D compared to its main competitors, especially as it was distracted, in the early stages, by the acquisition of Alcatel-Lucent in 2016. “It’s fair to say that 5G happened quicker than we and others thought,” Pullola said. “We have had pressure in R&D to get to the situation we are in now and that happened in parallel with product migration work related to the AlcaLu merger.”

As noted above, Nokia has some advantages, including a better strategy for market diversification, into enterprise and software platforms, than its Swedish neighbor. Suri added: “We will also continue to invest in our enterprise and software businesses, which are developing rapidly and performing well. Given these investments and the risks we see materializing, we are adjusting our targets for full-year 2019 and 2020; and we expect our recovery to drive improvement in our 2021 financial performance relative to 2020.”

He concluded: “I am confident that our strategy remains the right one. We continue to focus on leadership in high-performance end-to-end networks with Communication Service Providers; strong growth in enterprise; strengthening our software business; and diversification of licensing into IoT and consumer electronics.”