Why Nokia Backed Off From the Alcatel-Lucent Deal

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In September, Nokia considered acquiring Alcatel-Lucent's wireless division as part of its strategic restructuring, in light of the acquisition of its devices and services unit by Microsoft . By acquiring Alcatel, the Finnish group would be in a better position to compete against Ericsson and Huawei Technologies, the leaders in the network infrastructure market. Additionally, given that Alcatel has a strong technical expertise in IP, cloud networking, and wireless gearing, Nokia could capitalize on new synergies, thus becoming more competitive. A possible merger between Nokia and Alcatel would generate the second-largest network infrastructure company, trailing Ericsson's 36% market share. Yet, on Nov. 19, Nokia backed off from the Alcatel-Lucent deal.

Nokia-Microsoft deal changes Nokia's priorities
The Nokia-Microsoft deal will be completed early 2014. The partnership is expected to allow Nokia to promote its Nokia Solutions and Networks, or NSN, business and directly compete with Ericsson. NSN offers mobile broadband, multimedia technology, and consultancy services. Nokia plans to further focus on R&D and explore innovative solutions in advanced technologies to build high-speed mobile data infrastructure, but more importantly, improve shareholder value.

NSN has been weak in the wireless division, which dominates the U.S. market. This weakness would be covered by Alcatel's fast-growing IP routing and optical business. Plus, NSN's market share in the wireless network infrastructure market would fly to 30% from its current 18%. However, according to a Wall Street Journal report, after having explored whether Alcatel's IP-router and wireless divisions could fit with NSN, the Finnish group has decided to delay formal talks.

Alcatel's "Shift Plan" may be costly for Nokia
Since 2006, when the ill-fated merger with Lucent Technologies took place, Alcatel has struggled to become profitable. Having been steadily unprofitable for almost seven years, in spite of restructuring attempts by former CEO, Ben Verwaayen, today Alcatel tallies more than $10 billion in losses. New CEO Michel Combes has introduced "The Shift Plan," which aims to reshape the company by focusing on core businesses like IP routing, cloud computing, and 4G infrastructure projects, plus cutting R&D investments in legacy telecoms infrastructure. To achieve this, Alcatel plans to dedicate 85% of its R&D investment in 2015 to next-generation technologies. The target is $1.35 billion in fixed-cost savings and asset sales of more than $1.35 billion from 2013-2015, and $2.7 billion in debt reprofiling over the same period. In addition, Combes plans to raise $2.7 billion through new share issuance and debt financing to fund the company's overhaul.

In October, the Franco-American company announced major layoffs for the next two years to reduce fixed costs by $1.4 billion, or 15%, by the end of 2015. The job cuts are a routine practice in the telecom industry, as most companies upgrade their data network infrastructure to remain competitive and improve their position in the market. Two years ago, Nokia cut 17,000 jobs as part of a similar restructuring plan.

Alcatel's major restructuring might mean extra costs for Nokia, ones that the Finnish group may not be willing to leverage at the moment.

French government a barrier to the merger
The French government own 3.6% of Alcatel and, therefore, has a say on Alcatel's restructuring plan, mostly on limiting job cuts. Within hours of Alcatel's announcement of slashing 10,000 jobs, François Hollande and members of the French government opposed to the plan suggested that the job cuts were excessive. The government threatened to use the applicable law, which took effect in August 2013, to block Alcatel's layoffs if no compromise was reached with unions. This move not only frustrated the French business environment, but has also sent a signal to Nokia that the French labor system is not flexible.

Alcatel's huge patent portfolio
IP routing is one of Alcatel's major assets, and as such it is highly unlikely that the company is ready to monetize its 30,000 plus patents in the context of a merger. Analysts estimate that Alcatel's patent portfolio of has a value of $5.4 billion-$12.2 billion. The portfolio is currently secured in part by the collateral of a $2.2 billion debt deal with Goldman Sachs and Credit Suisse. Although the loan terms are undisclosed, it is highly likely that Alcatel faces significant limitations on patent policy, particularly with respect to licensing. Simply put, in a possible Nokia-Alcatel merger, the Finns would have to pay a fortune to become the new licensees, provided this is permitted by the loan terms.

Bottom line
Fierce competition in the telecom sector, and the fact that slower European economies reduce the demand for telecom equipment, practically force Alcatel to employ the restructuring plan. And of course, restructuring comes with a cost. If Alcatel manages to effectively implement the "Shift Plan," it will survive and become profitable. If not, it will be sold to Nokia or some other telecom provider. For the time being, Nokia is holding formal talks. NSN chief executive, Rajeev Suri, stated that Nokia didn't have to "do deals for the sake of deals," and that he was in favor of a "just wait" strategy that would let market forces take out weaker rivals rather than doing a deal.

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The article Why Nokia Backed Off From the Alcatel-Lucent Deal originally appeared on Fool.com.

Muhammad Bazil has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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