Today, Nokia pre-released 4Q12 results that were better than the copmany’s prior guidance and analyst expectations. The stock is up about 20% so far this morning given the combination of Nokia beating expectation, having a low valuation and the stock being under-owned by investors and under-loved by analysts with a low valuation. While Nokia is mostly known for its device/handset business, a big part of the earnings composition and surprise today is the performance of the Nokia Siemens Networks (NSN) division (a joint venture between Nokia and Siemens). In particular, NSN represented about half of Nokia consolidated sales (although keep in mind, Nokia owns about 50% of NSN, so prorated impact to Nokia’s profits are about 50% of reported NSN operating profits) and the vast majority of operating profit in 4Q12 (even when adjusting for the 50% ownership of the JV).
This is the third quarter in a row that NSN has performed better than analyst expectations. What I find relevant in the recent NSN results is whether there is a read through to Alcatel-Lucent, another legacy telecommunications equipment supplier that has been suffering. As I wrote in a prior blog on December 17th, I am positive on the Alcatel-Lucent stock (ticker ALU) given what I believe to be an improving capital spending environment in 2013, a low valuation, an under-owned/loved stock and the recent debt financing the company was able to raise which dramatically reduced the risk of bankruptcy in the next two years. I find the NSN results and business execution relevant to ALU and continue to be positive on the shares.
What I find most compelling in the NSN results in the past couple of quarters and in particular the 4Q12 preliminary results, is the improving profit margins of the company. NSN has targeted an operating margin of 5%-10% and delivered a 4Q12 operating margin in the 13%-15% range. While fourth quarter operating margins in any year are typically much higher than the full year average given the favorable seasonality of the telecom equipment in the fourth quarter, NSN continues to outperform on its operating margin guidance. I think a good part of this outperformance is the company’s restructuring program including its services business. In particular, NSN is in the middle of reducing 17,000 employees, has announced plans to sell its Optical unit to Marlin Equity Partners, has sold its Access business to Adtran and is aiming to be a more focused company specifically in the mobile broadband infrastructure market. NSN’s profitability seems to be benefiting from this new focused strategy.
Alcatel-Lucent in my view is probably 6 to 12 months behind NSN in terms of its restructuring and focused strategy but shares several of the problems NSN had a year ago, namely, a bloated cost structure primarily in Europe, unprofitable services contracts and being in too many businesses with lack of scale. I hope the ALU management team is watching at how the NSN restructuring actions has led to improved profitability and share price appreciation. I continue to think that ALU should focus on fewer businesses and be more aggressive in cutting its high cost structure in Europe. NSN shows, that while such a course of action is painful, it can be done and generate great results for shareholders. In particular, I have written in the past that ALU should consider selling its mobile infrastructure and enterprise networking businesses and become more focused on high market share business like Routers and Optical, after which the company could focus on margin improvement. Whatever the course of action the company choses to take, I still believe that the stock could be a strong performer if we see real action in restructuring in Europe, more focus in less business area and an improving telecom capital spending environment.
Disclosure: I do currently own shares of ALU, but do not own or plan to own shares of NOK in the next few days.