Nokia Oyj (NOKIA) Earnings Call Transcript

Great. Well, I think we can get started. I'm Alex Duval. I head up the European tech hardware team at Goldman Research. Delighted to be here with Raghav Sahgal, President of Cloud and Network Services from Nokia. Thank you so much for being with us. And I think the format is we'll go through some Q&A fireside chat format, and then we'll have 10 minutes for questions at the end. So I thought maybe we could just start high level, and you could -- I might ask you to summarize a bit about Cloud and Network Services division. Maybe we could just spend 5 minutes on the kind of main focus areas, some of the recent progress and then some of the commitments you've laid out at the 2021 Capital Markets Day.

Sure. So good morning, everyone, and thank you for taking the time to come and engage with us here. So we set up cloud and network services in 2020, which is the beginning of 2020 when we set up a new operating model in Nokia. And we are one of the 4 business groups inside Nokia. Cloud and Network Services is primarily a software group inside Nokia, which is divided into 4 groups. One is core networks, business applications. We have a small managed services business as well as enterprise solutions, which is really focused on campus private wireless networks. The strategy that we put in place very early in the inception of Cloud and Network Services was to really focus on how we are going to monetize the new and upcoming 5G ecosystem that's going to evolve. And that was the first primary focus. The second was to make sure that in order to support this journey into the future, that we build software which is very, very cloud-native in nature to take advantage of the 5G capabilities that will be brought. And finally is to transition the business from delivering software on-premise to Software as a Service. And this was a key focus for us and a journey that we started out at the beginning of last year. So those are the 3 primary tenets. And obviously, finally, we all know the hyperscalers are becoming a major force in the industry itself and as to how we will collaborate with the hyperscalers to bring joint value to the table in itself. As we set up -- we set up a 3-year strategy, 1 was about reset, which was 2020 - 2021. This year is all about accelerate and next year is all about scaling the business. And we focused our business into 6 key pillars. One is what [ it ] we call is our 4G, 5G core, which is a central part of the network. The second is around automation, which is what we call digital operations, because we have to drive a very digital infrastructure. The third area was analytics will become more and more important, AI and ML, just because of the amount of data that we'll be dealing with. And finally, as we disaggregate networks [ in shelf ], security will become a very -- even a bigger aspect because as you disaggregate the networks, you are vulnerable to security. So those are 4 and obviously, we are looking at how do you monetize the 5G world. So monetization became the fifth pillar. And this is much more on the consumer side. But as we looked at the growth on the enterprise side, campus private wireless became the sixth pillar of our strategy. And these are 6 pillars of the strategy that we're driving, underpinned by the ability that we will deliver all of these capabilities over SaaS over time, and that became the primary driver. In terms of the business performance, 2021, as we said, was a reset year. And our performance in 2021 was, we had given to the capital markets a very clear indication of where we would land in our operating profit, and we were well within that range. And we actually improved almost 750 basis points over 2020 and going into 2021. And in the first half of this year, we have further improved our profitability by almost 160 basis points going forward and have shown growth of about 3% year-on-year in the first half of this year. So that's a quick summary of Cloud and Network Services.

Really appreciate your setting the scene for us, Raghav. I guess maybe we can sort of delve a bit into 5G. Obviously, you talked about very much something which can enable digitalization and capitalize economic growth. And clearly, CNS should sort of play into that dynamic. So I'm curious how your division can help facilitate that? And what would you see as the kind of critical use cases in terms of applications of 5G?

Sure. As 5G evolves, you have to look at 5G on an end-to-end basis. And the first layer that you look at in a 5G environment is really the infrastructure. And this is where the radio, the transport and the core become a very integral part of the infrastructure. Now you have to -- what you have to do is to unleash that value of that infrastructure into the consumers and enterprises, into the digital ecosystem. And for that, you need this software that actually sits on top of the infrastructure that actually drives pushing the capability of the 5G network into the ecosystem. And so where we play as an organization, CNS, is really at that middle layer of unleashing the value of the network and delivering it in a programmable way into the ecosystem. And as such, as 5G evolves, you have to think of it much more on an end-to-end basis and in these layers, in order to fully utilize the capabilities of what 5G will actually bring. And if you're looking at use cases on the consumer side, obviously, the extended reality is going to be around extended reality, around entertainment. These are areas that you will see where a consumer is sitting in a stadium probably at some of the seats where it's very -- the field is very -- not as visible, how do you give them an immersive experience of the sport that's going on? What's happening in the dugout? How is the goalkeeper seeing the particular thing? So you have to be able to give those different types of immersive experience that we will see that 5G and 5G-Advanced will be able to deliver on the consumer side. But on the enterprise side, that's even a greater value to be delivered there, because as the enterprise side starts to digitize and digitization is going to be very necessary, they're much more in the asset-heavy industries where digitalization is less than 30%. There's a huge upside of that digitalization that needs to occur, which is [ which where ] represents the opportunities. And there are use cases by verticals that are different: what's in a manufacturing use case to an energy use case, you have public safety use case to a mining use case, what's required in health care. There are different types of use cases. And so obviously, digital twinning is going to be a very big use case that will continue to evolve. We're starting to see that evolve. And if anything, COVID actually drove the acceleration of digitization of different types of use cases. So the number of use cases is going to be pretty much infinite and depending on the industry, and they will keep evolving. What's important as you get into 5G is to create a platform that any kind of use case can be absorbed onto that platform. And so the idea is that use cases will continue to develop by industry, by verticals, and they will keep changing on the consumer side as well as the enterprise side. But you have to drive a platform strategy of absorbing any type of use case that requires network capabilities. And as the metaverse evolves and we look at the metaverse in 3 dimensions, there's the consumer metaverse, there's the enterprise metaverse and there's the industrial metaverse. And they will have -- they will require different types of network capabilities, and we have to render them as these evolve. So the 5G networks will play an enormous role in rendering capabilities to these different environments and different verticals depending on the use case type.

Very much appreciate that, Raghav. And I guess this is clearly a growth area. I think Nokia has talked about CNS addressable market growing at 5% CAGR out to 2024. Can you talk a bit more about what the sort of growth drivers are, number one. And number two, from a Nokia perspective, what will allow you to kind of outgrow?

Yes. The market is growing in the space that we're in, and we're fortunate with that. And I think what is interesting is to break up that 5% of growth into 2 categories. One is the high-growth areas, and there is some growth areas which will actually decline, like 3G core will decline. People will move away from 3G into 4G and 5G. So certain of those portfolio elements will actually decline. So this is a summation of all that. So we break that 5% into high-growth areas, which are the 6 pillars that I defined of our strategy: core, digital operations and analytics, security, so on and so forth. And those areas are actually growing at 11%. And so we have validated that this -- the selected pillars that we have chosen of our strategy reflects the higher growth areas. And that's where we are driving much of our investments into. And in -- that part of the business represents almost 43% of our business, and that will keep growing. So number one, we have selected the right growth areas, which is validated by the market and the spend that's happening. And the second is that, so far, we are outperforming that, even that 11% on those 6 pillars of our strategy. So that kind of gives us that confidence that there are still the macro trends that are out there, but at least directionally, we feel that we've taken the right strategy in the right specific areas.

Makes total sense. So effectively, these high-growth areas that are growing within the mix and having more of an impact over time. I guess if we look at sort of this year, 1 thing is I think there was a revision of the growth expectation from 4% to 3%. How should we think about that? Can you put that in context? And then a lot of investors at this conference are trying to look forward to sort of 2023. So what kind of market do you see in the coming year?

Yes. The 4% to 3% was just a perimeter change, looking at where we were focused, what the growth rates there were, and that was the minor adjustment that we made. It was just more on the perimeter side. So there's nothing more to read into that in terms of that. Going forward, we believe that the critical thing in our industry is going to be is how do you monetize 5G going forward and how do you unleash the capabilities of the network in itself. And we believe that what is going to be really important, which I don't think, as an industry, we did very well in the 3G and 4G era, where a lot of the value moved into the CPaaS vendors and into the ecosystem. And this time around, where we believe is the real value and where we can really make an impactful difference is making sure that we take the 5G vectors, the new vectors that 5G will create. Remember, in the 4G world, the 3 key monetizable vectors were voice, video and text. If you get into the 5G world, those 3 vectors now get compounded to 16 vectors of capability that a 5G network will be able to deliver. And in order to deliver that capability, software will play a very important role over and above the infrastructure, to unleash that capability. And so unleashing those 16 vectors of capabilities into the enterprise world and into the consumer world, depending on the type of use case and requirements, which is where we see the value. So again, I'd keep emphasizing this, when you look at 5G, you look at it from an end-to-end basis and how the capabilities are going to be delivered to the ecosystem, which is programmable for the ecosystem. And so -- that's an area where we see CNS being very well placed to be able to take that capability and unleash it into the upper layers of the monetization area.

Super helpful. And I think you cited at the second quarter results, growing order intake in your enterprise activities. I wondered if you could talk a bit more about sort of what gives you confidence you can have an acceleration in the second half of the year? Obviously, a lot of macro uncertainties around there. So any color you can give? And what gives you confidence in that macro -- given that macro environment?

Yes. If you -- first of all, I want to make sure that there's clarity that when we say enterprise, enterprise cuts across all of our business groups. So it's just not CNS. The thing that we are focused within CNS, which is a business that I'm a part of, is really on the campus networks business. And that's a business is still nascent, but it's -- depending on the analyst you follow, it can range from 30% to 100% of growth and somewhere in between. So whatever is your favorite analyst, you can decide what the growth rate. But it's still a nascent market, which is still developing this campus networks. And we believe that the -- as I talked about, the digitization in these industries is less than 30%. So there's a huge appetite of digitalization that's occurring, which essentially gives us, depending on what the analysts are saying, to what we're experiencing in terms of growth rates, where we are clearly outpacing the market growth in campus networks and leading that market. We're, by far, the leader in that market in terms of our strategy, which I'll be happy to share with you. And that's giving us the confidence that on the enterprise side, when we look at campus networks, we believe that there is an abundance of opportunity over the next number of years that will emerge. But exactly and precisely what that number might be is still too early to call in terms of growth. But there's significant growth that at some point the market is still developing and being made, but there's enough growth in there for us to say that this is in the right area to invest, but also it's the right area where we're seeing the growth, and we keep validating both of those metrics.

And just to clarify when you're talking about campus networks, that's including not just your traditional enterprise, but also these asset-heavy industries.

Yes. So when you're talking about campus networks, you're talking about manufacturing, utilities, mines in the energy sector. You're talking about logistics, and that then starts to move into other campus areas like health care, education and so on and so forth. That's asset-heavy -- ports, airports. These are -- any critical facilities that require these kinds of networks, because unfortunately, Wi-Fi will not be able to meet all the critical demands of critical network requirements, and this is where we believe 5G and 5G-Advanced capabilities will be able to deliver many of the use cases that are necessary.

Super helpful. And I think you referenced in your introductory remarks, the 5G core and understanding is that's required to really sort of underpin 5G stand-alone. So maybe just for those who are a bit less familiar, could you just elaborate on why 5G standalone does require that new core architecture? And what are the kind of benefits we're talking about here as we move to standalone?

Well, as we evolve 5G, 5G is much more distributed and will play a lot more at the edge as it develops. And as such, the software that we had in the 4G core and the 3G core was very monolithic and was very centralized. As you go to a 5G core, you have to decentralize in terms of how traffic moves right at the edge. And it's not only everything that is centrally managed. So you have to refresh the software into cloud-native capabilities and make it available a lot more distributed at the edge. So fundamentally, that architecture has changed significantly. There are still remnants of the 4G architecture which will be very much valuable in the 5G architecture in terms of standard voice capabilities, and they will coexist for some time. But as you get into building the broader macro networks in 5G, one of the key capabilities the 5G network over time will bring is something called network slicing, which means that you can take this massive network and industry needs a slice of that network to do which is dedicated to them to perform certain functions. In order to deliver those slices and that capability, you will have to put the 5G standalone architecture in place in order to create slicing opportunities. So this is why the 5G SA will become more and more important to deploy. And architecturally, it's fully cloud-native, it's very highly automated. It's very distributed, and so that allows edge computing to also evolve with building different types of use cases at the edge. So the standalone architecture. Today, we've on our side, we've got over 71 deployments of standalone architecture going on around the world, of which already about over 10 are live. So it is clearly the right architecture moving forward to deliver the full value of 5G at the edge.

Very clear. And it sounds like you're quite confident in your competitive position within 5G core. I mean, we've obviously heard one of your European competitors talk about a lot of wins in that space. It sounds like you're confident on that position.

Yes, we're definitely -- we are very happy with the progress that we're making, but I would distinguish ourselves in terms of how we monitor progress. One is to make sure that we are deploying the software to create that standalone architecture. And that's a clear objective, to make sure that we deliver that software capability to create the capabilities that I just talked about. But even more importantly, what we are focused on is connecting that core architecture to the digital ecosystem. That means you have to build network exposure capabilities on the core platform to tie the network into the evolving ecosystem of applications. And so it's not out just about creating a 5G SA architecture. And where we are more confident about our strategy is that we're doing that, but more importantly, enabling the exposure of the network into the ecosystem, which is where monetization will occur. And if you don't do that and just build software to do 5G SA, I think we would miss the bus. So that is why from a competitive standpoint, we believe that, that is even more important thing to do because that's how you'll be able to actually monetize 5G and become part of the evolving ecosystem where value is moving to. So how do you become part of that application service chain and participate in the application and not be relegated into just a connectivity play.

Makes total sense. And I think another part of your strategy and you've articulated in the past, is a shift from more sort of mature legacy business lines towards some of these emerging areas, higher-growth areas. Could you give us a bit of an update on how the progress is going there?

Yes. As I said earlier, we selected those growth areas, those 6 pillars of the strategy. That part of that business, from a market perspective, is growing at 11%. We're outpacing that currently in those specific areas. And so for the first half of this year, we beat that 11% in terms of growth in those 6 areas. But the other area that we are starting to evolve, underpinning that, is really to start delivering some of these capabilities in these 6 pillars as SaaS, which is where we are starting to also see success. And actually, at the end of last year we launched 7 use cases of SaaS use cases, and we already have multiple customers starting to absorb the SaaS capabilities of not only -- that's a delivery method, but it's more innovative to deliver software as SaaS, because you have more agility and better TCO going forward also for your customers. So I think so far we are pleased, but as always, a lot of work to do.

Makes total sense. And can you talk a little bit more about the sort of cost benefits that SaaS can bring to the customers? And then secondly, in terms of the shift from on-prem, on-premise, to SaaS, does that have an impact in the short term on top line for Nokia?

Yes. So first of all, the world of SaaS started out in the IT industry. And if you look over the last 10 years, that bus left the station. So SaaS has been very successful in the IT industry and for non-mission-critical applications. You see a lot of success. And that is now more and more becoming a de facto way of delivery. Why? Because it creates 2 or 3 very key benefits. It obviously has a better TCO. You don't need to have an old operating environment inside your organization to operate the software. It's very expensive to do that. You have to have operations teams. In SaaS, you just consume it. The second is that getting new innovations in typically, if you had software installed in your premises and you needed the next release of that software, you had to actually do an entire upgrade cycle, which could be 3, 6, 9, 12, 18 months. So it was too slow to do that and very expensive to do. And SaaS, you don't do that, you just get new capabilities. It's like your hand phone, your applications are automatically getting updated without you having to install them. So you're being, the most important benefit beyond the cost benefit is actually giving you agility of bringing new capabilities in at a much faster pace. So we see that as a benefit. In terms of our -- usually all SaaS companies, when they go through this process, transition from an on-premise business to SaaS. Obviously, the top line has an impact because you're converting upfront licenses into annual recurring charges or revenue, which has a better multiple, by the way, than on-premise. It's more predictable, it's more sustaining. But what we have done is actually we brought new use cases for the SaaS. So it's really not impacting what we have currently, but there are new capabilities that we are bringing on. So right now, we don't see a top line impact. But as that starts to scale and there is more adoption of SaaS in our industry, we will see some into the future, which is very natural as you go more and more SaaS.