Nokia and Alcatel-Lucent should heed the lesson of past mergers

Rajeev Suri, the chief executive of Nokia, has long believed the telecoms equipment market would consolidate into three strong groups. The only question has been when the Finnish company would make a move to buy Alcatel-Lucent, its smaller French rival.

Alcatel-Lucent, the result of an ill-fated French-US merger almost a decade ago, was always a target for Nokia as both companies struggled to find a way in a market becoming dominated by Huawei of Chin and Ericsson of Sweden.

The two sides have been in talks on and off for years. The latest round began with conversations to acquire Alcatel's wireless business, according to those with knowledge of the situation. They say that Nokia considers this crucial if it is to leapfrog Huawei to become the clear second-placed group after Ericsson in the mobile equipment business.

But the talks around a full-blown merger intensified last weekend when the Finnish group realised that Alcatel had other attractions, such as its success in IP routers.

A broader merger of the two weakest companies would create one strong challenger, said a person close to the talks, with a market capitalisation of about €40bn and sales of about €27bn, matching those of Ericsson.

It would enable the companies to share the high costs of research and development in next-generation telecoms equipment as well as the capital expenditure required to build advanced networks for mobile groups demanding ever greater data capacity.

The deal also makes sense geographically, say those close to the talks. Alcatel has a relatively strong position in North America, for example, a region in which Nokia has only begun to make headway again following a deal with Sprint.

But both companies will be acutely aware of the difficulties of merging telecoms equipment businesses - not least because each is the result of problematic and drawn-out mergers that necessitated intense restructuring.

The heavy costs to shareholders from the merger of Alcatel and Lucent in 2006 will serve as a warning to Nokia. The French group has not generated positive free cash flow since 2005 and its market capitalisation fell by four-fifths in the eight years after the deal.

The two businesses were never properly integrated, say insiders, who describe a culture clash of two companies joined awkwardly under the same banner.

Mr Suri will also be able to learn lessons closer to home, given an equally uncomfortable joint venture between Nokia and Siemens that eventually resulted in the buyout of the German stake to create the modern Nokia.

The Finnish group is only just showing the results of the latest round of restructuring by Mr Suri. It has returned to profitability and the share price has quadrupled in three years since its low in 2012 when investors worried that it might run out of cash.

Analysts say it is little wonder that Nokia's share price fell on news of the Alcatel bid given the risks of another potentially value-destroying merger.

Many are sceptical of a potential combination.

Juha-Pekka Helminen, former strategy director of Nokia and now a telecoms industry consultant, tweeted: "Alcatel-Lucent $ALU & #Nokia $NOK deal simply value destructive to Nokia shareholders. Today's stock market reaction is right."

In a subsequent tweet, he added: "Merger btw $ALU & $NOK reminds me of politics involved w/ NokiaSiemens. It is 5 yr project and worse b/c french gov involved."

A former Nokia director recently told the Financial Times: "My concern would be that you would be trying to meld together four companies, not two, and four cultures, not two. That sounds like a recipe for disaster to me."

He added: "Think about it: Germany and Finland are rather close culturally and there were still problems. What would it be like with Finland and France?"

Both Mr Suri and Michel Combes, Alcatel's chief executive since 2013, can point to the fact that many of the problems created by both mergers have been corrected under their watch through intensive cost-cutting plans.

Mr Combes has delivered on the promises of a plan to cut €1bn of costs and sell €1bn of assets while refinancing and restructuring its balance sheet and cutting 10,000 of the company's 72,000 jobs. The group is now at a point of moving from recovery to growth.

There will be much more to cut if the merger goes ahead, however. There are overlaps in operations in the infrastructure business, which has become core to Nokia since the sale of its handset business to Microsoft. This might mean job losses and a rationalisation of R&D resources which would be deeply unpopular with governments in Helsinki and Paris.

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In the core wireless business, Ericsson, Huawei and Nokia control four-fifths of the market and Alcatel-Lucent has a 10 per cent share. Analysts at Bernstein say this would boost the profitability of Nokia and move it into second place behind Ericsson - but it would not be profitable on a standalone basis.

"An acquisition of Alcatel-Lucent's wireless division by Nokia makes a lot of sense," said Pierre Ferragu of Bernstein. "It is the only option for a consolidation of wireless and it is highly valuable to Nokia."

Bernstein estimates that the acquisition of Alcatel's wireless business would be worth up to €10bn alone to Nokia given €1bn of cost synergies, limited revenue problems in spite of a risk of market share loss in China and the US and an increase in Nokia's earnings before interest and tax of €1bn.

Both Nokia and Alcatel described the talks as "advanced". The companies could now progress quickly, say people familiar with the proposed deal, although the main hurdle remains how the French government will react.

Alcatel is considered a strategic national asset by France, which has opposed the sale of smaller and less important businesses to overseas groups in the recent past. Last month, it stepped in to avoid the sale of Dailymotion, a video hosting website, by Orange of France to PCCW, a Hong Kong telecoms group.

On Tuesday, the economy ministry said the government would "be very watchful" of the consequences of any deal on jobs, Alcatel-Lucent's French sites, particularly in R&D, and the French telecoms sector in general.

"The government must have information with which to judge the rationale of the industrial project, and its ability to create a globally competitive European champion - an Airbus of telecoms," the ministry said.

Nokia could offer guarantees around co-location of headquarters, as well as promises to maintain jobs and a large research centre outside Paris, said a person familiar with the options.

However, Nokia will be mindful of the problems of failing to integrate the business properly as a sop to the French.

A management consultant who worked for Nokia Siemens Networks in 2007 said: "I've never worked in a more dysfunctional company. There were separate fiefdoms in Munich and Helsinki and very little communication. It was a very frustrating job."

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