Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) may be making progress on turning its NSN infrastructure business around, but there’s still a ways to go. Bernstein analysts Pierre Ferragu, Jasmeet Chadha and Viral Gandhi note that NSN is still on a margin override, but they believe that could change over the next few years.
Nokia could gain in wireless infrastructure
The analysts believe that Nokia has started to gain control over its profitability in NSN. They’re looking for the division to push operating margins of between 6% and 8% and revenue growth of between 4% and 6% on a normalized basis. They’re valuing NSN at €7 billion.
The Children's Investment Fund Management LLP is a London-based hedge fund firm better known by its acronym TCI. Founded by Sir Chris Hohn in 2003, the fund has a global mandate and supports the Children's Investment Fund Foundation (CIFF). Q3 2021 hedge fund letters, conferences and more The CIFF was established in 2002 by Hohn Read More
At this point, the analysts said this puts NSN on margin override, and they’re expecting the division to disappoint in 2014. They’re forecasting operating margins of 6.3% during the year, compared to consensus estimates of 8.9%. They believe ramping up project rollouts and chasing new services contracts will affect NSN’s margins.
Wireless infrastructure landscape now stable
They suggest that the “competitive landscape” in wireless infrastructure is now stable, which is good for Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V). They also note that wireless equipment requires high intensity in research and development and that it is a commodity business in which scale or low costs for research and development are “the only drivers of profitability.”
The analysts noticed that over the last five years, Chinese competitors within the wireless industry have caused it to consolidate by pressuring prices and margins, making a clear top three companies in the business. They name Huawei and Ericsson as the top two players and Nokia as the third. They report that Ericsson was able to “maintain its scale advantage” after responding to pressures, and prices in the industry fell nearly 45% in just six months. As a result, most “subscale players” were pushed out.
Nokia to set the pace
They don’t believe Ericsson or Huawei will pressure pricing going forward. As a result, NSN will be forced into negative territory. They believe it will be up to NSN to “decide where to set profitability, knowing that topline development will directly and inversely depend on it.”
The analysts estimate that if NSN breaks even in equipment, both Huawei and Ericsson will be able to make 14% margins, which is probably a lower target than they’re hoping for. At that level, the Bernstein team thinks they will focus “more on profitability than topline.”
On the other hand, if NSN becomes sustainable at around 5% margins, they think Huawei and Ericsson will be able to raise their margins to about 20%. This could provide more opportunities for them to be more aggressive and look for more topline growth. On a normalized basis, they believe NSN will be able to make operating margins of between 2% and 5%. At a 2% margin, they think the company can grow “in line with the market” at around 5%. However, at that rate, NSN would probably shed market share slowly and “barely grow.”
Will Nokia acquire Alcatel-Lucent’s wireless division?
Some have been speculating that Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) would buy Alcatel-Lucent’s wireless division. The Bernstein analysts say this is undoubtedly a “great opportunity” to build the scale of NSN. However, they don’t think Nokia is “in a good negotiation position” right now and could look for “a more organic strategy.”