Trump’s 5G China Security Deadline Will Force Nokia M&A | #corporatesecurity |


US President Donald Trump’s fury with China’s 5G security trickery will be laid bare in September after a deadline contained in the Secure 5G and Beyond Act of 2020 expires.

By September 20, a big reveal of US security threats and vulnerabilities will be exposed as China continues to dominate the global 5G landscape.

That’s why The Edge (the leading source for under-performing companies for activist involvement, Special Situations and Spinoffs) believes that an activist should move in to dominate and improve Nokia (NYSE: NOK) before private equity gets its hands on the Finnish firm in a hostile takeover bid.

Qualcomm, Inc.
QCOM
(QCOM) is one potential perfect partner for Nokia. They’ve been working together for 14 years and established a 5G partnership in February 2018. 

QCOM currently has a cash reserve of $4 billion and may provide the solution to NOK’s problems by teaming up and becoming the biggest US 5G player.

Trump’s right hand man, Senator John Cornyn (Republican Senate Majority Whip), introduced the Secure 5G and Beyond Act of 2020 on March 27, 2019. 

On February 6, 2020, US Attorney General William Barr called China the United States’ “top geopolitical adversary” at the Center for Strategic and International Studies’ China Initiative conference.

 He said, “If China establishes full dominance over 5G… from a national security standpoint, if the industrial internet becomes dependent on 5G technology, China would have the ability to shut countries off from technologies and equipment upon which their consumers and industries depend.”

Then, on March 23, 2020, President Trump signed the Act, requiring him to take control and develop an implementation plan and security strategy for US 5G and other next generation telecommunications systems and infrastructure.

Now, as Nokia faces a foe and has brought Citi in to defend itself after being caught in the crosshairs of a mystery private equity firm’s hostile takeover, it is imperative that an activist steps up to the plate.

Cisco CEO Chuck Robbins said the US government should stay out of the 5G investment business, but with their double-digit declines in service provider sales, Cisco may also be a potential acquirer of Nokia completely or look for a controlling stake. 

With no significant domestic 5G vendor, the US is losing out to international players like ERICB SS (Sweden), Nokia Oyj (NOKIA FH, Finland) and Huawei Technologies Co. Ltd. (Huawei). 

Why is it necessary to have a domestic 5G vendor? 

As all major telecom carriers rush toward the deployment of 5G, the much-needed upgrade to a next generation Gigabyte speed is finally here. The network will be ready to do much more than just voice and data for communication and has the potential to transform the world, and the ability to handle large quantities of data will enable IoT growth. Telefonaktiebolaget LM Ericsson (ERIC) expects total IoT connections to grow at a CAGR of 24% from $8.6 billion in FY18 to $22 billion in FY24E. 

Additionally, according to estimates, the 5G infrastructure market currently stands at $784 million and is expected to reach $48 billion by FY27E, growing at a CAGR of 67.1% during the period. 

The Edge believes the combination of artificial intelligence, machine learning and 5G represents enormous opportunity for businesses and governments to capitalize. As per estimates, Industrial Internet powered by 5G can generate new economic opportunities of $23 trillion by FY25E. Additionally, the healthcare, transportation and manufacturing sectors are expected to be the key beneficiaries from the 5G revolution. 

Healthcare: 

As COVID-19 locks nearly half of the world’s population of seven billion at home, the need for connected smart devices which can remotely perform most (if not all) healthcare functions has become immediately apparent. The Edge believes 5G technology can revolutionize key healthcare functions like remote diagnosis, virtual physician appointments, long-term patient monitoring and remote surgeries. 

Automotive and Transportation: 

A reliable 5G network with low latency and ability to handle real-time data will be crucial to build truly self-driving vehicles and transform the automotive and transportation sector completely. 

Industrial and Manufacturing: 

This sector can further leverage the automation capability as 5G will enable industries to monitor key data in real-time. 5G tech and AI/machine learning based solutions will help cut cost by reducing waste, saving energy, and improving efficiency. 

Therefore, The Edge believes there is a strong case for an activist investor to bring 5G to the US by pursuing a suitor to acquire Nokia, which is available at a discounted valuation. With the right leadership, financial muscle, and US government backing, Nokia will make a formidable competitor and eliminate US concerns over the risk of losing the 5G struggle to China. 

What’s the Opportunity for Activist Investors – No Domestic 5G Supplier is a Worry for US: 

As the major US telecom carriers look to upgrade their network infrastructure to 5G, they struggle to find a domestic vendor with the deep product line and execution expertise to match the dominant players Huawei, ZTE Corp. (ZTE), Nokia and ERIC. The lack of a domestic player means the critical network infrastructure that will form part of the multitrillion-dollar economy may be vulnerable to security concerns. Huawei is one of the leading players in the telecom infrastructure space, but the long-standing concern over the potential security risk Huawei poses means the US cannot let market forces dictate the future of the 5G market. 

Attorney General William Barr summarized the US’ concerns by saying that apart from the immediate security concern of using communications networks for monitoring and surveillance, China will have the ability to shut countries off from technology and equipment. In response, the US have practically blocked Huawei and its subsidiaries from doing business in the country, on top of trying to influence allies abroad (especially in Europe) to do the same by highlighting the risk factors associated with Huawei and its close-knit relations with the Chinese government. As there are strong concerns in the US with respect to Huawei taking the lead in 5G technology implementation across the world, and since the US does not have a home-grown competitor to match Huawei, The Edge asserts the country should invest in a European giant like ERIC or Nokia. 

Who is in the 5G Race? 

China has two of the leading Radio Access Network (RAN) infrastructure suppliers: Huawei and ZTE. Together, they hold a 40% market share with Huawei being the leading supplier on every continent except North America. Additionally, the Finnish firm Nokia (17% market share) and the Swedish firm ERIC (14% share) are the only two companies that can compete with Huawei right now as 5G infrastructure suppliers, as they both have the quality and reliable products to guarantee strong execution. 

Since the US does not have a domestic equipment supplier, The Edge believes these concerns can be met by the US aligning itself with Nokia and/or ERIC through American ownership of a controlling stake, either directly or through a consortium of private American and allied companies. This would put the US’ large market and financial muscle behind one or both firms and make the US a formidable competitor and eliminate concerns over its staying in the 5G race. 

Nokia Looks Attractive to Potential Acquirers: 

Nokia has underperformed the index and its direct peer ERIC, losing nearly ~41% of its market value over the last year compared to the -8% decline at ERIC and +19% on the OMX Helsinki 25 Index. Nokia currently trades at a FY20E EV/EBITDA multiple of 5.2x, a 31.2% discount to its Scandinavian peer and direct competitor ERIC, which is trading at a 7.6x FY20E EV/EBITDA multiple. Additionally, through a series of acquisitions, Nokia has built an end-to-end product portfolio (something its competitors do not offer) and it can leverage the depth of its products to differentiate itself in a highly competitive market. 

The Edge believes the discount is justified as ERIC has a better margin profile, financial strength and is ahead in the number of 5G contract wins (ERIC has 86 5G contracts compared to Nokias 63 5G contracts). However, in the research firm’s view, 5G prospects remain intact for Nokia, although the company is facing its fair share of issues after recently replacing its CEO Rajeev Suri. Additionally, it also faces cost issues and is struggling with growth and profitability, which have undercut its valuation. The Edge sees an opportunity to bridge the gap in valuation with ERIC if Nokia addresses its short-term concerns and keeps the pace in the 5G race. Most importantly, Nokia is primarily owned by US-domiciled investors and can look for investment/takeover by a US-based firm. 

On the other hand, ERIC has a significant Swedish investor base with more than 60% ownership in Sweden and this Swedish ownership may present a hurdle in any potential deal for a major US investment. Cevian Capital (8.4% stake) welcomed the US interest back in early February 2020 in response to AG Barr’s suggestion of direct or indirect investment in either Nokia or ERIC to counter Huawei. However, Cevian indicated any deal will have to be on completely different valuation levels, hinting that it will take a significant premium from current valuation levels for ERIC to accept a deal. Paying a hefty premium on an existing high valuation means the acquirer misses out on the potential upside in the stock resulting from the ongoing 5G upgrade. 

Cisco & Qualcomm (With the Financial Muscle and Expertise) are Potential Beneficiaries: 

Based on The Edge’s analysis, Nokia is an ideal acquisition candidate, which will allow US tech giants to look at the Finnish network hardware company’s technologies to capitalize on the 5G rush. Cisco Systems, Inc. (CSCO) and Qualcomm, Inc. (QCOM) are the two companies that will emerge as the strongest candidates for activist investors to use to acquire Nokia. 

CSCO is one of the largest networking companies with a market cap of ~$175 billion. It has built an industry-leading portfolio of products and is never shy to acquire leading companies at the forefront of technology and market transitions. CSCO’s acquisitions fit its strategy of a) entering new markets, b) accelerating its market participation, and c) expand its market position. 

CSCO has underperformed the S&P 500 and its peers in the last year with returns of -20% compared to the S&Ps -2%. Similarly, over the past three years, CSCO has underperformed even its closest peers like QCOM and Intel Corp. (INTC). Historically focused on acquiring companies, The Edge believes adding Nokia’s wireless telecom infrastructure business will complement its current networking business and help expand and cement CSCO’s position as a networking giant. The Infrastructure platforms segment offers CSCO core networking capabilities with products across switching, routing, wireless, and data center solutions. In FY19, CSCO generated ~$30 billion (68% of total revenues) from its Infrastructure platforms segment. 

The US company broke its silence over speculation of an acquisition of Nokia in February 2020, with CSCO’s CEO strongly denying the rumors (The Edge believes the reason was the low-margin nature of Nokia’s business). However, in this COVID-19 pandemic where a lot has changed in two months, as well as Nokia’s stock price falling sharply over that period, while a deal may take some convincing for CSCO, the opportunity looks much more appealing now. CSCO currently has net cash balance of $11 billion and a leverage ratio of 0.5x, so CSCO has the financial muscle to acquire Nokia completely or look for a controlling stake. 

Meanwhile, QCOM is a leading wireless technology player with its core focus on integrated circuits, and the company faces headwinds on multiple fronts. The Edge sees an increased push by mobile manufacturers towards reducing their dependence on third party suppliers. For example, Huawei and Samsung Electronics Co. Ltd. (Samsung) have already started using their own processor chips as of Q3FY19. 

Additionally, Apple, Inc.’s (AAPL) recent $1 billion acquisition of Intel’s smartphone modem business hints toward the company’s intent to reduce future dependence on QCOM products. The Edge expects QCOM’s sales will see a negative impact due to the ban on Huawei by the US government. Therefore, the complete acquisition or a stake in Nokia’s Telecom infrastructure business will reduce the company’s dependence on its processor business and improve revenue visibility. QCOM currently has a cash reserve of ~$4 billion. 

For more bespoke ideas in the activism and corporate catalyst space like this, reach out to The Edge (at research@edgecgroup.com) or directly to Jim to discuss the situations coming up.



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