Nokia (NYSE:NOK) recently signed a new agreement with China Telecom (NYSE:CHA) to expand its 4G network across 19 Chinese provinces to meet growing subscriber demand. Nokia claims that the agreement "will provide faster access to mobile Internet services as well as improve coverage in urban and suburban areas." Let's see how this massive deal could help both companies.
What this deal means for Nokia
Nokia's revenue from China fell 5% annually last quarter and accounted for 13% of its top line. However, that decline wasn't as steep as its 6% decline across the rest of Asia, and outpaced its double-digit declines across all other geographic regions. Nokia surpassed Huawei as the world's second largest vendor of mobile equipment earlier this year after fully merging its operations with Alcatel-Lucent.
Nokia's core Nokia Networks unit, which generates over 90% of its sales, sells telecom equipment to major carriers. That business is split into the larger Ultra Broadband Networks and smaller IP Networks & Applications businesses. Chinese revenue from the former fell 6% annually last quarter, but improved 3% in the latter. During last quarter's conference call, CEO Rajeev Suri noted that "price competition in China remains tough" and that 4G infrastructure upgrades are slowing down, but that he was "incrementally more positive on China than at the start of the year."
Back in January, Nokia also signed a $1.5 billion framework deal with China Mobile (NYSE:CHL), its largest customer in China. That new agreement ensured that Nokia's customer base would stay intact after combining its operations with Alcatel-Lucent. The deal with China Telecom complements that agreement and indicates that its business in China should continue outperforming its other regions.
What this deal means for China Telecom
China Mobile, China Unicom (NYSE:CHU), and China Telecom are all state-owned telcos. China Mobile controls about 63% of the country's mobile market, while the remainder is split between China Unicom and China Telecom. Earlier this year, China Unicom and China Telecom agreed to share network resources to cut costs and compete more effectively against China Telecom.
Although the three companies compete against each other, the Chinese government refuses to let China Mobile overpower its two rivals to become a monopoly. That's why it periodically rotates the chairmen of all three companies with each other and government officials.
Despite its smaller size, China Telecom has been growing rapidly. It had almost 207 million mobile subscribers at the end of June. 90 million of those users were on 4G networks, an increase of 31 million throughout the first half of the year. China Telecom also saw its total 4G traffic rise by over six times, and expects those higher-speed connections to account for over 90% of all mobile data traffic on its network by 2017. That surging demand is why China Telecom and China Mobile need to buy more telco equipment from companies like Nokia, Ericsson, and Huawei.
5G connections and better cost controls
Nokia believes that the China Telecom deal will help it lay the foundations for 5G networks in the future. Argus analyst Jim Kelleher recently stated that while Nokia will still "face near-term challenges" like the digestion of Alcatel-Lucent and slower infrastructure spending in certain markets, it remains "well positioned for the development and rollout of 5G networks over the next several years."
Kelleher also noted that Nokia's plan to reduce expenses by €1.2 billion ($1.35 billion) by 2018 (up from its original target of €900 million) would boost its margins and earnings over the long term.
But will these moves make Nokia a good investment?
Shares of Nokia have fallen 13% over the past 12 months due to weak sales growth and concerns about its ability to integrate Alcatel-Lucent's operations. Weak economic data from China has also throttled investor confidence.
Looking ahead, analysts expect Nokia's revenue to rise 79% (due to the acquisition of Alcatel), but improve less than 1% next year. Earnings are expected to fall 48% this year due to restructuring costs, but rebound 52% next year and grow at an average rate of 22% over the next five years. That gives Nokia a 5-year PEG ratio of 1.3, which is much cheaper than Ericsson's whopping PEG ratio of 16.7.
Therefore, investors shouldn't expect Nokia stock to take off in the near future, but its gradual top and bottom line improvements, low valuation, and 5% dividend yield make it an interesting stock to watch.