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6 March 2020

Ericsson merger is a red herring as Nokia explores its options

Nokia had a difficult end to 2019. Some of its challenges were the result of familiar pressures – price competition and delays in operator decisions about 5G.

Some related to the unambitious nature of early 5G roll-outs. Nokia is the best positioned of the big three, in our opinion, for supporting a fully software-based, cloud-native core and RAN in future. But operators are hesitating to deploy such radical architectures, and instead rolling out 5G in the conventional way, usually with existing 5G suppliers – which suits Ericsson and Huawei, with their greater scale and installed base in the RAN.

By the time operators catch up with Nokia’s software networks, its rivals may have caught up, and smaller challengers from the open RAN movement may have become credible in the macro network. Already, ZTE is leapfrogging Nokia in some cloud-native developments, and the Finnish company is seeing its share of the flagship cloud-based deployment at Rakuten in Japan being squeezed by NEC (see below).

However, the most concerning source of its recent problems was not a well-known challenge, and so caused a far greater blow to its market value and to the confidence of customers and investors. This stemmed from a strategic decision to design a complex, FPGA-based silicon platform for Nokia’s 5G base stations, which was designed to differentiate their performance clearly from those of its rivals. But this decision weighed on its performance in two ways.

One, the platform had almost inevitable teething problems, which caused delays for some high profile 5G customers such as Sprint (it was very clear that the first markets where Sprint switched on 5G were not its Nokia ones).

Nor was Nokia able to compensate by pointing to ways, short term, in which its silicon would deliver advantages. It is Ericsson, not Nokia, which has launched the critical DSS (dynamic spectrum sharing) technology to the commercial market first, even though DSS is just the kind of processing-intensive capability which might allow an advanced chip platform to shine. And the DSS situation will mean that in the USA – where the technology is most vital because most MNOs lack midband spectrum – once again a carrier, notably Verizon, will be upgrading its non-Nokia markets first.

And the cost of the inhouse, FPGA-based approach hit margins in Nokia’s fourth fiscal quarter, unnerving shareholders. It is probably this impact, from a strategic decision for which CEO Rajeev Suri takes full responsibility, that was the chief reason for him to step down this summer in favor of Pekka Lundmark (see below).

Meanwhile, Nokia is reported to be exploring strategic options, including possible asset sales or mergers, according to sources who spoke to Bloomberg. Nokia did not comment, but the sources said it has already hired advisers to examine the options.

Naturally, this report led to speculation that Ericsson might acquire Nokia. This seems to show a lack of imagination among the financial pundits. Such a deal would be extremely hard to get past European antitrust regulations, not to mention other national authorities which would be able to weigh in. It would be unpopular with customers, reducing the choice of network vendors still further, and therefore with governments – such as those of China and the USA – which have staked national pride on their operators being well-equipped to take a 5G lead.

In a world where networking and cloud technologies are converging, a more likely acquirer might come from that market. Cisco could finally have a RAN business and offer end-to-end 5G; HPE, Dell EMC or even Amazon AWS could add fixed, mobile and core networks to their portfolios and provide a complete package of cloud infrastructure, connectivity and analytics everywhere from data center to edge. Perhaps Facebook would even dig deep to buy Nokia and turn it into the engine for its bid to disrupt the networking supply chain through Telecom Infra Project (TIP).

Some of Nokia’s challenges stem from that convergence – the expense and effort of developing cloud platforms and processors capable of running a demanding function like a macro RAN baseband in software; the change in skills and processes that requires. As the shift from inhouse platforms to partnerships with merchant chip vendors like Intel and Marvell highlights, network vendors may do better to find complementary suppliers to fill their IT gaps, rather than aiming to develop everything themselves.

Of course, a left-field option would be to take the USA’s Attorney General up on his strange offer that the US government might take a stake in Nokia (or Ericsson) to bolster competition against Huawei!

Nokia’s shares rose by about 6% on Wall Street in the hours after Bloomberg’s report was published, a rare upward blip amid a 12-month downward trend which has wiped about one-third off its market value.

Last month, Nokia warned investors that it would not achieve its profitability targets until 2022, and acknowledged it had lost market share in 2019 (it claims about 27% of the 4G and 5G RAN market outside China). Prior to that, in October, Nokia cut its earnings guidance for the year and suspended dividend payments, blaming the FPGA platform for a fall in profits.

The most urgent priority, according to Nokia, is to reverse the decline in market share, especially in 5G; bring costs under control, especially on the base station chip side; and make progress towards better profitability. But the new chips will not appear in equipment until the turn of the year, and Suri has said that it will take about six months for the new chip strategy to impact visibly on core metrics once products are selling.

The last of these is the main reason for the process of exploring strategic options, as Nokia is reportedly looking for some creative ways to improve the bottom line. This must seem like a never-ending process to well-established Nokia employees, given the number of restructuring initiatives and job-cutting programmes there have been over the past decade, before and after the acquisition of Alcatel-Lucent.

The problem with that history is that there are falling numbers of assets or staff to cut, and most non-core businesses that remain would not raise sufficient cash to move the needle significantly. Nokia’s big gamble that its future was in converged telecoms infrastructure, rather than in end-to-end mobile systems right to the device, came when it sold its devices business to Microsoft and bought Alcatel-Lucent to increase the scale of its networks operations and add a major play in fixed-line products.

In its new structure, the Networks business dominates, but has been pared down in terms of the number of products; while Nokia Software is the key growth engine, and while some older or incremental products might be dispensable, they would not bring in much revenue as a sale, nor save much money in costs once gone.

Nokia could emulate Ericsson, which in 2017 backed away from many direct enterprise activities, but that would rob it of a business where the Finnish firm is undoubtedly in a position of strength, with platforms like WING and Cloud Packet Core – and the private networks, enterprise 5G and IoT opportunities, though small now, should deliver solid growth in the 2020s. Nokia Technologies is the smallest unit and is the engine for Nokia’s patent and technology licensing, so again, does not seem divestable.

Nokia’s big challenge is timing. It has more modern cloud-based platforms than many of its rivals, but these will not be widely deployed at scale for several more years. It has the chance to be the leading light in the open RAN movement, lending its weight to making ORAN a success and, in the process, wrong-footing Ericsson and Huawei, which remain cautious to hostile.

But outside small rural or small cell deployments, ORAN is unlikely, even with Nokia’s help, to become an at-scale business for several years either. Alex Choi, Deutsche Telekom’s SVP of strategy and technology innovation, and former TIP chairman, told LightReading: “The big vendors have to chase two rabbits. One is their delivery schedules for the immediate market demand. Introducing open interfaces and implementing these could bother their current progress.”

So in the short term, Nokia’s better route is not to break up its portfolio, since it has focused its whole strategy on offering end-to-end, fixed/mobile infrastructure; and not to face the disruption of a mega-merger. Instead it needs to address its cost base urgently and creatively in that converged infrastructure business, as it is already doing in its base station chips.