Nokia Oyj (NOKIA) Earnings Call Transcript

Good morning, ladies and gentlemen, and thank you for joining us to this call at short notice to discuss the agreement signed last night for Nokia to acquire Infinera. I'm David Mulholland, Head of Nokia Investor Relations. And on today's call, I'm joined by 4 speakers: Pekka Lundmark, Nokia's President and CEO; Marco Wiren, Nokia's CFO; Federico Guillen, who is President of Nokia's Mobile Networks business and also -- Network Infrastructure business; and also joining us is David Heard, CEO of Infinera. Before we get started, a quick disclaimer. During this call, we will be making forward-looking statements regarding our future business and financial performance, and these statements are predictions that involve risks and uncertainties. Actual results may, therefore, differ materially from the results we currently expect. Factors that could cause such differences can be both external as well as internal operating factors. We have identified such risks in the Risk Factors section of our annual report on Form 20-F, which is available on our Investor Relations website. The same statements also apply for Infinera, and you can also review the Risk Factors section of Infinera's annual report on Form 10-K, which is available on Infinera's Investor Relations website. Within today's call, where we make references to growth rates, it will mostly be on a constant currency basis and where we refer to margins, it will mostly refer to Nokia's comparable reporting. The presentation accompanying today's call has been published on Nokia's Investor Relations website. Please note that Nokia has not yet closed its Q2 financial period and is currently in its quiet -- silent period in relation to results that will be announced on Thursday, the 18th of July. We would therefore like to note that during today's call, we will only be discussing the transaction and not current trading or Q2 results. Please keep that in mind when we get to the Q&A session. In terms of the agenda for today, Pekka will kick off with a high-level overview of the acquisition. Then David will introduce Infinera and give his perspective before Federico will open with the strategic rationale and Marco the financial impact. Finally, Pekka will conclude with some remarks before we move to the Q&A. With that, let me hand over to Pekka.

Thanks, David, and hello, everyone. Thank you for joining the call today. So last night, we announced a definitive agreement for Nokia to acquire Infinera in a deal we believe has strong strategic and financial rationale. There are 3 key drivers behind the deal: first, we see a strong strategic and synergistic rationale for the transaction. We have long said that one of the key drivers we needed to improve the profitability of our optical business was scale. We have been doing well, improving that organically recently, but we believe this transaction can help us to accelerate the journey to a double-digit operating margin in optical. Importantly, it will also help us to accelerate our product road map and enable us to deliver better products for customers. We see a strong strategic fit with highly complementary customer, geographic and technology profiles between the two companies. The timing is also optimal to build on the strong momentum both businesses have had in recent years, which Federico and David will go through shortly, and this will improve our long-term growth opportunities. From a synergy perspective, we target net run rate synergies of EUR 200 million by 2027 at the operating profit level. Secondly, we believe this transaction will strongly enhance our network infrastructure business especially when combined with the announcement we made yesterday regarding the divestment of our Submarine Networks business. Going forward, there will be 3 strong and synergistic pillars to our Network Infrastructure business in Fixed Networks, IP Networks and Optical Networks. The transaction will also increase our enterprise exposure in NI, particularly when considering Infinera's recent web-scale design wins in systems and pluggables. The combined business will have over 600 million of annual web sale -- web scale sales in Optical. And finally, in terms of the financials, the price we are paying is $6.65 per share and at least 70% will be paid in cash with the balance in Nokia stock. Nokia's Board has also, however, committed to increase Nokia's share buyback program to mitigate dilution from the transaction to Nokia shareholders. The purchase price equates to an enterprise value of USD 2.3 billion and pro forma for the EUR 200 million of target synergies implies we are paying a multiple of 7.5 enterprise value over EBIT. We expect the transaction to be accretive to Nokia comparable operating profit and EPS in year 1 and to deliver over 10% comparable EPS accretion in 2027, assuming the transaction closes by the first half of '25. We also expect the acquisition to deliver a return on invested capital comfortably above Nokia's cost of capital. With that, let me welcome David Heard, the CEO of Infinera to the call. And thank you, David, for joining us. I'm very much looking forward to what our two companies can achieve together.

Thanks, Pekka. Good morning, everyone. Today is an exciting day for Infinera employees, customers, partners and shareholders as we announced plans to join forces with Nokia. For those of you who aren't familiar with Infinera, let me give you a quick snapshot of our company. Over the last 5 years, we've been on a transformational journey to bring Moore's Law to optical networking through our open and agile solutions. During this period, the Infinera team has achieved a solid track record of accomplishments. We've built an impressive team of innovators, including a world-class coherent optical R&D team, introduced advanced products and services, including our leading compact modular GX platform; streamlined our optical systems portfolio; won contracts with major telecommunication service providers around the world; meaningfully expanded our market share with web scalers; and launched a new line of pluggables and intra-data center solutions. At the same time, we've delivered above top line market growth and expanded our operating margins by more than 1,000 basis points. Looking ahead, we could not be more excited about our combination with Nokia. For many years, I've said that scale and vertical integration are critical to success in this business. In partnership with Nokia, we can now make this a reality. Together, we expect to set the pace of innovation, creating a compelling product road map powered by the highest-performing optical technologies that we believe will deliver the lowest cost and power per bit with the most agility for our customers. With greater scale and deeper resources, we expect to be able to address the rapid [indiscernible] market and better service our customers from web scalers to CSPs to AI companies inside the data center. We will have global reach and an unparalleled focus on bringing optical solutions to market that help customers manage this unprecedented growth in digital traffic. We're especially excited to join forces with Nokia, a company that is aligned with our mission, and quite frankly, our culture. We share a passion for technology innovation, quality, customer satisfaction and driving shareholder value. Finally, we're very pleased that this transaction will provide all of our stakeholders with an opportunity to participate in the upside of a global leader in Optical Networking solutions. With that, I'll turn it back over to Federico. Federico?

Thank you very much, David, and hello, everyone. I am Federico Guillen, President of Nokia Network Infrastructure business. And I want to spend some time digging a bit deeper into what Pekka has explained around the recent progress we have made within our Optical Networks business and why this transaction makes sense. After we created Network Infrastructure in the beginning of 2021, we made the decision to increase our organic investment into Optical Networks in order to get it to a place of technological usage. The team has done a tremendous job since then, significantly improving the competitiveness of our portfolio and the financials. We have made a number of technological advancements over the past few years. For example, the launch of the PSE-V-based product a few years ago was a very important step in improving our product competitiveness, and in essence, put us back on the map. We then follow that up quickly with the PSE-6s, which we launched at the start of 2023. PSE-6s is a product, which was already in the hands of our customers in late '23. It has been receiving great feedback, we have already received orders from 15 customers. The product is the best performing available on the market today, offering 2.4 terabytes per second in a single line car and can deliver 800 gigabit per second at distances of over 2,000 kilometers. We also offer our customers the complete suite of products for complete line system to transponders and pluggables and all wrap up in our end-to-end optical network automation solutions, which simplify operations and TCO by leveraging AI and machine learning capabilities. This has also driven a significant improvement in the financial performance. The business has grown at a 4% CAGR in constant currency, gained market share and improved its operating margin by 10 percentage points going from loss-making in 2020 to a high single-digit operating margin business last year. So we have 2 businesses, Nokia and Infinera, that have good momentum. And that is obviously an important part of why we believe now is the optimal time to merge. This decision is also shaped by the market environment. You are well aware that the optical market has been soft since late '23 and remains so in 2024. We do believe, however, that we will start to see a return to growth from 2025 onwards. And as you can see, Omdia is forecasting a healthy 5% CAGR growth rate for the market through the rest of the decade. The fundamental need to invest in optical transport remains strong and is driven by the demands that AI and cloud will place on the network in the coming years. An important part of the acquisition is also how it will increase our penetration into webscale. The combination will increase Nokia's overall enterprise sales to approximately EUR 2.8 billion on a pro forma basis for 2023 and the combined Optical business will have over EUR 600 million of sales from webscale. Infinera's recent wins in this space will also be an important driver of this into the future and will ensure that the combined business is well exposed to the growing segments of the market. We also see some exciting new opportunities in how the optical portfolio could enter into new opportunities such as intra-data center for service to server connections to support the increase in demand of new AI workloads. Another reason why this acquisition makes sense is the fact that the two businesses have highly complementary geographical footprints. Nokia's strength in optical has historically been in the Europe, Middle East and Africa, Latin America and Asia Pacific regions, as you can see on this slide, accounting for over 70% of its sales. The U.S., while an important market, was less than 20% of sales last year. Infinera, on the other hand, has a strong position in the U.S. market with this region making 60% of its sales. Combined, this significantly expands our presence in the optical market across regions and globally. Taking a step back and looking at the competitive landscape. As you can see on the slide, Optical remains one of the few network equipment market that is still highly fragmented with a long tail of small players. This creates a challenging environment, especially when it comes to being profitable. This is why scale is so important as Dave was referring before. And through the combination of Nokia's and Infinera's Optical business, we believe we will have the scale necessary to be a strong competitor. If you then take our improved scale and put that against the optical market forecast, Nokia is well positioned to participate in this growing market. Finally, from my side, I'm really excited about what the combination will enable us to do for our customers. The first thing I want to say, and this is in the DNA of Nokia, is that we progress through this acquisition and the integration processes. We will look after customers and ensure that they see as little disruption as possible. We have done it before in optical when we brought Alcatel-Lucent together and we are committed to doing it again with this transaction. The combined business will, I believe, have a very special mix of capabilities to deliver the best possible outcomes for our customers. We will have an expanded DSP team that will really help us to accelerate our product road map. Separately, we have been able to improve our competitive position in recent years. But together, this means that we need to make fewer trade-offs when allocating resources across different product development efforts and deliver broader and more complete road map for customers. This will be supported by our fundamental research within Nokia Bell Labs ensuring that we have access to real cutting-edge innovations in the optical domain. The combined team will also have a more complete technology capability across different material science using optical, greater vertical integration and increase our capabilities in pluggables and the offerings towards intra DC applications. Finally, on the integration capabilities, it will enhance our manufacturing capabilities with Infinera's U.S.-based fabrication and packaging expertise. Bringing all of these elements together, we will be able to deliver faster innovation, accelerate our product road map and deliver customers a broader and more complete product offering. With that, let me hand over to Marco to touch on some of the more financial aspects.

Thank you, Federico, and good morning from my side as well. To reiterate from an operational standpoint, this deal both improves our diversification into webscale and increases our presence in the North American market, both are important for long-term growth potential. Looking at the financial aspect, the combination will increase our revenue scale by 75% to EUR 3.4 billion on a pro forma basis in Optical. And if we consider the synergy opportunity as well, this gives us the opportunity to significantly improve the operating margin profile of our Optical business. In 2023, Nokia's Optical Networks business delivered a high single-digit operating margins benefiting from some of the supply chain catch-up, volume while Infinera on a post share-based compensation basis was low single digit. And if you compare these and the pro forma for the synergies we target, the combined business should be solidly double-digit margin business. And I will now explain further the synergies and the opportunities we see. We target EUR 200 million of net operating profit synergies by 2027 based on the deal closing in the first half of '25, and we would expect some synergies to already start next year and continue to ramp up to the EUR 200 million by 2027. To be clear, this is net of any dissynergies we might experience from the merger, but given the highly complementary nature of the two businesses, we expect those to be minimal. Then in terms of where these synergies are expected to be generated from, about 1/3 will come from cost of sales where operational efficiencies can be found in areas like vendor contract negotiations, services and through more verticalized portfolio. The other 2/3 of synergies were expected to come from operating expenses through reductions in support functions costs and other stand-alone entity costs of Infinera. Also, the new optimized portfolio road map will generate savings, even with our target to accelerate the product road map. Then looking at the impact to Nokia Group. We anticipate that this transaction will be accretive to both Nokia's comparable operating profit and EPS in the first year and expect it to deliver more than 10% accretion to our comparable EPS by 2027. This is expected to come through the combination of the growth opportunities we see and the synergies that I just discussed. It will deliver a return on invested capital that is comfortably above Nokia's weighted average cost of capital, making this highly attractive and creating significant value for the [ orders ]. And we expect that this transaction, we would remain within our net cash target range of 10% to 15% of net sales. And this is including the upfront cash out, Infinera debt repayments and the share buyback. With that, let me hand it back over to Pekka and to provide some final thoughts.

Thanks a lot, Marco. As many of you are aware, last year, we launched a new strategy based on 6 pillars that you can see here on this slide. I strongly believe that the acquisition of Infinera aligns strongly to a number of the boxes and with the direction we are looking to take Nokia in the future. In the first pillar, we are significantly increasing our scale in Optical and with the broader CSP market. This deal increases our enterprise and webscale presence and with Infinera's recent design wins with these customers ensure that we have a continued path towards growth and further expansion here. As we continue to actively manage our portfolio, we are significantly increasing our technology offering, as Federico described, and this will enable us to offer better solutions to our customers. This is supportive of our initiative to build new business models, particularly as we strengthen our presence in the pluggable space. And finally, partly on the new business model, but also on our ESG commitments, we see new opportunities within the data center where new low-power, high-performance intra-data center chips can improve the power efficiency of server-to-server communications, which is expected to be a high growth area driven by webscale. With the combination of our existing Optical business and Infinera, our Network Infrastructure business will be significantly strengthened. Also, following the agreement, we announced yesterday to divest Submarine Networks, which has previously been part of our NI business group. The business group will now be built on 3 market-leading pillars. Fixed Networks continues to be well positioned to benefit from strong demand in the fiber market. This is evident in markets where fiber is not yet deployed around the world and in more mature markets where customers are starting to upgrade to XGS-PON or 25G PON. Elsewhere, government-funded projects are expected to start towards the end of this year, and Nokia was the first vendor to announce the availability of Buy America compliant products. Given these dynamics and opportunities, we target mid-single-digit growth for Fixed Networks. Our IP Networks business continues to see the ramp of FP5 and FPcx routing products and the expansion into new markets like data center switching. It has been showing continued momentum in expanding its presence beyond CSPs into the enterprise and webscale markets, and we expect this to continue. In this business, we are also targeting mid-single-digit growth. We have spent most of this call explaining our new strengthened position in optical, which we believe has at least a mid-single-digit growth opportunity and now a compelling path to a mid-teens operating margin. These businesses combined will give us a unique position in Network Infrastructure. On a pro forma basis for the two transactions, Network Infrastructure will be an EUR 8.4 billion revenue business that targets mid-single-digit net sales growth and with margins that would pro forma be around 12%, but we believe can expand over time to mid- to high-teens. And then to wrap up before Q&A. We are very excited about the opportunities that the increased scale of this transaction will bring. Nokia will benefit from strong positions in both North America and with webscale customers. Our customers will benefit from a broadened product portfolio with greater innovation and faster time to market. The deal creates value for both Nokia and Infinera shareholders. With that, let me turn it back over to David to start the Q&A session.

Thank you to all four of the presenters we've had today. For the Q&A session, we also have James Watt, the Head of our Optical Networks business on the line, just in case any specific questions come up. [Operator Instructions] George, could you please give the instructions?

[Operator Instructions] I will now hand the call back to Mr. David Mulholland.

Thanks, George. We'll take our first question this morning from Jakob Bluestone from BNP Paribas Exane.

Congratulations on the deal, guys. I was wondering if you can go a little bit deeper into the synergies, given they clearly account for the vast majority of the earnings accretion that you're guiding from. Can you just explain in a little bit more detail where exactly particularly the OpEx synergies are coming from? And if you can maybe also expand a little bit on how much is in-sourced versus outsourced in terms of the manufacturing?

Federico, do you want to start?

Yes, sure. Basically, if you look at the level of synergies that we are targeting, we do not believe that these are too aggressive in the context of our combined business, which will have a cost of sales of about EUR 2 billion, and the operating expenses of about EUR 1 billion. Our ambition with this transaction is to be able to deliver faster innovation to our customers and accelerate product road maps. And of course, on top of that, we separately have the experience of having made this type of integration and deliver the synergies. Before in our side, my team and I were part of the Alcatel-Lucent integration in Optical and Fixed business in the past. And David might comment also on the experience that they have in Infinera with the Coriant acquisition. And in both cases, we delivered successfully in the program time.

David, did you want to comment?

No, I think as Federico said, I think my experience in doing this, especially with open networks, is those synergies are quite reasonable.

Thank you. Did you have a follow-up, Jakob?

Yes. Just if you could maybe comment on -- I mean, obviously, we're a little new to Infinera on the European side. So how much of your manufacturing is insourced versus outsourced?

Yes. No, it's a good question. I would tell you that in our world, it's very much like a PC where optical processors or optical engines, optical semiconductors are the large -- a very large portion of the bill of materials that were typically bought merchant in the network. We make our own in our U.S.-based fabs. And that is a very large portion of our bill of material. So we do all that ourselves. That's the high-value stuff that drives high margins. The lower value stuff in terms of assembly and test is all done with contract manufacturers. So that's what allows us to drive margins and the additional volume coming with this partnership will drive margin expansion by leveraging that vertical integration.

Thanks, Jakob. We'll take our next question from Andrew Gardiner from Citi.

I was interested in the customer reaction you may have had to this. I presume you've done some -- had some conversations with the customer base ahead of announcing this. And that's, in particular, for the Infinera team, David, you announced a number of new contract wins on your last earnings call. I think at the time, there was some concern amongst the market that, yes, you run these deals, great, in terms of sort of a statement about your technology position, but would there be incremental R&D required in order to support those deals? I'm just sort of interested in how now being part of Nokia might help that. And I suppose, in particular, yes, the reaction from your customers, have they been encouraging you guys to do such a deal to gain scale and support your technology? Anything additional on that side would be helpful.

I will leave the floor to David afterwards, but the first reaction of the customers that we contacted yesterday after the announcement in both sides of the world, I would say, were very positive, from positive to very positive. And we're excited about that because the first reaction on both Nokia and Infinera, and they refer to both, were positive that together we want to create a great platform for innovation in the future. So David, you can share what you got.

No. Thanks, Federico. Yes. Now for the last 5 years, look, what our customers really, really care about is driving lowest cost per bit, lowest power per bit, which is becoming super important right now. And so driving the scale has always been something they pushed us towards as well as obviously the financial strength and reach that we were not able to get on our own was something that they wanted to see us accentuate. And that was prior to the transaction. Those would just be discussions going on. Although it's early, I would tell you the initial reactions from our client base, both across webscale and CSPs has been extremely positive along that same theme.

We'll take our next question from Sandeep Deshpande from JPMorgan.

Congratulations on the deal. I want to go back to the synergies question. I mean has Nokia identified the products where there is overlap? And which products are going to be developed going forward? Or are there lots of products where there is very low overlap that they can be independently developed and that because we see -- we've seen in the past in these mergers, whether it was in wireless, in particular, but also in the Alcatel-Lucent merger, the product that goes forward causes issues with customers, given that some customers do like a particular product. And then when a different product is chosen to go forward, there tend to be share losses. So is there going to be a lot of that revenue dissynergies associated with that? And has that been identified?

So let me start from the beginning. It is early. It is early to comment on which product offering will prevail. But the good news is that the technology has evolved from the time of Alcatel-Lucent or Infinera and Coriant. Now we have a lot of customers where we deliver open-line systems with wavelengths already. And those type of decisions, of course, will be made early in the process after closure. We cannot still today tell you what are we going to specifically deliver in the future. The good news is that we can work together to deliver the commitments that we have today to our customers, and they work on a common platform for the future generations of products. And this is the way things are done in optical. Openness is of course, helping us on this market.

We'll take our next question from Sami Sarkamies from Danske Bank.

Yes. I mean I would actually like to continue on the previous topic. So maybe if you can discuss a bit the integration plan from process and that time line perspective, why do you think it will be relatively straightforward to combine forces from product offering and R&D road map perspectives? I think we are all mindful of the previous challenges with Alcatel-Lucent acquisition where there was overlap in terms of products.

Well, yes, but the Alcatel-Lucent acquisition, of course, there were overlaps on products on the mobile side. In this case, we are talking about optical. And we feel very confident that -- because of what I just said, we feel very confident that the converging the road maps in this particular technology stage is going to be much easier than in the mobile world. On top of that, as you know, in optical and in other technologies within NI, we don't do swaps, for example, which is also very important. We cap and grow on our technology. So the key thing is, and David and I agree and James on this is make decisions as fast as possible given the integration process. We have a very detailed plan on when do we have to make each decision during the first 100 days. And then execute, execute is something that we know how to do and decisions is something that we will do fast in the process, once, of course, the deal is approved.