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Nokia's Network Profits Drop, Raise Concerns Over Alcatel Deal

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Finland’s Nokia (NOK1V.HE) reported quarterly profits well below market forecasts at its telecom network equipment business, sending its stock tumbling 9 percent and raising concerns over its planned takeover of smaller rival Alcatel-Lucent (ALUA.PA).

With Nokia shares now trading about 20 percent lower than before the Alcatel deal was announced, significant divergence in the performance of both companies could call into question the terms of the offer valuing Alcatel-Lucent at 15.6 billion euros ($17.5 billion), analysts said.

Shares in Alcatel-Lucent, which reports quarterly earnings on May 7, also dropped 6.6 percent at 10:14 GMT.

Alexander Peterc, an analyst from Exane BNP Paribas, said it would arguably be better for the deal’s prospects if Alcatel also posted a weak first quarter.

“Otherwise disgruntled shareholders deploring what they describe as low exchange parities in Nokia’s all-share bid for Alcatel might start campaigning for an upward revision of Nokia’s bid.”

Similar pressures recently imperilled the cement industry’s mega-merger between Holcim and Lafarge before new terms were reached, and could affect Shell’s planned buy of BG.

Nokia’s overall network revenue in the first quarter was slightly ahead of expectations, but profits dropped 61 percent from a year ago due to the mix of products sold, specifically less high-margin software and more low-margin mobile gear in China, as well as higher research and development costs.

Investors will want to know whether the weaker profitability is a blip or a new reality, a year after Nokia doubled down on network equipment as it sold its flagship handset business to Microsoft (MSFT.O).

Nokia on Thursday also tweaked its operating margin profit goal for the year, pointedly aiming for the middle of an earlier range of 8 to 11 percent and further spooking investors who had hoped for the top of the range.

Chief Executive Rajeev Suri defended the terms of the Alcatel-Lucent deal, although he declined to say whether they could be revisited.

“We’ve met many investors in the last couple weeks, and there’s very strong, good feedback,” he said, adding that both boards had already approved the terms.

Odey Asset Management, Alcatel’s second-largest shareholder with 5 percent, said in a letter to investors that it would not tender its shares in the takeover as the price of the deal was too low, according to the Financial Times.

Suri said that some of the negative factors contributing to Nokia’s weak first quarter would ease in the second half of the year.

“The capex conditions are challenging at this point, and there is a little bit more competitive activity overall,” Suri said, referring to capital spending by network operators to upgrade mobile networks in key markets around the globe.

The network unit, where Nokia competes with Swedish market leader Ericsson (ERICb.ST) and Chinese low-cost powerhouse Huawei [HWT.UL], saw its core operating profit fall to 85 million euros ($94 million), or 3.2 percent of sales, compared with analysts’ average forecast of 226 million euros.

The Alcatel takeover aims to boost scale to better compete with Ericsson and Huawei, as well as wringing out cost savings of 900 million euros by 2019 amid weak growth prospects for the industry.

“The networks business has performed well in the past two years, so this drop in profits is a real surprise and a disappointment,” said Mikael Rautanen of Inderes Equity Research.

“Estimates will be cut hard, and this raises concern whether this was a turning point for the worse for the unit.”

In addition to the network equipment business, Nokia also owns a mapping business called HERE, which it has put up for sale, and a smartphone patent portfolio.

HERE, which analysts value at 5 to 7 billion euros, has attracted interest from several bidders including tech companies Facebook and Uber, as well as private equity firms.

Suri declined to comment on how the sale process was going, saying only that Nokia was not a forced seller and noted that the profit outlook had improved for the business.