The two companies hope to generate more than $1 billion in annual revenue each, by 2018, and more importantly, counter the synergies and operating leverage gained by Nokia (NOK) after its acquisition of Alcatel-Lucent (ALU).
In fact, the war of words and competition is already heating up, with Cisco’s chief John Chambers saying “the odds are good” that the merger between NOK and ALU will fail. But in reality, ALU and NOK is where the real value lies.
ERIC & CSCO Have Every Reason to Worry
Investors can look to CSCO and ERIC’s most recent earnings to see that both companies have their fair share of problems. Cisco stock fell 6% in response to earnings, as IP routing revenue declined 8% year-over-year to $1.8 billion. IP routing and IP switching account for 45% of CSCO’s revenue and three-quarters of its profit.
Meanwhile, Alcatel-Lucent’s IP routing revenue grew 9% year-over-year during Q3, behind its best-in-class core routing line, the 7950 XRS. Over the past decade, ALU has consistently stolen market share from CSCO in routing, and Q3 was no different. So while CSCO may have the overwhelming market share in IP related products and services, ALU is the up-and-coming star
CSCO’s new partner ERIC lowered long-term guidance last week, thereby causing its stock to decline more than 6%. In essence, ERIC and NOK sell many of the same products, base stations, towers, and products involved in the construction of wireless networks, whereas CSCO and ALU deal more with making wireless networks stronger with better communications and faster connectivity. Combining ALU and NOK creates a super vendor of sorts that is diversified in every area of the industry.
Proof That Chambers Is Wrong
With that said, Chambers could not be more wrong in his assessment of the odds for ALU and NOK’s success post-merger. The merger hasn’t even finalized, and we are already seeing the effects.
During NOK’s last quarter, revenue in China grew 29% sequentially to $489 million. Up until then, NOK had been nowhere near $500 million in quarterly revenue from China, a region where it is historically weak. However, China is ALU’s specialty, and we have already seen NOK lock up huge deals with China Mobile (CHL) and piggyback on the success of ALU’s joint venture in China.
These are the types of deals that investors can expect when NOK completes its acquisition of ALU early next year. It will give the combined company a partnership with all four nationwide carriers in the U.S., strengthen NOK’s business in China, and give ALU new opportunities in India and Europe.
While ERIC and CSCO may be partners, each company cares more about its own business. Therefore, CSCO employees may be able to sell ERIC products, but they won’t do so with the same success or intensity as an ERIC employee, nor will CSCO be as anxious to push ERIC products over its own.
Nokia alluded to that fact in a statement to FT.com, saying “The integrated sales team of the new Nokia will look forward to pitching against a Cisco salesperson selling Ericsson products.”
For Nokia, however, this merger should lead to $1 billion of cost reductions and increased synergies, as well as accelerated revenue growth and market share gains.
All things considered, NOK is clearly the best long-term investment opportunity of this bunch. It has the most to gain following its acquisition — and even before the acquisition as it continues to reap the benefits of new deals and partnerships from ALU.
That said, ALU is a slightly better stock to own right now before the merger ends. NOK’s acquisition of ALU is all-stock, 0.55 shares for each ALU share, which comes out to $3.93 based on NOK’s closing price of $7.14 on Friday. That’s 7 cents higher than ALU’s closing price on Friday, or a near 2% takeover premium.
The good news is that ALU stock will continue to trade in tandem with NOK until the merger closes, plus 2%, and then ALU shareholders will receive NOK stock. So, why not own ALU now, and then NOK after the merger?
Granted, Nokia is a great long-term investment moving forward, with Goldman Sachs estimating that the combined company’s market share of the global wireless equipment market will rise from 18% to 25% due to synergies and new opportunities like that seen for NOK in China.
Therefore, it is no surprise that Cisco and Ericsson are so defensive regarding the NOK and ALU merger, but at the end of the day, Nokia certainly seems to have the most to gain, whereas CSCO and ERIC have the most to lose.
As of this writing, Brian Nichols was long ALU.
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