Nokia forced into 5G U-turn as pace accelerates, creating new risks

Nokia’s second quarter results looked positively shiny next to Ericsson’s latest downbeat quarter and a surprise downturn at Huawei. However, the Finnish is still navigating three major transitions at the same time – towards being a software-driven company with a standalone business in this area; towards a more diverse client base with less reliance on mobile operators; and towards 5G.

While the first two, which are closely related and particularly target vertical and industrial markets, are showing some early hopeful signs, in the all-important issue of timing the shift from 4G to 5G, Nokia has been caught short. It has now announced a U-turn in its strategy. It will adapt its 5G FIRST platform – initially based on pre-standard specs from Verizon’s Technology Forum – to support 3GPP specs earlier than it had planned, in response to an earlier than anticipated surge in 5G uptake.

Earlier this year, when an AT&T-inspired group persuaded 3GPP to fast-track the non-standalone strand of the 5G New Radio standard, to enable earlier deployments, Nokia – along with various operators – stood aloof. It did not sign up to the AT&T initiative, saying that it did not want any distraction from its own 5G efforts. Among the big vendors, it has perhaps been the most focused on 5G packet core and slicing issues, and it has been clear in its view that RAN standards should be developed in tandem with those for the core and systems architecture, not before them, or risk a disconnect which will compromise new business models based on approaches like slicing.

However, though this focus on an end-to-end 5G platform is supported by companies like Telefonica and Orange, many operators are impatient to begin deployments as soon as possible, even if they can only use 5G NR Non-Standalone at first (this requires an LTE anchor network). This has forced Nokia to change its direction, and it will now bring forward its 5G NR developments, with CEO Rajeev Suri saying, on the Q2 results call, that 5G momentum was accelerating earlier than the company had expected.

This will be music to the ears of Ericsson, which is placing a big bet on early 5G to help it resuscitate revenue growth in its core Networks division. But Suri was cautious, perhaps reflecting that, while Nokia may be ahead in virtualized platforms, Cloud-RAN and other important 5G enablers, in the RAN itself it is not out in front. Suri said he expected to see major trials in 2018 and “meaningful deployments” by 2019 in the US, China and elsewhere, ahead of Nokia’s earlier expectations of 5G taking off in 2020-2021.

He told analysts on the call: “We also believe that 5G is likely to last longer and be deeper than we first thought. This is not just a small cell game; 5G will go big into the macro world; it will cover low, mid, and high bands to address both capacity and coverage, and drive changes and investment requirements in other parts of the network as well.”

But he warned: “This situation does create some near term risk as it makes the timing of certain project completions and acceptances more uncertain than is typical for us.” While he said a wider, deeper adoption of 5G would be good news for Nokia in the end, the firm would need to adapt its roadmap to the new expectations. “What is less good is that it puts increased pressure on us to accelerate our 5G roadmaps, expanding the workload on our R&D team and Mobile Networks that is already extremely focused on product integration, and new feature requests.”

However, he insisted he was confident that Nokia’s past experience, deep relationships with customers, and strong balance sheet would enable it to rise to the challenge. “We believe, we are gaining share from a competitor that is struggling, and we are focused on working hard and fast to meet the needs of our customers,” he said, presumably referring to Ericsson, whose own CEO, Börje Ekholm, was clear, on last month’s earnings call, that 5G success is critical. “We need to be leaders in 5G and we are committed to being.”

While Ericsson joined the Non-Standalone acceleration group, and has been increasingly bullish about early adoption of 5G, Nokia certainly has more of an adjustment to make if it is to star in the first round of 5G contracts. However, it has not entirely scorned pre-standard efforts, as long as they had an end-to-end context. So while working on full 5G NR, and the associated 5G New Core work, it has also been part Verizon’s 5G Technology Forum, which has been developing a pre-standard system to support early roll-out of fixed wireless networks in high frequency spectrum.

At this year’s Mobile World Congress, Nokia announced 5G FIRST, an end-to-end platform including AirScale base stations with Massive MIMO adaptive antennas, Cloud Packet Core and mobile transport. This was based on Verizon’s 5G TF specs and will be used in some of the Verizon trials, notably in Dallas, while other tests in other cities will be run with kit from Ericsson and Samsung. Nokia said it had upgraded AirScale, and its AirFrame data center platform, to support 5G capabilities, using specs from Verizon 5G TF and from Korea Telecom’s Special Interest Group (KT SIG). Both of these will be adapted to support full 3GPP specs when those emerge, as will 5G FIRST, said Nokia.

Now it seems that the work to adapt 5G FIRST for 3GPP standards will happen earlier than planned – to support NR Non-Standalone, due to be finalized by March, as well as NR Standalone, scheduled for September. In a statement, Nokia said it would broaden its focus to include the 3GPP technology and integrate it into 5G FIRST, and would now “push for accelerated 3GPP industry standardization”.

Marc Rouanne, president of mobile networks, managed to make it sound like a well-planned move rather than a change of timing, saying: “There should be no doubt about the huge potential of 5G. Through 5G FIRST, Nokia is evolving its 5G strategy to drive the industry rapidly towards the adoption of standards-based commercial applications – as early as 2019.”

Another of Nokia’s transitions, towards software, is going more smoothly, if early results are to be trusted. Eight months after the company announced that it would create a significant standalone software business, it claims the move is already affecting profits. Last year, the applications and analytics division made about €1.6bn ($1.9bn) in revenues – tiny relative to €21.8bn ($25.8bn) from network sales. In the second quarter of 2017, apps and analytics reported a year-on-year revenue increase of 9%, to reach €365m ($431m), with 2% being organic growth (the rest came from the acquisition of Comptel). That contrasts with a 4% fall in sales (on constant currency basis) for the company as a whole.

“There has been huge growth in customer experience and analytics technologies and we are also seeing a lot of activity in our cloud infrastructure and network management portfolio,” Bhaskar Gorti, president of the unit, told LightReading.

As well as helping it to target new types of customer and deal, independent of the networks themselves, the standalone software business has the key objective of driving margin improvement for Nokia as a whole, and feeding into a networks platform that will increasingly software-driven. In Q2, Nokia’s operating margin was 10.2%, up from 5.9% in the year-ago quarter, but that was boosted by the high margin Nokia Technologies with its licensing revenues, as well as cost-cutting programs and a patents payment from Apple.

To make such margins sustainable, the software business will play a big role. In the Networks division, Nokia is aiming for full year margin of 8% to 10%, but the longer term objective is to increase that to as much as 15% because of the rising software component.

“On software we are benchmarking ourselves against the margin profiles that exist for software companies and we are slowly inching toward that,” said Gorti. “For year-on-year growth relative to total addressable market, and all the way from gross margin to operating margin, we are beginning to see clear results.” He added: “We are building a business with applications and analytics but at the same time we are creating best practices and the components that can be used to modernize the company.”

Overall in Q2, Nokia reported sales down 0.7% on the previous year, to €5.63bn, while operating profit was up 73% year-on-year to €574m ($674m), well above analyst forecasts. Net income was up 158% to €441m helped by the royalties payment from Apple.

Suri said: “We are actually taking some share in the market … early signs look quite promising in terms of market share development.”

In the Networks division, sales fell 5% year-on-year to €4.97bn. Within that division, ultra-broadband networks revenue fell 8% to €2.17bn; global services revenue was flat at €1.45bn; and IP networks revenue fell by 4%, to €1.36bn.

At Nokia Technologies, revenue was up 90% year-on-year to €369m with operating margin of 62.3%. About 40% of this unit’s revenue was non-recurring and related to catch-up sales for the first quarter but the rest was driven by new license agreements.

Like Ericsson, Nokia was downbeat in its forecasts for the networks market as a whole. Suri said: “We now expect a decline in the market in the range of 3% to 5%, versus our earlier view of a low-single digit decline.” Once again, Nokia did not provide guidance for the technologies segment because of uncertainties in the timing and value of licensing agreements.

Huawei reports surprise slowdown in growth:

Huawei has been accustomed, in recent quarters, to delivering strong results even as its rivals suffered, but this time it was feeling some of the pain too. It has reported its slowest rate of revenue growth for about four years, according to Light Reading’s calculations, at 9.6% year-on-year in the first six months of 2017.

Of course, other vendors will look with envy at near-10% growth, but it is a sad contrast, for Huawei, with last year’s half-year progress report, which included a 40% year-on-year sales increase. In the first half of 2017, sales were up 15% to CNY283.1bn ($42bn). Rotating CEO Eric Xu had already warned, in interviews at Mobile World Congress in February, that growth would slow in the carrier networks division. “Even a 10% [annual] growth would be a stretched target to work on,” he said.

Huawei said it had achieved “solid growth” in all three of its businesses – carrier, consumer (handsets) and enterprise – in the first half. It does not break out full figures for the three divisions, but the consumer unit did say its sales had risen by 36.2% in the first six months, to CNY105.4bn ($15.6bn). That means the carrier and enterprise operations will have grown by 9.6%, to CNY177.7bn ($26.4bn). In the same period in 2016, consumer and enterprise reported growth of around 40% each while the carrier unit reported about 24%.

Huawei’s net income was essentially flat in 2016 and in the first half of this year, its operating margin was 11%, down from 12% a year earlier.