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According to Nokia’s (NOK) website, there has been a “global network and edge computing alliance” between the Finnish communications equipment supplier and Kyndryl (KD). For investors, the latter is a spin-off by International Business Machines (IBM) and includes the managed services infrastructure business plus consultancy work for big enterprises. Kyndryl, whose shares have suffered from more than 60% downside since its IPO because of falling revenues, now has a big opportunity to expand on sales.
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According to me, amid all the partnerships Kyndryl has been forging since November, the one with Nokia is by far the most meaningful one, and, with this thesis, I explain the underlying reasons in the context of Industry 4.0, which is the application of technologies such as AI, connected sensors and robotics to digitally transform the manufacturing sector into becoming more efficient and nimble.
The business case for private 5G in Industry 4.0
Fifth-generation cellular or 5G is often touted as a key pillar in the digital transformation of the manufacturing sector with specific use cases built around ubiquitous coverage of an operational site that may span across a large geographical area. In this case, the inability of public 5G or 4G LTE (an advanced form of 4G) networks to cover all the sites of large corporations operating in industries like mining, for example, is driving private wireless networks. These also allow secure connection of remote Internet of Things (“IoT”) devices and computing found at the edge (perimeter of a 5G coverage area) to central data centers.
Explaining further, the 4G LTE or 5G icon you see on your smartphones pertains to signals transmitted by mobile service providers like Verizon (VZ) who serve the public (you and me). These providers buy radio access and core network equipment from Nokia.
In addition, the Finnish equipment supplier also has private wireless (5G) customers, a business that has known double-digit growth in the last reported quarter (see below).
In this context, according to some independent reviews published on Nokia’s website, the company has a leadership position in private wireless, with over 420 4G LTE and 5G customers.
Still, the private wireless business forms part of the Cloud and Network Services segment together with Cognitive, Managed Services, and Digital Automation/Analytics/ IoT. This segment brought a combined 964 million euros in the fourth quarter of 2021.
Thinking strategically, the turnover from Nokia’s private 5G business still constitutes a small amount when considering that, as per Analyst Mason, the forecast is that enterprise LTE/5G capital expenditures will grow from around $208 million to $3.1 billion in the 2020-2026 period. Moreover, according to Nokia’s CEO during the fourth-quarter earnings call, private wireless together with 5G core and digital operations are key areas of focus for growth.
Now, while private 5G can provide faster speeds and more mobility (for robotics technology), CEOs of manufacturing companies who are facing supply chain bottlenecks and inflation concerns may fail to see the benefits unless they talk to salespeople coming from the enterprise world and who are knowledgeable about their specific requirements as these can be significantly different from public mobile operators like AT&T (T). This is why Nokia needs Kyndryl.
The Kyndryl differentiator
Nokia’s sales and implementation teams are more oriented towards designing public 4G and 5G projects in conjunction with mobile network operators whose consumers are the wider public. Now, this is significantly different from selling to private 5G clients in the emerging Industry 4.0 where there is a need to connect sensors based on IoT technology to enterprises’ IT systems. This calls for a different sales approach and specific capabilities in terms of consultancy, design, and managed services. This is where Kyndryl’s expertise comes into play.
Now Kyndryl is not a mere startup but has a 90,000 strong workforce with a market cap of $3.5 billion. It is focused on the sale of software for cloud computing and data analysis, as well as servers and mainframes. More importantly, Kyndryl’s scope of activities and customer contracts are not limited to installing just IBM’s products but it can also source equipment from Hewlett Packard Enterprise (HPE) or Dell (DELL). This said IBM remains Kyndryl’s largest supplier.
Along the same lines, far from restricting itself to IBM’s cloud, Kyndryl is also open to customers hosting their infrastructure on other cloud platforms than IBM like Amazon (NASDAQ:AMZN) Web Services and Google (NASDAQ:GOOG) Cloud. For this matter, it has already inked a partnership with Microsoft (NASDAQ:MSFT) for its Azure cloud and AI services.
Pursuing further, Kyndryl proposes Network & Edge Unified Network services for cloud and data center connectivity as shown below. Now, with Nokia’s DAC (Digital Automation Cloud) already incorporating private 5G together with edge computing, the Kyndryl-Nokia alliance can deliver end-to-end solutions for customers encompassing project planning, implementation, sourcing, and managed services. This would constitute a one-stop shop for those wanting to migrate to Industry 4.0.
Thinking aloud, one area which is often overlooked by analysts is spectrums or the frequencies required to interconnect communication equipment, and these differ based on the country. For this purpose, Nokia already partners with CSPs (communication service providers) and has different spectrum options as part of its private wireless bundles.
Looking at potential competitors, Amazon recently launched its private 5G service as part of its AWS cloud offerings. It operates in the CRBS spectrum (using the 3.5Ghz frequency range for U.S. customers) and also allows private enterprise customers to use their own frequency range. They can also use those allocated by public mobile operators. Now, Knowing Amazon’s aptitude at designing easy-to-use and pay-as-you-go products as part of its cloud platform, its offerings should attract clients wanting to collect device data and seamlessly transfer these to their databases, and this, without having to go through the complexities of buying radio antennae and setting up edge datacenters.
Therefore, this space should see a lot of changes given the number of players proposing edge solutions and equipped with IoT platforms, but the Kindryl-Nokia partnership does suggest that they are looking at the bigger picture.
Valuations and key takeaways
The bigger picture is the Industry 4.0 market instead of just private 5G. The related market is forecasted to inflate to $165.5 billion in 2026 after growing at a CAGR of 20.6% from 2021.
This represents a considerable opportunity and the alliance has already performed preliminary work as evidenced by “several proof-of-concept (PoC) applications for Dow Inc. to support Industry 4.0-enabled worker safety and collaboration, asset tracking, and other capabilities using a blueprint that it plans to expand and deploy across its sites worldwide”.
I will now value prospects for Kyndryl and Nokia individually.
Kyndryl’s strength is that it holds IBM’s global managed infrastructure services unit together with staff already knowledgeable about IoT, the edge, and AI through its Watson services. Thus, it can potentially beef up its consultancy revenues from the current quarterly amount of around $4.7 billion. This is feasible as Kyndryl possesses considerable scale, has an experienced team, and benefits from IBM’s reputation for reliability. One instance where the company’s expertise will be paramount is advising companies about how to deal with the multitude of network interfaces available today in the form of WiFi, Ethernet, fixed connections, public cellular, etc.
With a trailing price to sales multiples of only 0.18X, I consider that this company should be on investors’ watchlist.
Thus, Kyndryl needs to be watched closely in 2022 as its alliance with Nokia does create an entity that is global, both in IT consulting and Communications equipment, two complementary sectors for comprehensive 5G and edge implementation within private corporations. Additionally, both companies favor openness, with Kyndryl being open to working with any cloud provider and Nokia, as an early adopter of Open RAN (O-RAN).
This alliance should be immediately revenue accretive for Nokia with its leadership position in private 5G, which should, in turn, benefit gross margins, currently at the 40.4% mark.
At this stage, it is important to mention that competitor Ericsson (NASDAQ:ERIC) also focuses on private 5G, but uses a different approach, namely by primarily working jointly with public service providers to harness enterprise opportunities. Nokia, on the other hand, has a more direct approach, by engaging with large corporations for their private wireless needs. For this purpose, it launched its cloud-native edge solution back in October 2021, and now, with Kyndryl it has a strong partner which can easily take on competitors like Cisco (NASDAQ: CSCO) and Ericsson.
Now, assuming that Nokia is able to tap in just one-fifth of the $165 billion Industry 4.0 market, or around $33 billion, this amount would be higher than the total revenues of $25 billion obtained in 2021 which, by the way, englobes sales from all the operating segments. The enhanced revenue opportunity is the reason why, at a trailing price to sales multiple of 1.27x, Nokia is undervalued, and just assuming a P/S of 1.5x, I obtain a target share price of $6.7 based on its current share price of $5.67. There should also be benefits for the bottom line as the company does not need to spend on recruiting and training staff for selling private 5G and edge solutions to enterprises.