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Nokia under pressure to make right call on China 5G

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Nokia under pressure to make right call on China 5G

Nokia Corp.'s cautious approach to participating in China's 5G rollout contrasts with that of rival Ericsson and could deprive it of long-term profits, analysts said.

Nokia is weighing a pullback from bidding on 5G contracts in China as it could take years for the agreements to reach profitability, CEO Rajeev Suri said Oct. 24. 5G is set to offer download speeds many times faster than the current 4G LTE wireless networks.

If Nokia decides not to compete in China, it will miss out on revenue from subsequent network upgrades and the chance to build scale, analysts said.

China historically has not been a major market for Nokia, which is focused on supplying data centers and optical and routing equipment to a wider range of telcos, noted principal analyst at Ovum, Don Frey, who specializes in core networks. This offers more pricing flexibility than selling to state-owned operators, Frey said.

Nokia would also be losing money on China contracts, said a London-based analyst following Nokia, who asked not to be identified. The analyst said the profit margin would be negative 5% to negative 10% for Nokia.

Last week, Nokia warned profits will be lower than expected due to increased competition and costs related to 5G, prompting a 25% drop in stock price.

"Given where Nokia is in terms of profitability, it does make sense to focus on markets where they can make money," the unnamed analyst said.

Moody's downgraded Nokia's corporate family rating Oct. 28, saying the decision "reflects our view that Nokia's operating performance in 2020 will recover more slowly than we previously expected, due to increased margin pressure in the mobile access business and additional investments to support its competitive position in the upcoming 5G technology cycle."

Investors are "probably worried about Nokia having to make these decisions [on whether to compete in China 5G]," Frey said. "It means things are running a bit tight if they have to look at each businesses' profitability so closely."

Margins are under pressure from competitive pricing in China, but Nokia's production costs are also higher than those of local competitors, such as Huawei Technologies Co. Ltd., the analysts said. The Finnish company acknowledged it has a mobile access production cost "issue" during its earnings call Oct. 24 and said it is addressing it.

The Chinese government may help lower Huawei's costs by granting it access to local industrial facilities, the London-based technology analyst said. The auction process effectively favors local providers, he said, so that Huawei builds the core network and "breadcrumbs" are left for foreign vendors.

"Huawei may source components from China, and Nokia may be working with US-based providers," Frey said, which impacts end costs.

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The size of the 5G equipment market in China also gives suppliers who participate in its rollouts a chance to score large volume contracts, the analysts said. This means Huawei, which dominates the Chinese market, has an advantage over both Nokia and Ericsson as it can reduce per-unit prices as it gains scale, Frey said. China's leading telco China Mobile Ltd. awarded about half its 5G network equipment contracts to Huawei this year. Ericsson will supply approximately a third of the equipment, with Nokia at about 10%, according to auction results cited by South China Morning Post.

Ericsson, which competes with Nokia for 5G equipment contracts globally, is taking a more aggressive approach in China, the analysts said. This is because Ericsson is more dependent on 5G as a revenue stream, Frey said. It is also not facing the same margin pressures as Nokia, he noted.

But Nokia also stands to lose out to Ericsson in terms of long-term profits from network upgrades in China, the London-based analyst said, with its cautious approach in the country versus Ericsson's aggressive strategy of pursuing contracts there. Upgrades are cheaper to carry out since they only involve updating existing equipment and can offer good margins due to their frequency, the analyst said.

The 5G market in China is rife with potential for suppliers. According to data from the mobile trade group GSM Alliance and the China Academy of Information and Communications Technology, the Chinese market for 5G connections is expected to jump from 4 million connections in 2020 to 428 million in 2025.