Nokia’s cunning plan to out-grow the market just doesn’t add up

Finnish kit vendor Nokia is holding its Capital Markets Day today, in which it tells investors how it plans to turn things around.

As indicated in the announcement of yet another round of job cuts earlier this week, Nokia’s cunning plan is to reduce overheads to free up money for increased R&D spend. This, in turn, will make the company more competitive, especially in 5G, resulting in increased revenues and everyone living happily ever after.

This plan is being fleshed out today and Nokia published the outline ahead of the main investor/analyst call. “Nokia is repositioning itself to deliver sustainable, profitable growth, adapting our business to lead in an increasingly digitalized world,” said Nokia CEO Pekka Lundmark. “We have a clear and detailed plan for how we will reset the business, accelerate competitiveness and scale up our lead in the markets we choose to play in. This plan will enable us to deliver double-digit comparable operating margins in 2023.

“We have moved away from end-to-end as a cornerstone of our equity story and have instead put in place four fully accountable, empowered business groups, arranged according to how customers buy. Each of these business groups has solid strategies and targets to grow market share and margins through enhanced technology leadership.”

Since the whole point of the Alcatel-Lucent acquisition, which did so much to blow Nokia off course, was to offer ‘end-to-end’ connectivity, that would appear to be a formal admission that the move hasn’t paid off. Lundmark seems to be betting the farm on 5G technology leadership, which is where the need to significantly increase R&D spend comes in, but it’s hard to see how his sums add up.

Nokia expects to save around €600 million per year from its latest cost-cutting drive but, as Light Reading details, it has cut its R&D spend my more than that amount over the past couple of years. So even if it allocated all of that saving to R&D immediately, it would still only be getting back to 2018 levels. On top of that, Nokia expects to increase its profitability by out-growing the market in the mid-term on the back of all this extra R&D.

¹  Assuming continuation of 2020 year-end EUR/USD rate of 1.23.

² Comparable measures exclude intangible asset amortization and other fair value adjustments, goodwill impairments, restructuring related charges and certain other items affecting comparability.

³ Free cash flow = net cash from/(used in) operating activities – capital expenditures + proceeds from sale of property, plant and equipment and intangible assets – purchase of non-current financial investments + proceeds from sale of non-current financial investments.

⁴ Comparable ROIC = (Comparable operating profit after tax) / (Average total equity + average interest-bearing liabilities – average total cash and current financial investments).

 *Although we are now providing our outlook assumption for Nokia Technologies in terms of comparable operating margin, we continue to maintain our expectation for Nokia Technologies to deliver a slight improvement in comparable operating profit in full year 2021, relative to full year 2020, and stable performance over the longer term.

Mobile networks account for around half of Nokia’s total revenues, so this is clearly where the turnaround needs to be based. As you can see from the tables above, Nokia is planning to increase the operating margin for that group by six percentage points in two years, all on the back of all this lovely new R&D, but it’s hard to see how those sums add up.

For Nokia to ‘grow faster than the market’ it would presumably have to out-invest its competitors. That’s surely going to require a lot more than an extra €600 million a year and yet it’s hoping to maintain its current levels of profitability this year, before significantly increasing them after that. Where is the money going to come from?

The icing on the cake was provided by the announcement that Nokia wants to restore its dividend, thus returning money to investors it could otherwise be spending on R&D. Maybe we’re missing something, but the sums just don’t seem to add up. Far from restoring the dividend, if Nokia is serious about technological leadership it should sacrifice this year’s margins on the altar of investment. Otherwise it’s hard to see how those 2023 targets are realistic.