Good Deal But Bad Idea: Nokia Corporation Buys Alcatel-Lucent SA

By Markets Fool.com

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Image source: Nokia.

Nokia has been sniffing around Alcatel-Lucent for a while. Buyout rumors started flying in 2013, and took another bow four months ago. But the talks always fell apart before reaching a real deal.

This time, it's different. The usual rumor mill outlets dropped fresh hints of "advanced talks" between the Finnish-German telecom networking giant and the French-American networking hardware specialist. Then Nokia confirmed these reports, and just a few hours later, it was a done deal.

So the merger moved from iffy rumors to "there can be no certainty at this stage that these discussions will result in any agreement or transaction," and then to a full-blown $16 billion combination, all in a matter of a couple of days. That escalated quickly.

Under the final agreement, each Alcatel-Lucent share will be exchanged for 0.55 Nokia shares, and Nokia will then take full control over its brand new hardware asset. The deal still has to muddle through the usual labyrinth of approval processes, but Nokia expects to close the buyout in the first half of 2016.

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Both stocks dropped on the announcement. Alcatel-Lucent shares fell as much as 20% on the news, following a 27% surge over the previous three days as the rumors took shape. Nokia's shares also lost the 8% buzz they had acquired since last Friday. The speculators out there seem disappointed in the final terms.

What's happening?
If Alcatel-Lucent investors were hoping for a 20% higher buyout price, it's fair to say that Nokia landed a decent price on the deal. Since it's a pure stock-for-stock exchange, the merger won't drain Nokia's cash coffers at all. The company even comes with a modestly positive net cash balance, so Nokia won't shoulder any crushing debt loads.

But what is Nokia really buying?

Well, Alcatel-Lucent comes with a long history of negative earnings and cash flows:

ALU Free Cash Flow (TTM) Chart

ALU Free Cash Flow (TTM) data by YCharts

Total revenues have fallen 30% over the last seven years. Meanwhile, Alcatel-Lucent's arch rivals Juniper Networks and Ciena showed no signs of slow sales at all:

ALU Revenue (TTM) Chart

ALU Revenue (TTM) data by YCharts

So Nokia is buying a laggard, not a leader, in the telecom networking hardware space. At the same time, the Finns tether themselves to one specific hardware provider, limiting its ability to shop around for the best deals on the best solutions from all players in the market.

And for this, Nokia shareholders will endure massive dilution of their existing positions. I don't think that's a great idea.

If anything, this agreement looks like a positive event for LM Ericsson as well as other network installation and maintenance specialists. A major competitor just hamstrung its choices for hardware installations, and the whole affair smells like desperation and stale Koskenkorva.

Nokia CEO Rajeev Suri says that this is "the right deal, with the right logic, at the right time." In his view, the merger is all about innovation and economies of scale. Alcatel-Lucent CEO Michel Combes can only nod in agreement.

From where I sit, Nokia is risking billions of dollars in shareholder value (but not in cash -- smart choice!) to build a fully integrated network infrastructure provider. With hardware, installation services, and network management operations all under a single roof, Nokia does become a unique player in this market.

But it's a risky bet. If I were a Nokia shareholder, I would much rather have seen the company doubling down on what it does best and continue to shop around for the best deals and solutions in hardware. The one-stop shopping model doesn't automatically make sense in every sector.

Nokia might get lucky and become a top-to-bottom power player just as the Internet of Things starts requiring serious wireless network upgrades. By the same token, Nokia could also completely miss the boat on the IoT revolution and the upcoming 5G network rollouts.

There are no guarantees but tons of risk. Feel free to place your bets. Me, I'll be watching Nokia's big hardware play from the sidelines.

The article Good Deal But Bad Idea: Nokia Corporation Buys Alcatel-Lucent SA originally appeared on Fool.com.

Anders Bylund 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.