Nortel value for Ericsson is to keep out rivals

July 27, 2009

Ericsson headquarters in StockholmLONDON, July 27 (Reuters) – Ericsson’s last-minute bid of $1.13 billion for Nortel Network’s wireless assets is difficult to justify on sales prospects alone.
A merger won’t wring out much in the way of efficiencies either: Nortel has already undergone years of huge job cuts. 
There is, however, another factor at work here: The value of keeping competitors out.
The Swedish mobile network equipment maker snatched the Nortel business away at auction from Nokia Siemens, which last month agreed to pay $650 million for the same assets — a little over half Ericsson’s final price. 
Ericsson also significantly outbid a third bidder, private equity firm MaitlinPatterson, which offered $725 million, for Nortel. BlackBerry-maker Research in Motion is seeking a separate patent licensing deal with Nortel after its $1.1 billion offer for Nortel’s mobile business failed to win support.  

Understanding the deal requires knowing some of the technology dynamics involved. Nortel’s main franchise remains in CDMA networks, the technology that came to dominate the North American mobile market in the 1990s and earlier this decade. It’s a region where Nokia Siemens has struggled to make inroads.
Ericsson, on the other hand, shares some of the same customers and technology as Nortel. As the world’s biggest maker of mobile network equipment, Ericsson bought its way into the CDMA market earlier this decade by acquiring the wireless network assets of CDMA pioneer Qualcomm Inc.
Nortel Networks has also been working on the next generation of high-speed networks based on a technology called LTE, or Long Term Evolution. Nortel sold around $2 billion worth of CDMA and LTE equipment in 2008. 
But the business has been in decline. Customers have been taking a go-slow approach to upgrading their networks, even before the global economic downturn. Nortel also lacked the scale of bigger rivals like Ericsson, Nokia Siemens or Alcatel Lucent that would have helped it compete with lower-Ericsson engineer checks cablescost Chinese and Korean competitors. 
Nomura analyst Richard Windsor estimates that at a price of $1.13 billion, Ericsson stands to receive only a meager return of 6.25 percent on Nortel assets, assuming continued sales declines and optimistic operating margins of 20 percent — far higher than Ericsson itself is predicting for the Nortel business.
The value of Nortel’s wireless business depends on milking the remaining market for replacement CDMA equipment, while working with those customers to help them make a stable long-term transition to LTE and other next-generation equipment. But that would be paying a lot to simply reinforce relationships.
Call the additional price Ericsson is paying the “keep-out premium.” To make this deal work, Ericsson needs to turn its greater scale into sustained gains in operating margins. Keeping competitors at bay is the only way to justify the acquisition price.
— At the time of publication Eric Auchard did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Read some of Eric’s previous columns and blogs here. —

(Editing by Martin Langfield)

(Photos: Reuters/Bob Strong, Stockholm; Reuters/Karoly Arvai, Budapest)

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