Nokia can fight Huawei and Ciena after $2.3B Infinera buy – CEO

Few big companies are such a Frankenstein's monster of parts as Nokia. Back in 2006, a networks merger with Siemens preceded a complete buyout of the German business unit in 2013, just months before Nokia amputated its diseased handset division and left that with Microsoft. Less than two and a half years later, in a €15.6 billion (US$16.7 billion) deal, the Finnish company bolted on the giant Alcatel-Lucent, itself the product of a troubled merger between France's Alcatel and Lucent of the US. The latest deal, a $2.3 billion takeover of Infinera announced this week, is the biggest since then.

It combines two major players in the market for optical networking equipment and will leave prospective customers with fewer options. Infinera, an optical equipment specialist based in California, made $1.6 billion in sales last year and generates the bulk of its revenues (around 60%) in North America. With sales in 2023 of about €1.9 billion ($2 billion), Nokia's optical unit, a part of its network infrastructure business group, does most of its business in other regions. Customer overlap is limited, it insists – presumably hoping any authorities worried about negative effects on competition get the message.

But why, and why now? The telco appetite for investment in network products has looked weak for the last year. Optical equipment sales at Nokia fell 35% in the recent first quarter, to €344 million ($368 million), a decline the company blamed on an unfavorable comparison with the lucrative year-earlier quarter, when there was a rebound after the supply chain constraints of 2022. Infinera's first-quarter sales dropped 22%, to $307 million. CEO David Heard described it as "the bottom of a demand cycle." Both vendors clearly expect improvements ahead.

AI boom

They may be right. While telcos are spending less on the access network, and especially 5G, optical equipment is increasingly needed for the transport superhighways into the data center as artificial intelligence (AI) takes off. Besides strengthening Nokia's optical position in North America, where it claims to be relatively weak, the Infinera takeover positions it for an anticipated wave of contracts with data center and so-called "webscale" customers – the paymasters of generative AI. Internet content providers, Nokia points out, today account for 30% of Infinera's revenues.

"AI is driving significant investments in data centers at the moment and one of the key attractions of this acquisition is that it significantly increases our exposure to data centers," said Nokia CEO Pekka Lundmark on a call with reporters earlier today. Of particular interest seems to be Infinera's expertise in intra-data-center connectivity, linking up servers within a single facility. This, said Lundmark, "will be one of the fastest growing segments in the overall technology communications market, and this is one of the most notable strengths that Infinera has."

Improved scale is another big rationale for buying Infinera, helping Nokia to accelerate product development and ratchet up the pressure on rivals. "We have both in a way been suffering from being a little bit too small in the market to be able to invest sufficiently in R&D to compete against the largest players in the market, which actually are Huawei and Ciena," said Lundmark.

"This will now deliver to us the scale needed to be able to invest sufficiently in R&D to be able to fully match the capabilities of the key competitors," he added. Research by Omdia, a Light Reading sister company, gave Huawei about 29% and Ciena around 19% of the optical equipment market last year, with Nokia and Infinera on 12% and 8% respectively.

The combined company will have a beefed-up development team for work on digital signal processors (DSPs) along with expertise in silicon photonics and other critical technologies in this field. Infinera's assets in high-speed and low-power optical components, apparently suited to the needs of AI workloads, were an evident attraction for Nokia.

Execution risk

Still, there are dangers. Nokia believes the takeover will generate operating profit "synergies" (often a euphemism for cutting costs) of about €200 million ($214 billion) by 2027 through supply chain efficiencies and portfolio optimization. Simon Leopold, an analyst at Raymond James, is not so sure. The figure, he said in a research note, "seems aggressive to us assuming most investors will probably expect a conservative initial estimate."

While he downplays the prospect of what he calls "material sales dis-synergies," Leopold is also worried about execution risk. "The vendors have distinct product architectures, and harmonization might present a challenge," he said. Nokia would know a thing or two about such matters after earlier takeovers. Its 5G product problems before 2020 were blamed partly by previous management on the complicated task of integrating Alcatel-Lucent's mobile assets with those of Nokia.

But Lundmark dismisses those objections. "Probably the comment about two different architectural approaches has to do with the fact that some of the applications are based on silicon photonics and some are based on indium phosphide, and we don't believe that those are mutually exclusive," he said. "With this acquisition we will have significant capabilities in both, and we will have a significant DSP design team that will be able to take us forward."

He expects integration to be aided by the optical industry's shift toward open architecture platforms and says the synergy target of €200 million is relatively conservative. "These two businesses have a combined cost of sales of over €2 billion [$2.1 billion] and combined operating expenses of over €1 billion [$1.1 billion], and that is a combined cost base of over €3 billion [$3.2 billion]," he said. "Against that, €200 million is not a particular stretch."

Execution, nevertheless, will be crucial. Any difficulties could become an opportunity for chief western rival Ciena, which seemingly had a better first quarter than either Nokia or Infinera, with headline sales down just 1.8%, to about $1.04 billion. While Infinera reported a $61 million net loss, Ciena managed a profit of about $50 million. Just as Ericsson stole mobile market share from Nokia in the aftermath of the Alcatel-Lucent takeover, Ciena may hope to gain at Nokia's expense if the latest merger proves a distraction.

The transaction values Infinera at a 28% premium to its closing share price on June 26 and comes in the same week Nokia sold its submarine networks business to the French state in a €350 million ($374 million) deal. "Combined with the recently announced sale of submarine networks, we have now reshaped our network infrastructure business group to ensure it is able to strengthen technology leadership, grow and improve profitability," said Lundmark.

Nokia has indicated it will pay at least 70% of the Infinera fee in cash and the remainder in shares. It has, accordingly, promised to increase its share buyback program beyond the €600 million ($642 million) previously announced.

Omdia expects optical networking market sales to rise at a compound annual growth rate of 5% between now and 2029. A well-executed takeover may, then, give Nokia a growth story during a period of difficulty for its large mobile business group, responsible for about 44% of total sales last year. With optical, Nokia may find some light.