Long dominated by its largest players, Ericsson and Huawei, the global telecom-equipment market is arguably one of the most fiercely competitive markets in all of tech. It was this same thrive-or-dive atmosphere that led Nokia (NYSE:NOK) to propose a $17 billion merger of equals with Alcatel-Lucent (NYSE:ALU) last April, a deal the two companies said would close in early 2016.
Fast-forward to today, and the companies have jointly announced that they would, in fact, begin operating as a combined entity on Jan. 14. As these two become one, what does this mean for both Nokia's investment outlook in 2016 and beyond?
Even as recently as this fall, legitimate regulatory risks remained that threatened to scupper a merger that many, myself included, viewed as necessary for both companies to remain competitive against heavyweights Ericsson and Huawei. However, due to a number of recent successes for Nokia, the deal now appears certain to conclude smoothly in the coming days.
On Monday, Sept. 4, Nokia announced that the window for its initial tender offer for Alcatel-Lucent shares had officially closed. Nokia published the results the following day, stating that, according to the French stock market authority, Nokia had successfully purchased more than 76% of Alcatel-Lucent's outstanding shares. For context, the deal's terms required Nokia to gain control over only the majority (50% plus one) of Alcatel's outstanding securities in order for the deal to stand.
Furthermore, while the two companies had already gained regulatory approval from U.S. and European authorities, French regulators this month were the last to give the deal their blessing, removing the final regulatory hurdle that could conceivably threaten the merger. Now that the deal is happening -- barring unforeseen catastrophe -- how should investors be looking at Nokia's stock?
When two become one
In reviewing the terms of the deal and their likely benefits, it's hard not to get bullish about Nokia's future. Nokia structured the Alcatel-Lucent acquisition as a stock swap, meaning it will use newly created Nokia shares exchanged for publicly traded Alcatel shares.
Such a move can have a dilutive effect on a company's earnings per share, as its earnings now have to be divided among a greater number of outstanding shares. However, in the case of a beneficial acquisition, the added earnings from the acquired company more than compensate for the expanded share count. Fortunately, for Nokia, the situation appears to be the latter for a few reasons.
As part of the deal, Nokia stated that it plans to reduce the combined entity's operating costs by some 900 million euro by 2019, and reduce interest expenses by 200 million euro. Looking at the revenue or market opportunity aspect of the deal, Nokia said it believes the combined entity, and its newly competitive stance, will allow the company to expand its addressable market by 50%, from 84 billion euros to 130 billion euros. Per the initial release of the deal, Nokia believes it can realize roughly 3.5% average annual revenue growth through 2019 thanks to the deal alone.
However, in a recent note to investors, Credit Suisse cited four specific points that it believes could lead to Nokia benefiting far beyond what it has projected to investors. Quoting from Credit Suisse's note, those factors are:
- We see potential for more rational pricing in the highly consolidated wireless infrastructure market
- We see excessive levels of real estate at ALU, which could create potential for further savings
- Applying Nokia's discipline to ALU's wireless operations could drive GM upside beyond our current expectations, adding as much as ~7% to EPS on our estimates.
- There are saving opportunities from pruning the Alcatel-Lucent portfolio which could provide scope for additional synergies.
All told, the company makes a compelling case that Nokia's earnings before interest and taxes (EBIT) could more than double by 2018. With Nokia shares currently trading at 21x P/E ratio, there's a legitimate case to be made that Nokia could markedly outperform the market as it prepares to finally conclude its Alcatel-Lucent acquisition.
Andrew Tonner has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.