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Nokia's Network Profits Drop, Raise Concerns Over Alcatel Deal

First-quarter revenue was ahead of expectations, but operating profit dropped 61 percent.

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Finland’s Nokia reported quarterly profits well below market forecasts at its telecom network equipment business, sending its stock tumbling 10 percent and raising concerns over its planned takeover of smaller rival Alcatel-Lucent.

First-quarter revenue was ahead of expectations, but operating profit dropped 61 percent, which Nokia blamed largely on the need to cut prices to secure major mobile contracts in China and on weaker software sales.

With Nokia shares now trading about 20 percent lower than before the Alcatel deal was announced, significant divergence in the performance of both companies could call into question the terms of the all-share offer valuing Alcatel-Lucent at 15.6 billion euros ($17.5 billion), analysts said.

Alexander Peterc, an analyst from Exane BNP Paribas, said it would arguably be better for the deal’s prospects if Alcatel also posted a weak first quarter. “Otherwise disgruntled shareholders, deploring what they describe as low exchange parities in Nokia’s all-share bid for Alcatel, might start campaigning for an upward revision of Nokia’s bid.”

Similar pressures recently imperiled the cement industry’s mega-merger between Holcim and Lafarge before new terms were reached, and could affect Shell’s planned buy of BG.

Shares in Alcatel-Lucent, which reports quarterly earnings on May 7, dropped more than 7 percent by 1328 GMT (0928 EDT).

The ranks of investors betting against Alcatel-Lucent appear to be growing: According to Markit data, 44 percent of the shares that can be borrowed are out on loan, indicating high levels of interest from short sellers who believe shares will fall. That compares to 38 percent before the Nokia deal was announced.

It remains to be seen whether Nokia’s weaker profitability is a blip or a new reality, a year after the company doubled down on network equipment as it sold its flagship handset business to Microsoft .

Nokia on Thursday tweaked its operating margin profit goal for the year, pointedly aiming for the middle of an earlier range of 8 percent to 11 percent and further spooking investors who had hoped for the top of the range.

Chief Executive Rajeev Suri defended the terms of the Alcatel-Lucent deal, although he declined to say whether they could be revisited. “We’ve met many investors in the last couple weeks, and there’s very strong, good feedback,” he said, adding that both boards had already approved the terms.

Odey Asset Management, Alcatel’s second-largest shareholder with a 5 percent stake, became the first big holder to come out against the deal on Thursday. In a letter to investors, the fund, which had been buying shares in the three months before the deal to reach 146 million in mid-April, argued that Nokia had not given Alcatel a high enough premium to justify a takeover and called the terms “unacceptable”.

Suri said that some of the negative factors contributing to Nokia’s weak quarter would ease in the second half. “The capex conditions are challenging at this point, and there is a little bit more competitive activity overall,” Suri said, referring to capital spending by telecom operators to upgrade networks globally.

The network unit, where Nokia competes with Swedish market leader Ericsson and Chinese low-cost powerhouse Huawei [HWT.UL], saw its core operating profit fall to 85 million euros ($94 million), or 3.2 percent of sales, compared with analysts’ average forecast of 226 million euros.

“The networks business has performed well in the past two years, so this drop in profits is a real surprise and a disappointment,” said Mikael Rautanen of Inderes Equity Research. “Estimates will be cut hard, and this raises concern whether this was a turning point for the worse for the unit.”

The Alcatel takeover aims to boost scale to better compete with Ericsson and Huawei, as well as wringing out cost savings of 900 million euros by 2019 amid weak growth prospects for the industry.

In addition to the network equipment business, Nokia also owns a mapping business called HERE, which it has put up for sale, and a smartphone patent portfolio.

HERE, which analysts value at 5 billion to 7 billion euros, has attracted interest from several bidders including tech companies Facebook and Uber, as well as private equity firms. Suri declined to comment on how the sale process was going, saying only that Nokia was not a forced seller and noted that the profit outlook had improved for the business.

(Written by Jussi Rosendahl and Leila Abboud; additional reporting by Anna Ercanbrack and Nishant Kumar; editing by Eric Auchard and Vincent Baby)

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