Nokia warns of possible China pullback as support for local vendors grows
Finland's Nokia has been forced to assess its strategy in the Chinese market amid signs of growing support for local vendors such as Huawei and ZTE, according to its chief financial officer.
The warning from Kristian Pullola came as the company reported a strong set of results for the second quarter of its fiscal year, with sales rising 7%, to about €5.7 billion ($6.4 billion), compared with the year-earlier period, and operating profits up 35%, to €451 million ($502 million). After a difficult start to the year, the figures sent Nokia's share price up 6.5% when markets opened in Helsinki this morning.
The Finnish equipment maker, whose main international rivals are Huawei and Sweden's Ericsson, was boosted by the sale of 5G technology: Nokia now boasts 45 commercial deals and nine "live" deployments of the new-generation mobile technology. The update should help to check any lingering concern that Nokia was losing out to its competitors after it flagged 5G software issues at the start of the year.
But in his statement on the results, CEO Rajeev Suri alluded to various second-half risks, including "execution demands" and "trade-related uncertainty and challenges in the China market."
Asked by Light Reading for more details, Pullola said: "As we go through the transition from 4G to 5G, there is more support for local vendors in China -- that is something we need to recognize and take into account when we make assessments and look at where to invest and when to back away from some of the competitive situations that hinder us to deliver profitable and longer-term growth."
The remarks indicate that Huawei and ZTE may increasingly squeeze Nokia out of Chinese contracts for next-generation 5G equipment as a trade-related clash between the US and China continues to rock the sector.
Authorities in the US are fighting to exclude Huawei from Western 5G markets, arguing its links to the Chinese government make it a potential security threat. US officials have also accused Huawei of intellectual property theft and selling technologies to Iran, in breach of US sanctions. The Chinese company already faces restrictions in Australia, Japan, New Zealand and the US, while other countries -- including Canada and the UK -- are considering whether to ban it.
Market commentators have long feared that China could retaliate by forcing its state-backed operators to rely more heavily on Huawei and ZTE. Any shift toward local vendors would also help to prop them up financially if restrictions lead to sales declines in other parts of the world.
Pullola declined to comment on the exact reasons for the shift toward local vendors. "China is going to be one of the markets where large-scale deployments -- particularly for the industrial use cases 5G will enable -- will start," he said when quizzed about the opportunity that remains in China. "Having said that, from a revenue and sales point of view it doesn't always equate to a large profit pool and, in that sense, a large opportunity to do good business, and that is what we need to take into account now when assessing how strongly to participate in China."
Chinese operators are starting their deployment of commercial 5G networks and have long awarded the bulk of network contracts to Huawei and ZTE, leaving a smaller share for Ericsson and Nokia.
Nevertheless, China still accounts for a substantial chunk of Nokia's revenues. In the second quarter, sales in Greater China slipped 2%, to €515 million ($573 million), compared with the year-earlier period, and accounted for 9% of Nokia's overall revenues.
Last year, some 17,200 of Nokia's 103,000 employees were based in Greater China. Most business is done through a joint venture called Nokia Shanghai Bell, whose other shareholder is a state-backed firm called China Huaxin.
That Chinese involvement might leave Nokia in a stronger position than rival Ericsson, which at the time of publication had not responded to a question about similar China risks. The Swedish company made 12% of its revenues in North East Asia in the second quarter.
Commenting on the overall performance, Pullola attributed the year-on-year improvement in Nokia's operating margin -- up from 6.3% to 7.9% -- to sales growth in 5G as well as other product areas, including IP routing and optical equipment. "Being able to sell a leading portfolio helps improve the business mix and, in that sense, it helps to improve margins," he said. The company also saw a boost from its licensing and fledging software businesses.
Despite flagging risks, Nokia revised its guidance to slight growth this year, from a "flattish" performance previously, and said it expects growth to continue in 2020. Due to seasonal factors, it is guiding for a "soft" third quarter and a "particularly strong" final one.
Table 1: Nokia Headline Figures (€M, Except Earnings Per Share in €)
|Q2 2019||Q2 2018||YoY change||Constant currency YoY change|
|Operating margin||-1.0%||-4.2%||3.2 percentage points||N/A|
|Earnings per share||-0.03||-0.05||N/A||N/A|
It has also been able to start booking some of the €200 million ($223 million) in 5G revenues it was unable to recognize earlier this year because of software difficulties. Asked if this meant those problems have now been addressed, Pullola said: "We have made our 5G software generally available to customer teams to deploy and sell and we expect to see more in the second half when it comes to progress."
The comments follow reports in late June that Nokia was set to release a new software platform and take advantage of 5G standards progress to address various interoperability issues.
Besides China, the other big concern for Nokia is that "competitive intensity" may grow as certain rivals seek to grab market share. Ericsson has already indicated its margins could suffer later this year as it tries to build market share for business it deems strategically important.
"Some competitors are positioning themselves aggressively and we need to be alert to decide if we want to match that or not," said Pullola. "If it happens it could have a short-term impact on margins, of course, but longer term there is a benefit from the position of being able to maintain market share."
Nokia also acknowledged that security concerns about certain vendors had created some immediate pressure to make investments. "The point is that there may be cases where a components swap is involved and so the deal is a bit more challenging in the short term," said Suri on a call with reporters. "We only take deals that make good commercial sense in the long term."
Pullola said it was "too early" to talk about deals where Nokia has replaced an existing 4G vendor as an operator starts its 5G rollout. "The majority of deals are converting existing customers to 5G and maybe expanding some share," he told Light Reading.
When deploying the "non-standalone" version of 5G technology -- which relies on a 4G core network -- service providers say it is difficult to use different 4G and 5G vendors in their radio access networks because of the need to maintain interoperability between those systems. The first deployments in Europe are based on this non-standalone variant.
But a move to standalone in future will "break the link between 4G and 5G," said Pullola. Does that mean competitive pressure will become even more intense? "The 4G networks of operators will be used in parallel with standalone 5G over the long term and because of that we still believe that strengthening 4G will bring benefits when it comes to working with the same operators in standalone 5G," he said.
One black spot in the latest results was a huge year-on-year decline in net cash, which tumbled 77%, to €502 million ($559 million). Nokia blamed the drop on restructuring costs, dividend payments and other "temporary headwinds" it said would reverse mainly in the third quarter. "There was [also] some inventory build-up as we prepare for 5G deliveries," Pullola told reporters. "We cannot be pleased … and there is a strong drive toward improving overall performance and releasing network capital in the second half."
Restructuring costs relate partly to Nokia's latest cost-saving plan under which it aims to cut annual expenses by €700 million ($779 million) next year, compared with the full-year figure in 2018. The company said it was on track to meet that target.
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— Iain Morris, International Editor, Light Reading