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Nokia Siemens Networks (“NSN”), a leading equipment, infrastructure and service provider for telecom networks globally, is now concentrating on the U.S. market, which has so far been its weakest business zone. Formed in 2007 as a 50-50 joint venture between Nokia Corp. (NOK - Analyst Report) and Siemens AG , NSN currently is the second largest global telecom equipment gear maker. Despite the reputation, it was only in the third quarter of 2012 that NSN achieved its first operational profitability.

Incurring Losses since Inception

We attribute a number of reasons behind the losses incurred by NSN. First and foremost, though NSN boasted of a strong GSM portfolio, it had lacked severely on the CDMA front. We note that CDMA is the dominant network protocol used in the lucrative North American region. Added to it was cut-throat competition from emerging low-cost Chinese vendors like Huawei Technologies and ZTE Corp. Their low bids for network infrastructure contracts gave NSN a run for its money. The company had also diversified into many non-lucrative segments, such as microwave-transport and fixed-line broadband-access businesses.

Restructuring Phase

During the last couple of years, both Nokia and Siemens were trying every means to restructure NSN. In April 2011, NSN bought the 3G/4G CDMA network gear businesses of Motorola Solutions Inc. (MSI - Analyst Report), which gave it a solid foothold in North America. NSN has also been systematically selling its non-core operations while concentrating on the wireless and fiber-based segments.

Meanwhile Nokia and Siemens have had several failed attempts to sell NSN to private equity groups. But the offer prices were far from attractive. Rather the parent duo decided to invest Euro 500 million each in the venture in August 2011. This went largely to initiate a bold headcount reduction move, laying off 17,000 or 23% of the total NSN workforce. Management expects its proposed restructuring to result in an annual cost reduction of approximately $1.35 billion by 2013.

Hope Alive in the U.S.

The U.S. market once again looks attractive for NSN. Counting among the positives is the significant growth witnessed in high-speed 3G and growing deployment of 4G LTE network in the U.S. These next-generation super-fast wireless technologies have revolutionized the entire telecom landscape. Telecom carriers are heavily investing in network upgrade to support massive demand for mobile data and video. As of now, monetization of data and video generates huge profit for the carriers rather than a simple voice call.

In a volte-face, the low-cost Chinese vendors, Huawei and ZTE, are now facing political hindrance in the U.S. There are raging concerns that these companies may act as sources for the Chinese Government to use U.S. telecom network for spying. Hence, the absence of Chinese competition and the current depressed state of the incumbent Alcatel-Lucent S.A. (ALU - Analyst Report) provide an open space for NSN to capitalize on.

Following the acquisition of assets from Motorola, NSN has started to get contracts from T-Mobile USA and to some extent from AT&T Inc. (T - Analyst Report) and Verizon Communications Inc. (VZ - Analyst Report). This is another definite good sign.  

Our Take

As attempts to sell NSN to private equity groups failed, both Nokia and Siemens toyed with the idea of a spin-off of NSN as a separate, standalone entity in an IPO. Interestingly, the agreement between Nokia and Siemens for NSN will come to an end in 2013. However, to conduct a successful IPO, NSN must first set its business in order with sequential profitability and future growth projection. Undisputedly, a strong footprint in the U.S. market will serve that purpose the most. Whether it actually materializes or not is yet to be seen. At least there are signs on the horizon that signal such a possibility.

For the long term, we reaffirm our Neutral recommendation for both Nokia and Siemens. However, Nokia currently has a short-term Zacks #2 Rank (Buy) and Siemens has a short-term Zacks #3 Rank (Hold) on their stocks respectively.

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