China Mobile (CHL), the largest telecom company in China, recently left Finnish telecom equipment maker Nokia (NOK 0.77%) out of its new batch of 5G contracts. The abrupt move was a gut punch to Nokia, which was already struggling to grow its business in China. Let's look back at the partnership, why it ended, and what it means for the future roles of Western companies in China's 5G upgrades.

Back in 2018, Nokia won a major contract from China Mobile to supply equipment for its regional optical transport network. The partnership was considered a major victory for Nokia, which was struggling to keep pace with Ericsson (ERIC 0.88%), ZTE (ZTCOY), and Huawei in the telecom equipment market.

Nokia said the optical network would "support the next-generation of network services, especially 5G," in China. Many investors likely assumed Nokia would remain a top supplier for China Mobile's new 5G networks, which already served 15.4 million of its 942.2 million subscribers at the end of February.

A speedometer shifting from 4G to 5G.

Image source: Getty Images.

Last year, China Mobile selected Nokia, Ericsson, Huawei, and ZTE as the four suppliers for the first phase of its 5G rollout. Nokia gained 12% of China Mobile's mobile management entity device contracts and 9% of its system architecture evolution gateway contracts. However, China Mobile recently left Nokia out of the second phase of the 5G rollout, splitting its contracts between Huawei (57.3%), ZTE (28.7%), Ericsson (11.5%), and China Information Communication Technologies (2.6%) instead. 

Why did China Mobile ditch Nokia?

China Mobile's decision seems to be politically motivated. In late January, France's top telecom company Orange (ORAN -0.17%) stated it wouldn't award any 5G contracts to Huawei, and it would only work with Nokia and Ericsson.

The move mirrored decisions in other countries, including the U.S., to drop Huawei from major wireless infrastructure projects over national security concerns. China's French embassy responded in early February, accusing the government of "blatant discrimination" and "disguised protectionism."

It also issued a thinly veiled threat, stating it didn't "wish to see the development" of Nokia and Ericsson's Chinese businesses affected by actions against Huawei in Europe. Orange didn't change its decision, so it seems like China Mobile -- which is majority-owned by the Chinese government -- is retaliating against Nokia.

Meanwhile, Huawei's fresh revenue from China Mobile could offset its loss of revenue from Orange and other European telecom companies. Ericsson is still hanging on, but it wouldn't be surprising if China Mobile also booted it from future 5G contracts.

What does this mean for Nokia?

Nokia's revenue in China fell 15% and accounted for 8% of its top line last year. Nokia attributed that slowdown to market pressure, slower-than-expected deployments of 5G networks, and "some product development challenges" in 5G devices. All of its other global regions posted flat to positive growth.

A visualization of wireless network connections across a city.

Image source: Getty Images.

Nokia stated that it faced "significant profitability challenges" and "unique market dynamics" in China. It noted its rivals (particularly Huawei and ZTE) were gaining market share with cheaper products and services, and that "intense competition" would weigh down its margins.

Nokia has also operated a joint venture in China, Nokia Shanghai Bell, with China Huaxin since 2017. The JV was aimed at boosting Nokia's market share across China, but the recent developments could jeopardize that partnership. Nokia still holds a 5G contract with China Mobile's smaller state-backed rival China Unicom (CHU), but it's unclear if the telco will also pivot toward Huawei and ZTE in the future.

The loss of China Mobile, which is expected to account for about half of China's 5G spending this year, is certainly a nasty blow for Nokia. But it could also be a blessing in disguise: Nokia could pick up Huawei's lost 5G contracts in Europe, the U.S., and other regions wary of the Chinese tech giant's ambitions. Its margins could also expand as it reduces its dependence on the low-margin Chinese market.

The key takeaways

Nokia, like many Western tech companies that do business in China, is becoming collateral damage in the escalating tech war between China and Western countries.

China is reducing its dependence on foreign technologies while selling its tech abroad, but overseas customers are scrutinizing the ties between China's government and its top tech companies. That rift will likely widen over the next few years, so it's probably better for Nokia to cut ties now and reduce its dependence on China.