Financial Analysis of Nokia and Alcatel

The telecommunication industry has seen so many changes especially in the 21st century. Due to the advancements in technology, so many electronic companies have come to board with varying products, making the mobile industry a very competitive area. That is to say, a company like Nokia was one among the few that dominated the telecommunication industry until a couple of years ago. With the incoming of the stiff competition, the sales in the leading mobile organizations like Nokia have depreciated drastically, leading to their managements to seek alternatives in their market plans. For instance in Nokia, since the year 2012 to 2014, although they attained the margin forecast, the registered income were not the required equals (Exhibit 3). In the same vein, the Alcatel-Lucent showed a similar downfall in the annual incomes as Nokia. Nonetheless, although Nokia is extremely bigger than the Alcatel-Lucent, the total returns of the Alcatel organizations were still higher than those of Nokia (Nokia, 2015, p. 172). That, together with the fact that Alcatel-Lucent is also a multinational telecommunication provider with its base in France, attracted Nokia to an acquisition.

Therefore, this paper is report of a twofold analysis of the company as though each was a single entity and the acquisition in inclusion and exclusion of the synergies. The paper gives the insight of the elaboration of the two companies’ financial management techniques including assumptions and models like the Beta calculation with regression coefficient, equity betas, cost of depth and CAPM. The assumptions and models apply for both Nokia and Alcatel. However, for the acquiring organization’s purposes, the paper will also cover the NPV analysis. The discount cash flow model will also be reviewed with an approach to study the target in the acquisition both in regard of the synergy and without them. Finally, the outcomes and the situation of the emerging organization and the sensitivity of the new organization will be covered.

Analysis of the Nokia and Alcatel-Lucent acquisition

Researchers propose that the best way to conduct an analysis of mergers and acquisitions is through the individual analysis of the parties involved and comparing the results against the target outcome. Thus, there is a variation between the results in the acquisitions with synergies and those without. In the acquisitions without the operational synergy, there is hardly any considerable profit because the target company may operate independently from the acquiring party (Pawlicki, 2017, p. 3). On the other side, those associations in which there is operational synergy sees to it that both parties enjoy many benefits from the acquisition.

Also, since the analysis covered a long period of about 8 years for each company and 4 years for the outcome of the acquisition, all analysis were conducted in Dollars with the value of $1.1 per Euro due to the high volatility in the Euro crisis. The analysis also took care of the historical data between the year 2011 and 2014and the macro-economic values the two mobile companies.

Model description

Discounted Cash Flow methodology is the approach used in the evaluation of the predicted company’s value. The approach is also vital in subtracting the task expenses and running costs before deducting the weighted-average cost, a move through which the involved parties can use to approximate the amount of risk they are likely to encounter (Carpenter & Lazonic, 2017, p. 76). Although there are other evaluation methods that incorporate Adjusted Present Value and Expected Equity Cash Flow among others, this paper demanded the utilization of the DCF through the WACC and Free Cash Flows as deduction rate. The formula below is the WACC calculation that will be used in the calculation of the discount rate. It will also take into consideration the currency and inflation rate expected by the firm and the business risks at hand.

Since the annual dividend payments of the two firms and the growth rates are not clear, the company may use the CAPM approach to work out the cost of equity to be used in the equation under the sign, Re. Also, the market risk premium of the two nations that harbor Nokia and Alcatel were collected and the 8 country government bond rate used as the risk free rate for the calculation. The CAMP formula also encompass the utilization of the beta formula, which may be calculated through two varying approaches (Nokia, 2015, p. 200) (Exhibit 5). The levered beta and the regression analysis are the two among many methods that are used in this research. The main reason for excluding the unlevered Beta is the fact that it does not apply in both the cases of the Nokia and the Alcatel companies. Nonetheless, the levered Beta incorporates the unlevered Beta such that, the outstanding debt ratio is divided by the tax rate and the equity of the companies as elaborated below.

Other important calculations are the potential liquidation value and the Free Cash Flow of the partnership. To begin with, the potential liquidation value is done with the presumption that there comes a time when the assets of the bureau will be marketed for the bit value. Also, the value of the acquisition is the value of the current FCF added to the Terminal value and the ended period FCF as in the formula below.

On the other side, through the DCF model, we may work out the possible Free Cash Flow and approximate the costs and the benefits of the cooperation (Nokia, 2015, p. 172). According to the FCF formula, it is equal to the net operating profit after the net operating profit and tax are deducted off the capital expenditure. Through that approach and the DCF model, we may then workout the Terminal value as in the formula below.

Nokia company case evaluation.

Nokia was the leading company in the mobile industry until Samsung and Apple saw drastic growths among other telecommunication companies. Therefore, as the fallen giant is trying to get back to its roots, the evaluation of its endangered time is vital. By that, we used the Discount Cash Flow model and approximated the cash flows by the year 2025. Nonetheless, through the use of the -0.2% GDP annual growth rate, and the inflation rate of -0.24%, a -0.44% stable and favorable growth rate for the Nokia company was used as an estimation (Galetovic & Zaretzki, 2018, p. 75).

There has been a down trend in the revenue of the Nokia Corporation for quite some time, until the year 2012 when it showed its first positive result in the income figure of the revenue. In that case, the promising analysis is used as the base for the conclusions, resulting a steady growth outcome for the corporation (Exhibit 7).

Therefore, several approaches are employed in the computation of the variables to demonstrate the real value of the Nokia Company. One of them is the cost of equity calculation CAPM to establish the DCF. 0.73%, 10 year government bond rate took the place of the risk free rate of the model and a nation market risk premium figure of 5.78%. Also, in the better computations, the regression analysis depicted greater levered beta and the unlevered beta. Thus, despite the limitations, the levered beta was used and the eventual cost of equity of Nokia turned out as 9.13%.

Finally, the WACC calculation and the DCF model evaluation resulted in the persistence of Nokia to acquire the Alcatel mobile firm. WACC was done by finding the product of the current share price, 6.9, and the share outstanding, 2.8 billion. Finally, the Nokia WACC turned out as 8.17%.

Alcatel-Lucent base case evaluation

Through the application of the Discounted Cash flow model to the Alcatel- Lucent organization, we may workout the NPV by the Nokia firm. Generally, that provides the estimation of the acquisition amount pf the target party for the Nokia Company. Nonetheless, there are a number of uncertainties(Dziechciarz-Duda & Król, 2017, p. 39). The uncertainties bring in the essence of bull, base and bear case scenario computations with the ratios of 20%, 50% and 30% respectively as the possibilities for each scenario. A similar valuation to that of Nokia applied in the Alcatel- Lucent case with a 12.33% discount rate in computation of WACC. The eight year terminal value result showed 19.357 billion for Alcatel and a 16.514 billion dollars for the acquisition. Nokia stated that it was going to pay 16.6 billion dollars for the acquisition. On the other hand, the computation of the RONA resulted in a value bigger than WACC, 14.64% and 12.33% respectively. That shows that the acquisition may be beneficial to Nokia because has Alcatel-Lucent has steady growth that is greater than the discount rate.

Valuation of the acquisition

The best way to estimate the profitability of the resulting enterprise to Nokia and Alcatel is through the valuation of the target firm either with synergies or without synergies. The basic difference of the two scenarios is that the acquisition with no synergy result in a dragging revenue growth than the one with synergy. For example, 2% and 4% are the approximations of the revenue growth without the synergies and with synergies in that order. On the contrary, the later shows better percentage of cost of sales than the former. Therefore, the two companies will reduce the expenses in the case they undertake the acquisition process and they will grasp a bigger market with a lower marketing cost, benefiting them.

We also learn from the assumptions that the value of the tax rate and the WACC are equal in the case of the projected outcome enterprise (Gan & Roman, 2017, p. 264). Alcatel-Lucent also showed a greater tax rate than the Nokia firm, an effective tax rate of 34%. For the purposes of terminal value calculation, the DCF was completed by Alcatel’s growth rate.

NCW was assumed to be a representation of the two companies in the absence of a functional synergy cost of revenue. Considering all those assumptions, the final projected value of the new enterprise value was at 395.5 billion. That is foreseen to bring positive revenue growth to both companies in the acquisition. The idea of operational synergy makes it even a double advantage of `625.1 billion making it better for this union like operation (Blau, 2014, p. 21). Nonetheless, the RONA for both Nokia and Alcatel is bigger than the WACC of the enterprise resulting from the acquisition, making it more profitable for the acquisition without synergy than that without synergy.

OUTCOMES OF THE EVALUATION

Analysis of the sensitivity

In spite of the estimation examination of the two companies of the acquisition, Nokia and Alcatel, the mobile market that both of the target is very inflammatory, making the examination very sensitive to the assumptions of the research. For the case of the Nokia organization, there would be a negative growth of the revenue but end that would end in a small increment within the prediction time. It is also assumed that there would be a 0.01% decrease in the terminal growth rate of the Nokia Company and an increase in the cost of revenue (Pawlicki, 2017, p. 49). It is also important to note that the share price is less that the predicted and the current value, $4.7 (Pawlicki, 2017, p. 51). On the part of the bull case, there is an approximate variation in the share price of $2 from the positive revenue growth of all time. Moreover, from the data table analysis of cost of capital rate, it was evident that the acquisition value would reduce if the cost of capital was higher.

Relative Valuation

It is also vital to calculate the profitability ratios of the outcome. That will be useful in the analysis of the market share of the bureau in the mobile market. The operating margins of the historical financial statement was also important to calculate. The good thing is, upon comparison of profitability ratios of the outcome of the acquisition against those of competing organizations like Ericson, Chico and Motorola, EBIDTA, the results showed a better position for the Nokia-Alcatel acquisition than most of the competitors. It was comparable with that of the Chico organization, showing a 30% equity (Carpenter & Lazonic, 2017, p. 131). The results also predicted a smaller operating margin than that of the Chico organization. The earnings yield of the acquisition were lower in percentage when compared against those of great competitors; a 1.5 or 1.7 with synergy and without synergy respectively (Souminen & Seppänen, 2017, p. 89).

Drawbacks of the Model

The operation of this model in the calculation of the DCF was all backed with the financial theory and the underlying assumptions to establish the value of the two mobile firms, Nokia and Alcatel. That brings along with it so many limitations. For instance, the use of CAPM approach in the working out the cost of equity has many non-viable assumptions in the formula. For example, it uses the historical rates of return to predict the probability of systematic future risks in the organization. It is not a rational approach, yet is implemented in the figures (Pawlicki, 2017, p. 109). Therefore, the beat calculation of the future outcomes may not truly give the accurate results of the outcome. The evaluation also assumes that there is only a small variation in current value and the cost of debt and outstanding depth undergoes simplification during the computation. The formula also assumes that the value of the assets of the two organizations will not change over the prediction period, which we all know may not be right. The volatility of the market and the probability of the two parties to sell or purchase anything in their fixed assets also brings about another limitation.

Conclusion and recommendations

All in a nutshell, the Nokia Company made a move to acquire the Alcatel- Lucent to save its drowning reputation in the mobile industry. This paper has conducted a review of the acquisition considering all the economic factors in the history of the two parties, the current values and the predicted value of the end result after the acquisition. In lieu of that, the paper elaborates an in depth analysis of the approach used in the valuation of the union and the various formulas and assumptions used in the analysis. From this, it became evident that the current share of the Nokia mobile Company is a small positive variation. Nonetheless, Alcatel-Lucent showed a high value and that was vital in its valuation together with its counterpart, Nokia. The repost also documented a 16.514 Net Present Value Estimation (NPV). The valuation demonstrated a number of uncertainties in the valuation process, bringing about the bull and bear case. The paper also entailed a detailed report of the valuation of the Alcatel-Lucent both in the presence and the absence of the synergies. The paper was essential in showing the drop in the Net Income of the two firms since the year 2012, and in insisting on the necessity of the acquisition. Nonetheless, the study saw many drawbacks that may have led to inaccuracy in the projection.

Regarding all these, it is essential that the companies make the acquisition move to maintain the high market profile and maintain high income and economic value. However, they should carry out a more critical analysis and make the final decision if and only if the projected class of the enterprise is better than the current positions of Nokia of Alcatel- Lucent. They should also consider additional details like the revenue growth, percentage sales and the COGS in this whole process.

References

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Blau, J., 2014. European high-tech industry at the crossroads. Research Technology Management, 57(1), p.2.

Gan, D.Y.C. and Roman, D., 2017. MOBILE BIG DATA: THE SILVER BULLET FOR TELCOS? A CASE STUDY IN THE NORWEGIAN TELCOS MARKET. In INTERNATIONAL CONFERENCES COMPUTER GRAPHICS, VISUALIZATION, COMPUTER VISION AND IMAGE PROCESSING 2017 and BIG DATA ANALYTICS, DATA MINING AND COMPUTATIONAL INTELLIGENCE 2017, Lisbon, Portugal July 21-23, 2017.

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Appendix

Exhibit 1

Relative valuation ratios

(Ycharts.com, 2015a)

Exhibit 2

Alcatel historical income statement

(Alcatel-Lucent, 2015)

Exhibit 3

Nokia Income statement from 2012 to 2014

(Nokia Corporation, 2015)

Exhibit 4

CAPM

Exhibit 5

Dividend policy and historical annual dividend payments for Nokia and Alcatel-Lucent

Exhibit 6

WACC calculation

(NOKIA CORPORATION, 2009)

Exhibit 7

DCF Nokia

Exhibit 8

Forecast of the relative valuation ratios for Nokia for 10 years

Exhibit 9

DCF Alcatel

Exhibit 10

Forecast of the relative valuation ratios for Alcatel for 10 years

Exhibit 11

DCF without synergies

Exhibit 12

DCF with synergy

Exhibit 13

Nokia bear case

Exhibit 14

Nokia bull case

Exhibit 15

Sensitivity without synergy

Exhibit 16

Sensitivity with synergy

Exhibit 17

(Yahoo! Finance, 2015)

Exhibit 18

(Ycharts.com, 2015b)

Exhibit 19

Relative valuation without and with synergy respectively