When Nokia (NYSE:NOK) announced that it would be acquiring Alcatel-Lucent (NYSE:ALU), a curious thing happened: Both stocks fell.
This sent a bad signal that large investors in both companies didn’t like the deal. It’s also extremely rare. The typical pattern in a public-market acquisition is for the shares of the acquiree to rise. The Boston Consulting Group says the historical average premium for the acquired company is 34%. So what gives?
A big factor in the selling of shares after the deal was Nokia investors, according to some sources. Many of the Nokia shareholders were interested in owning Nokia for the intellectual property benefits of Nokia’s Advanced Technologies division, which licenses patents. Adding another telecom equipment merger didn’t do much for them.
“Many of the people that owned NOK only cared about intellectual property licensing revenues and the bull case that NOK can get more Chinese handset players to pay it,” said Michael Genovese, Managing Director at MKM Partners, when I inquired by email. “They don’t feel great about telecom equipment so they are getting out of the stock.”
Other factors contributed to the less-than-enthusiastic reaction. Alcatel-Lucent has already been through many years of restructuring so some investors see limited upside in the “synergy” of cost savings in merging. Also, although there was no premium to the market price, ALU shares had already risen substantially in the prior months, perhaps in anticipation of a deal. ALU shares on Thursday were a few pennies lower than they were on Monday — and 20% lower than they were on Tuesday (shares rose 20% on Tuesday on rumors of the deal), but they are still up 60% from their 52-week low in 2014. So many investors may have just felt it was time to get out.
The Alcatel-Lucent-Nokia deal is an all-stock merger, in which investors in Alcatel-Lucent shares will get .55 shares of newly issued Nokia stock for every share they owned. After the merger, Nokia shareholders will own about two-thirds of the combined company.
In an all-stock deal like this, investors in Alcatel-Lucent must take faith in the ability of the Nokia management to create value out of the newly combined entity, which we’ll call NokiALU. This often comes down to the potential for cost savings, and earnings “accretion,” that is, adding to earnings by eliminating overlapping costs or overhead of the two companies.
The Boston Consulting Group says that mega-deals are on the rise in the relatively sluggish economy, as large corporations look for ways to generate a return. One of the more common drivers of M&A activity is industry consolidations, as combine companies seek to team up with the competition to improve pricing and reduce costs. The NokiALU fits this description well, as the
Despite the negative short-term reaction to the NokiALU combination, analysts are split on what this deal will mean in the long run. It’s a consolidation play designed to boost market share, pricing power, and earnings through cost savings. MKM’s Genovese is somewhat optimistic about the potential of earnings accretion in the long run. He thinks the deal will result in Nokia earning 2016 pro forma Earnings Per Share (EPS) 34% higher than his existing estimate for Nokia. He also believes that Nokia got Alcatel-Lucent for a good price.
“Given that the ALU price tag looks relatively attractive for Nokia, we expect NOK should move up from the current level in the coming months.”
Not everyone is so sanguine. Simon Leopold, Managing Director with Raymond James, sees less potential for cost savings.
“The combination could result in Nokia re-positioning itself with a combination of mature and growing businesses, with only marginal potential for accretion while introducing potential execution risks,” wrote Leopold in a research note issued on Wednesday after the deal was announced. “Consolidation may benefit the industry, but Nokia may face limited synergy opportunities.”
In the short term, Mr. Market was unkind to the deal because Alcatel-Lucent investors were disappointed with the price that was paid and many Nokia investors felt it may diluted the value of Nokia’s intellectual property. In the long term, the share price will be reliant on how well the management executives the costs savings and profit lift they anticipate from the combination.