Should Nokia Networks Buy Alcatel-Lucent?

Nokia's Espoo, Finland headquarters. Source: Nokia.

Shares of Alcatel-Lucent jumped as much as 6% higher in pre-market trading on Wednesday, buoyed by reports that Nokia might seek a partnership or even buy the company outright. Nokia shares also rose on the news, but they settled at a more modest 2% gain.

The potential merger news comes from Reuters, citing sources in Germany. According to anonymous insiders, probably hailing from the Siemensnetworking operations that were swallowed by Nokia Networks in 2013, the companies explored merger options in the pastwhichhave always fallen apart. This is a fresh round of talks.

Neither company has commented on the report, which also included hints of Nokia entering the wearable computing market. Absorbing large-scale networking equipment maker Alcatel-Lucent would do little to bolster Nokia's mobile device strategy, but anything is possible as recently appointed Nokia CEO, Rajeev Suri, works to establish his personal legacy at the reformed Finnish company.

So, there may or may not be a real deal on the table. Partnerships are easy by comparison, and the two companies have already worked together for years. Nokia resells and supports many Alcatel-Lucent hardware packages as part of its telecom networking infrastructure operations, but the French-American company is not recognized as an official Nokia partner.

So there's plenty of room to get these two companies working closer together without going as far as an all-out merger. That's enough to lift the spirits at Alcatel-Lucent, where sales and cash flows have been sagging in recent years:

ALU Revenue (TTM) data by YCharts.

But with the buyout alternative reportedly on the table, how would that strategy help Nokia -- or Alcatel-Lucent?

First, let's consider the price tag.

After 10 years of weak results and matching stock market performance, Alcatel-Lucent is worth about half of what it was in 2004. Alcatel-Lucent shareholders would love a quick and profitable exit, but Nokia's payoff is less obvious. Even at these lower prices, it would be a big bite for anyone to swallow.

Acquiring the company, hide and hair, would cost about $10 billion plus a reasonable buyout premium. Nokia only has $9.5 billion in liquid cash reserves (and $3.2 billion of long-term debt already), so a deal like that would have to rely on a large batch of share swaps. Nokia's market cap is much larger than Alcatel-Lucent's, so it wouldn't be a merger of equals.

Nokia could sidestep this enormous investment by buying some smaller piece of Alcatel-Lucent's operations, such as its optical networking or wireless base station operations. But it's unclear how much any of these options would cost, and Nokia should be more interested in the integrated package of Alcatel-Lucent's networking hardware.

Owning these assets would make Nokia a one-of-a-kind network infrastructure play that makes the hardware, then installs and even manages it if clients are interested. Nobody else offers that type of top-to-bottom package for telecom clients. Cisco Systemscomes close, but it isn't terribly interested in installation and network management. LM Ericssonshould also be interested in a hardware play like Alcatel-Lucent, but it has yet to make any moves in that direction.

A hookup between Nokia and Alcatel-Lucent has been contemplated many times, and for good reason -- these businesses would work well together. That's only more true now that Nokia is free to focus wholeheartedly on infrastructure networks, having offloaded its money-burning handset operations to Microsoft.

The question is: Does Rajeev see more than $10 billion of value in creating this mythical beast of a long-haul communications specialist?

Going through with this merger would amount to the third game-changing reorganization at Nokia in less than two years. First, the handset division went to Washington and then Nokia bought out the Siemens half of Nokia Siemens Networks. I'm not sure Nokia is ready to take on another massive system shock right now, even if the long-term benefits seem valuable enough.

So, while I wouldn't be shocked to see a merger announcement here, I'm also not loading up on pre-buyout Alcatel-Lucent shares. Chances are, nothing will happen.


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Anders Bylund has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of Microsoft. 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.

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