Nokia Oyj (NOKIA) Earnings Call Transcript
November 17, 2021
Earnings Call Speaker Segments
Hello, good afternoon, everyone. I'm Dom Olszewski. I cover European Semiconductors and Tech Hardware at Morgan Stanley. With me today, I'm delighted to introduce Pekka Lundmark, CEO of Nokia. So welcome, Pekka.
Thank you very much, Dominik. Nice to be here.
Glad to host you. And obviously, we'll be discussing the latest developments ever since the CMD earlier this year, but also recent results and then continued momentum. As with other sessions, you've probably heard this a million times already, but please do type in your questions on the investor side at the bottom of the webcast box. You should be able to see a question box to submit that, and we'll weave that into our conversation today.
So as a starting point, Pekka, coming from the outside, maybe it would be interesting to hear about your view on, are we getting to peak 5G, given the fast growth that we've seen through this year and given COVID? And how does the 5G cycle from your perspective compared to what we've seen on the 3G and 4G in forming your decisions?
Of course, this has been a strong year in terms of the market development. We are looking in Euro terms out of China at 5% market -- total market growth, and we are not seeing the market peaking yet. If we take 5G, obviously, that continues to grow, and we expect that the 5G market is still 2 years at least before it will peak. And then the difference will be that when we compare 5G cycle to earlier cycles, we expect that when the market peaks, then there will be a plateau that could last a few years and then gradually start declining towards the end of the decade when then gradually 6G will start to play a role. And the key reason for this different shape of the market will be the significant industrial campus wireless, private wireless, private 5G investment that we expect to start taking off in the coming years.
Very clear. And then in terms of mobile networks, I guess, that's the obvious area where margins have been a disappointment in the long-term historical context. And on a comparable basis, obviously, look lower than what you see of peers. You're obviously targeting high single-digit margins by 2023. But could you discuss the types of issues that you really need to recover? And how you intend to catch up? And is there upside to those aspirations?
Yes. The fundamental thing that we are obviously addressing at the moment is the product competitiveness. And we have made great progress there. And we said earlier that our target is to, in a way, catch up by the end of this year. And I believe that that's exactly what will happen. We said about a year ago that we will invest whatever it takes to repeat our technology leadership in 4G, also in 5G, and we are definitely getting there. And this, of course, is the big driver behind margins and market shares and everything. Then, of course, this is a business where the R&D investment is very high, which means that you need scale, you need volume. So now when we have addressed the technology competitiveness, then the next challenge, of course, that we will be addressing is then to get to the volume game and start getting market share. The 5% to 8% goal that we launched at the Capital Market Day for 2023, that's not something that we would be happy with in the long term. And I believe that Tommi Uitto actually did say that he wants his business to go double-digit then in the future. And that's definitely where we want to get.
Looking broadly, again, in broad brushes about around history, it's inevitable that many people and investors, when we speak to them, make the comparison to Ericsson's recovery around 2017 and '18. So as you're executing your planned recovery today, are there any particular idiosyncratic things that you want to draw out from Nokia's perspective? Obviously, there's different business mix. But just conscious of, are there any specific issues that Nokia's facing or opportunities that you see that are different versus just during this sort of historic template?
Of course, I mean, as I already said, we have made a lot of progress in 5G now, and the feedback we are getting from customers today is significantly better than what we were receiving still about a year ago. So from execution standpoint, I believe we have made very strong progress. But then, of course, when you are comparing us to our peers, it's always good to keep in mind that we actually have a broader portfolio. And the interesting thing in our market at the moment is the fact that we are seeing simultaneous demand now from both mobile, driven by 5G, but also from fixed, driven by home broadband fiber to the home. And then, of course, both of these are then leading to additional investments on mobile network backhauling, different types of gateway routers and then ultimately in metro and backbone optical network. And in these segments, in addition to 5G, we also have significant technology advantages, which we are now taking advantage of. And this is actually pretty visible in the financial development of network infrastructure business at the moment. As you will have seen, we have great growth there. There we have top line growth and also margin expansion at the same time. So you can't really compare apple -- this is not an apples-to-apples comparison of spend, especially if you compare us to Ericsson.
That's very clear. Again, looking at the longer-term perspective, is there any scenario in which the dilutive effect of swap outs is sort of reduced long-term given Huawei's diminished presence in the market given the regulatory pressures there? And is it conceivable that the entire sort of practice around year 1 swap outs being dilutive and then recovering the cost over time frame changes and the entire sort of profit pool for radio access network equipment changes structurally. Any sort of long-term thoughts around that?
Of course, the fundamental nature of the radio access business is the R&D cost, the development cost is pretty high. So that means that the number of players that the market can support is actually quite limited. And we have not seen any significant numbers of new players entering the market. But at the end of the day, what will drive your margins is really our technology competitiveness. And that's what we have been suffering from earlier in 5G, and now we are catching up. So obviously, that will then be seen in the margins that we are getting in new deals. Swaps are always a slightly different case. And also there, you get what you negotiate. I mean, typically, the margins in the first years of a swap project would have been lower. And then you would have seen gradual improvement. But it's very difficult to know how the different types of political pressures will develop in the future. This is not only a mobile networks question. This is a significant question also in fixed broadband access, in the core network, in routing and in optical networks because there are -- these discussions are ongoing in many different parts of the network. I want to emphasize that we are not the political player. We want to position ourselves as a trusted, reliable partner for our customers for all significant parts of their network. And then we are seeing that what they will decide.
Very clear. And if we look at what's happened with Huawei, could you describe what the latest win rates that you're seeing in terms of within mobile networks, but also maybe touching also on network infrastructure as well. The win rates you're seeing for those opportunities as Huawei see some market share loss. And then the time frame over which that actually translates into revenue? And what kind of lead times are you sort of averaging right now for those wins and when they actually translate to revenue?
I mean, some of these projects are ongoing already now. But on a very general level, in mobile networks, we have estimated that we have won about 50% of cases where there has been swaps because of various politically driven reasons. Again, I want to emphasize that we are not driving any political agenda. We are a commercial player. But this is the outcome that we are currently seeing, about 50% win rate of these cases. We have -- this is -- Dominik, this is for mobile networks. We are outperforming in network infrastructure at the moment. But we have -- there we have not given any kind of an estimate that what the win rate would have been. This all discussion has been dominated more like -- by the mobile network side. That's why we are not giving any estimate on the network infrastructure side at this time.
So that's a good segue on to network infrastructure. Obviously, that's been an area of real strength year-to-date and also on the isolated quarters that we've seen positively surprising on a consecutive basis. Could you just describe what's driven that outperformance versus expectations? And the visibility you have on that continuing into 2022 because one what imagines that, obviously, with outperformance, you've now set the bar higher. So how much continued momentum is there in that performance?
Of course, bar is now higher, and we will be facing tougher comparables next year because of the tremendous growth we have had in this business this year. But what we are seeing is actually a continued strong market going forward. And this is really driven by the pandemic and the fact that working from home, remote work is really here to stay. I mean, companies are going back to various types of hybrid models, but the permanent consequence of all of this is that people will want to have much higher quality connections from home, and that will consume significantly more bandwidth, not only downlink, but also in the future. On top of all the new generation of gaming applications, which will be extremely bandwidth hungry, when you start integrating augmented reality and other stuff like that into the gaming platforms, and you need to be able to support then those needs at the same time when there may be other people doing high-quality videoconferencing or other remote meetings from home. So -- and this means, for the fixed access market that now the innovative cycle which has been pushing down the market, which has been the phasing out of the copper market starts to be over. And now we are enjoying the big growth in the -- on the fiber side, which is now accelerated by COVID and the very encouraging thing for us here is that this is a segment where we have strong product competitiveness at the moment. We are leader in GPON. At the moment, we have approximately 35% market share in optical line terminals outside of China and GPON. When we move towards the next generation, which will next year start to be the main technology, which is XGS PON, which is 10 gigabits in 2 directions. We have an even higher market share in those optical line terminals outside of China. We are clear #1 outside of China in this business. And actually, the competitors that we are facing in this business, they are all quite much smaller in terms of market share than us. So we are encouraged by this development. And this is not for us -- this is for us not only optical line terminal game, it's also a CP ONT, optical network terminal business, in many cases, when there is a new technology operators actually buy the network side and the home side of the equipment in 1 package because they want to ensure high-quality interoperability. So this is the home driver. But then, of course, when you increase capacity from homes, you need routers. And then ultimately, you need optical networking gear. And when it comes to routing, we have just launched our next-generation routing silicon FP5, which is further increasing our technology competitiveness in routing. And we have recently taken #1 position in the whole world in service provider edge routing. And that is exactly the sweet spot where we are expecting new investments, which are required by both home broadband access and backhauling of 5G base station. So we are pretty well positioned here as well.
In terms of, thank you for flagging the routing point. On optical, obviously, that's been an area where profitability was sort of subdued versus the rest of the 4 major subsegments. So could you just talk us through the work underway, the developments and the opportunity to regain competitiveness, obviously, driven by the product, but also from a profitability standpoint.
Optical networking, you are absolutely right that their profitability and our relative technology position has been a little bit weaker than in the other segments, but it's now quickly improving. We are gaining market share, especially in Europe. At the moment, we see a lot of interesting investment by customers. We are now starting our PSE-V deliveries. And obviously, the development will not stop there. We have in a way, optimized in our offering, the price performance range ratio for the 400-gigabit services, which comes at the same time with the 400-gigabit interfaces in routers, and that seems to be the right choice because it's always a trade-off between cost and performance and range. And we seem to be hitting the right sweet spot here, and we are seeing that now in increasing competitiveness. But of course, as I said, this is going to be a continuous development, and we are not stopping at PSE-V, and we expect -- we have exciting stuff in the pipeline for the coming years. And what we are seeing is that this, what many people call optical IP convergence, the convergence between layer 2 and layer 3 switching and routing in network architectures is actually going to grow in importance. So we do feel that it is important to address both of these segments.
Which actually has neatly tucked into an investor question, which is where does Nokia expect to gain more market share into next year, in 2022, optical or IP?
I would say that those 2 are not mutually exclusive. FP5 in routing is, of course, an extremely important step. And we see a pretty straightforward path from where we are today in routing with the help of FP5 to continue to increase our market share in the segment where we already are the leader, IP, as I said, edge routing service provider routing and then gradually also to increase our market share in core routing. But we do see opportunities to increase market share also in optical network. So I would say that these 2 are not mutually exclusive.
And then obviously, at Q3, you also had that very nice slide, which you touched on earlier around the copper to fiber transition. Could you just describe how much additional investment is necessary there? And does that -- do you see meaningful operating leverage? Does that kick in as quickly as next year? Because it really looked like it's ticking upwards, and that's before we even get to the next topic, which is fixed wireless access as well.
You're right. It is ticking upwards. And of course, we have had fantastic growth in fixed networks, over 30% year-to-date, which is, yes, raising the bar as we discussed. There are, in a way, 2 subsegments in fixed broadband. And we partly discussed this already earlier. There is the network side, and then there is the customer premises equipment side. And of course, what is typical to this business is that margins are higher on the network side compared to the CPE side, which means that the CPE side of the business is a business where you need high volumes. And that's exactly what we are now seeing coming through, and there is pretty nice leverage in that business when the volumes grow. Of course, in all segments, we are looking at opportunities to optimize R&D investment. And if there are reasons to increase R&D investment, we may do so. But this is not something that would require kind of significant increase in R&D investment in the same way as we have seen in 5G because we are already pretty strong in technology. The Quillion chipset that we have, that's the kind of technology foundation that is supporting us in GPON. It is the same chipset that provides upgradability also to 25G PON, which will be the next technology. So I think we are well served on the R&D and the technology kind of platform side in this business, which means that this is very much now becoming a volume game to maximize operational leverage.
And then to the final sort of initially smaller, but fast-growing area of fixed wireless access. How big do you see that opportunity emerging over time?
It is a big opportunity. There, when we talk about margins, we, of course, need to understand that, that's very much a CPE game. Because the network side is pretty much the standard mobile network, which, of course, is extremely important. But when we talk about that segment, inside network infrastructure, the home broadband fiber to the home business for us in NI is both network equipment and CP equipment. Fixed wireless access inside network infrastructure is only CP equipment. So that is important to keep in mind when you think about the margin potential. Margin potential is there, but it is structurally lower gross margin potential than there is on the network side, which means that volume is very important. Technology differentiation and quality and brand are all important in that business. And then, of course, we are testing different scenarios at the moment that in terms of make or buy and what are the right chipsets? And what is the right integration level of software that what is -- what are all the functionalities that are needed in that home equipment, that how much software should be there? And what type of service platform should that actually offer for the home? So these are all kind of things that we have in the making at the moment, with just 1 goal, to maximize the margin that is available through that business. But the demand is clearly there.
Taking a bit of a step back, at the group level. Obviously, you've talked throughout the year, including at Q3 around supply chain disruptions. As I think I'm not putting words in your mouth, is that sort of one of the biggest factors of uncertainty into the end of the year and early next year? Could you just elaborate? Are you seeing any decommit from your semi suppliers? And how are you combating these challenges? Have these challenges actually accelerated even further from the earnings results?
There is no big difference between today and what we commented on the earnings day. We have been able to deal with this situation, I would say, very well. We had 6% year-to-date growth despite the fact that the semiconductor supply is limited. There has been some decommits. And when we have been challenging the suppliers that why is that, they are then saying that, well, they have been decommitted by wafer suppliers. So it is a challenging situation out there, but we have to remember that we actually, after Q2, we upgraded, increased our top line guidance for this year. And now in Q3, we said that our margin will be closer to the upper end of the 10% to 12% range. So that just shows that we have been able to deal with this challenging situation. And it also shows that, yes, there would have been even more upside on top line and margin side, had there been more components available.
I guess, that naturally brings us to the question of thinking about early thoughts into next year. So could you describe the pressures and the quantum of those pressures that you're seeing from cost inflation? And I guess, the initial supply chain issues that perhaps will continue into early next year. You've been very clear about there being a lot of positive one-offs in this year. But maybe you could sort of quantify for investors underlying what's the level of uplift for underlying margins if we're trying to strip out some of those positive one-offs and supply chain disruptions?
I'll try to answer your question without guiding our result for next year because that we will not do before we publish our Q4 results. But the -- first of all, yes, you are right, there is about 100 basis points of positive one-offs this year, which is important to keep in mind when we model next year. The main message that I want to give is that the underlying development, both when it comes to end-user demand, both in mobile and fixed and then consequentially on routing and optical is all positive. And we continue to look positively to the demand development when we look at next year. So that's the first positive fundamental. The other positive fundamental is our strengthening technology position, and we were already discussing that for the most segments. So that will continue to support our margin development into next year. We are looking at a combination of strong market demand and all the time strengthening technology competitiveness. On top of that, we have the new simplified operational model that is clearly delivering more productivity, more accountability, better results, better R&D productivity through faster introduction of new features and so on and so on. So all this is very positive. And nothing on the component side will take anything away from this development. But then, yes, I mean, this is not a Nokia specific issue. This is an industry wide issue. There is inflationary pressures. Semiconductor prices are going up. Hopefully, then longer term, they will return back to, in a way, normal when there is, again, more capacity available on the semiconductor side. But right now, there is inflation. And there is inflationary pressures also in other parts of the business system, not only semiconductors. So what all that means, of course, for us is that all new deals that we are now making, we are taking into account all the cost pressures, and we are doing our utmost to push this development into customer prices. Ultimately, then every customer situation is different. Every competitive situation is different. And that ultimately then determines what the margin in that particular deal will be. Very difficult to answer precisely on the question that when will the semiconductor supply situation get easier. I said in Q3 that I'm hoping that it would gradually get better during 2022, but we all know that there are uncertainties there. But again, this does not take away anything from the positive underlying development that we are seeing. All we are saying is that this may limit the margin expansion potential next year.
Understood. Turning away from something that's hardware dependent and supply dependent. Cloud and network services obviously had a very strong performance in Q3 with 22%, I think, headline improvement, but 10% underlying, which is the sort of the really impressive part. So could you talk through what's the continued work that's happening in that business? And maybe touch on the sort of as a service type transition that I think even just in the last day or so at the Nokia Global Analyst Forum has been a focus.
Yes. We -- I mean, there is strong development in cloud and network services towards cloud-native software developing towards new business models such as network as a service and ultimately delivering outcomes as a service, which is very, very important, especially in the enterprise segment because we want to hide the enormous complexity of the network from enterprise vertical application developers. So this is kind of a big strategic shift that we are pushing through in the cloud and network services business. And we are doubling down on this because we see that this opportunity is so significant. There is really a big opportunity to create a new way of doing business, again, simplifying the whole network delivery from what we have traditionally seen. We are right now in the middle of pretty big rebalancing of the portfolio. We are phasing out some of the older products that are coming to the end of their economic lifetime. We are refocusing the business around 6 growth segments and the biggest growth driver, actually, in Q3, which was a good quarter, as you said, was the 5G core network. We have over 150 5G core customers at the moment, and that is really driving growth in cloud and network services. But then there are other important growth drivers then, when we move on and private wireless is one of the most important ones. Network security as a service is extremely important. AI and automation of network deployment is a very important segment, just to give you a couple of examples.
Enterprise has been another area that have seen continued growth within the business, although slightly slowed down in recent quarters. So just curious about what sort of internal targets do you set yourself around growing that business? Related to that, how would you go about growing that business? Do you need to go and hire thousands of salespeople and have a different distribution model for that business versus going to 200 large telco providers where you might currently go and deliver that business? How do you sort of think about framing the opportunity there? Because obviously, one of your peers is now very vocal about the fact that they want to grow there. You have a strong position there. So does it give you the impetus to say, we need to attack even further and led from the front?
We actually, just a few weeks ago in our management team meeting, we decided to double down our investment on enterprise. We are investing in both on the product and the solutions side and then also the distribution -- sales and distribution side. It does not mean that we would hire thousands and thousands of new salespeople, but it does require that we look at the distribution models. And of course, partnering there is extremely important. We are working with several partners, including web scalers. The opportunity is really big, and we believe that enterprise will be the growth driver of this business going forward. The CSP, the service provider market, has interesting dynamics as well. But structurally, it will not be a fast growth market. So there, it's more identifying the segments and taking market share within those segments as we are doing. But the enterprise market, especially the campus wireless, 14 million industrial campuses, they will invest in new generation networking capabilities in the next few years. And as we've been discussing a lot, this whole long-standing promise for the industrial revolution, it is now finally starting to come through the combination of 5G cloud and artificial intelligence. This massive amounts of data that industrial machines produce that go very much underutilized today is a big opportunity to improve enterprise and industrial productivity, digitalization of physical industries will happen. And that will mean that we will see a new breed of applications for manufacturing automation, manufacturing process control, automation of CNC machines, taking advantage of the data that turbines and generators producing power plants, digital twins, digital remote maintenance of industrial facilities, digital remote troubleshooting. All of these applications will require massive connectivity at very low latency. We are talking about milliseconds, if you want to control robots. This presents a big significant opportunity that we want to address. And for us, it means that we are going to go after the critical inflection point, which is the emerging edge cloud market. We are not going to be a cloud infrastructure player. I mean, there are much better players for that, the web scalers and others. But we want to be the company that provides the networking software for these platforms. And on top of the networking software, we want to provide the critical layer that takes care of assurance, deployment, quality control, end-to-end security, monetization and provide open APIs for industry vertical application developers. That's really our sweet spot. And we see tremendous interest in these discussions from various industrialists at the moment. Sometimes, this market will be served by operators. And that's great. But in some cases, it will not. And that's why it's very important for us that we develop multiple distribution channels to address this opportunity.
We have an investor question here around private wireless. Would you be targeting entry there where you're providing mostly hardware connectivity? Or is there a plan to catch market share in the ecosystem from developing service platforms and/or software solutions?
Absolutely, it is both hardware and software. And actually, our goal is really to provide the networking and the layer on top of it, which I just described as a service so that we would be able to, as I said, hide the enormous network complexity from the application developers. We may provide some vertical applications ourselves as well, but that's not really the main thing. What we want to do is to enable an open architecture, open API ecosystem where the networking functionalities will be available to the developers through simple APIs. And if we enable that ecosystem with open interfaces, I definitely believe that everybody wins. This is a little bit similar type of development that we already a long time ago, started to see on the mobile equipment side with the App stores, et cetera. This has not taken off yet on the industrial side in a big way. But now the enabling technologies start to be there, and we want to be fueling this new type of ecosystem.
Maybe just in the last few minutes, it'd be interesting to think about regional perspective on growth into next year, particularly, obviously, North America is one area where we're expecting strength to continue through the end of this year and into 2022. So maybe we start with North America, we just sort of think about what type of spending strength do you continue to see into 2022 there? And then I have a follow-up on that.
Yes. It is a strong market. And of course, we have been facing some challenges on the 5G radio market share. But now those challenges start to be behind us as well. And we look with optimism at '22 and '23 also in 5G for the simple reason that our competitiveness has improved as much as it has. But remember that 5G radio is only one of our segments there. We see a lot of opportunities at the moment. And actually, a lot of growth in network infrastructure business in North America at the moment and then in CNS business as well. So it is an extremely strong market, and we continue to look positively to the future potential it offers.
And then just staying with North America, obviously, in the past few weeks, there have been these increasingly public discussions between the FAA and FCC around the safety of C-band deployments and what's going on with that spectrum. Without sort of going into the company specifics on this, there has been sort of an agreed delays towards January. So how does that impact Nokia's perspective, obviously, I guess, around Q4 and beyond?
It has all been taken into account in our guidance for this year, both top line and profit. So it does not really, and of course, we can't comment our customers' deployment schedules, that they have to do themselves. But let's just remember that we are more, in a way, supply limited than demand limited in our Q4 deliveries, #1. And then #2, typically, our revenue recognition is not tied with the commercial launch schedule of our customer services. It's more tied to the deployment of the infrastructure and delivery and/or installation of equipment. Of course, operators have invested significant amounts of money in C-band in the U.S. So of course, we hope that they will find a solution for this question as soon as possible.
And then a final question from an investor basis, just as we're approaching into the year-end and you're having the discussions, I guess, with the Board. Can you describe to us the thinking around dividends and then you have a few investors here also asking about the potential for down the line share buybacks and the philosophy to that?
Well, this is one of the most important things that the Board will discuss when Q4 results are ready to be published. And we have said earlier that we, of course, understand the needs that the shareholders have in this respect. And our balance sheet has become stronger. We have a good, both gross cash and net cash position, which is, of course, one of the factors that the Board will consider when the decision is to be made. But I will not -- I'm not in a position today to say anything more about this. So we'll get back to this question after Q4.
Very clear. Well, I would like to thank you, Pekka, for your time. Thank you to the Nokia Investor Relations team. And thank you to you, the investors, for listening to the conversation. Thank you very much.
Thank you.
Bye.
Bye-bye.
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