Nokia, Siemens Point the Way
As the two European giants join forces to compete globally, telecom's long-awaited wave of consolidation has likely begun
By pooling their resources in the highly competitive telecom equipment business, Nokia Corp. and Siemens AG stand a better chance of competing for huge contracts that will soon come up for bid in critical growth markets such as China and India.
Nokia (NOK), the Finnish telecom equipment giant, and Germany's Siemens (SI) said on June 19 they will combine their network equipment businesses in a 50-50 joint venture valued at $31.6 billion. The deal is clearly aimed at cutting costs to make the companies more effective in the global market. The companies say they expect to be able to cut annual costs by more than $1.5 billion because of the merger.
"We believe the partnership with Siemens is the most effective way to build the scale and broad product portfolio necessary to compete globally and create value for shareholders," Nokia CEO Olli-Pekka Kallasvuo said (see BusinessWeek.com, 6/19/06, "Nokia, Siemens Plan to Join and Conquer"). He will serve as chairman of the joint venture, which will be called Nokia Siemens Networks.
The biggest battles in the global communications equipment market will occur in Asia, particularly in China and India. Over the next three years, China is expected to put up for bid contracts for third-generation wireless networks worth $10 billion to $12 billion, according to analyst Susan Kalla of Caris & Co. "The Siemens-Nokia deal is a cost-cutting exercise aimed at getting business in China by pooling resources and cutting overlap so the companies can sell their products at lower prices than they could have on their own," Kalla said. She downgraded Nokia to "above average" from "buy," reflecting concerns that the joint venture will face risks in the global market.
The China contracts are the biggest contracts up for grabs. Other big opportunities in the global market include India, where deals worth at least $5 billion are expected to be signed during the next few years.
CHINA RIVALS. Ericsson (ERICY) is the current leader in China's telecom equipment market, which Kalla says is worth about $15 billion a year. It has a market share of about 40%. Siemens and Nokia aren't the first big companies to make dramatic moves with this target in mind. Alcatel (ALA) is buying Lucent (LU) (see BusinessWeek.com, 3/24/06, "Lucent-Alcatel: A Marriage of Equals?"), in part to help maximize their prospects in China. Ericsson has acquired Britain's Marconi. The Nokia-Siemens deal may put pressure on other companies such as Nortel Networks (NT) and Motorola (MOT) to build scale by finding a partner.
The most potent rivals in China may be homegrown, though. China-based equipment makers Huawei and ZTE (see BusinessWeek.com, 11/23/05, "Cisco's Middle Kingdom Alliance") have a great advantage going into the battle for new wireless contracts. Third-generation, or 3G, wireless service, which allows people to access the Web at faster speeds, is catching on in Europe and the U.S. Equipment makers are lining up to compete for similar business in China.
Huawei, once known in the U.S. mostly for getting into intellectual-property disputes with Cisco Systems (CSCO), has come into its own. It has landed customers outside China, including British Telecom (BT), a sign of growing respect for its technology. Thanks in part to its access to cheap loans from the Chinese government, Huawei is able to underprice its rivals by as much as one-third, Kalla says. While Huawei's share of the China telecom market is currently in the high single digits, it could be a much bigger force in the future.
TRIGGER FOR CHANGE. Even rivals that manage to win business in China will face huge risks. The profit margins are expected to be low, reflecting fierce competition. Big players in the global telecom equipment market feel they need to have a presence in the China 3G market, if merely to maintain their current share of the global market. But their main hope of making money on a deal isn't the initial contract. It's the opportunity to upgrade the initial networks with more capacity, as traffic grows in the range of 50% a year. Those deals could have higher margins because there will likely be fewer rivals.
The Nokia-Siemens deal will make it harder for telecom equipment providers to resist the global wave of consolidation. Motorola has enjoyed a comeback under CEO Ed Zander, the former president and COO of Sun Microsystems (SUNW). The company has regained much of the momentum it lost years ago to Nokia in the handset market. But Nokia and Siemens have a much bigger presence in the infrastructure market.
Zander isn't keen on big tech deals (see BusinessWeek.com, 5/23/06, "Motorola's Zander Looks Beyond the Q"). "I have been in tech for 30 years. And if there's been a big tech merger that has worked, you'll have to tell me what it is," he said in an interview before the Nokia-Siemens deal was announced. "They are hard. They're not impossible, but they are hard." But some analysts say he may have little choice. "A Nokia-Siemens merger will help Nokia penetrate the wireline market, something touted by Motorola in the past few quarters. This may imply that Motorola may be pushed to join the pack and also make a large wireline acquisition," telecom equipment analyst Tal Liani of Merrill Lynch said in a report on June 19.
INDEPENDENCE NOT VIABLE. Motorola could try and link up with Nortel, which has been struggling for several years to shake off the back-to-back crises of an industry downturn and an internal accounting crisis. It's common wisdom in the telecom world that the Canadian government would not want one of its most important national companies to fall into foreign hands, but that might be preferable to watching the company continue its slow decline as an independent player. "Nortel could face increasing pressure with its subpar scale in multiple segments," Liani said.
In another possible scenario, either Motorola or Nortel could try to beef up its wireline portfolio by acquiring a smaller company. Options include optical networking powerhouse Ciena (CIEN), diversified telecom vendor Tellabs (TLAB), routing upstart Redback Networks (RBAK), or network access specialist Adtran (ADTN), Liani says. But none of those potential targets would create the scale of Nokia and Siemens.
The Nokia-Siemens deal might actually help one important player remain independent. Routing giant Juniper Networks (JUN), which ranks second in the router market after Cisco, has a sales agreement with Siemens Communications. Now that Siemens is joining forces with Nokia, Juniper will have a much bigger and stronger sales force to help peddle its products. That will help boost its top line, or give it more leverage should it choose to find a partner.
The telecom equipment business has resisted consolidation for years. The big players remained independent through years of financial crisis, technological upheaval, and consolidation by their big customers. But now the moment of change has arrived, driven by the irresistible force of globalization.
Rosenbush is a senior writer for BusinessWeek Online, based in New York |
