By Jussi Rosendahl and Leila Abboud
HELSINKI/PARIS (Reuters) - Nokia Oyj (NOK1V.HE) is in talks to buy smaller telecom equipment maker Alcatel-Lucent (ALUA.PA), a deal combining the industry's two weakest players that is backed by the French government but could pose challenges in cutting costs.
In a joint announcement, the Finnish and French companies said they were in "advanced discussions" on a "full combination, which would take the form of a public exchange offer by Nokia for Alcatel-Lucent". The two, which have been seen as a possible combination for the last several years, cautioned that the discussions could still fall apart.
Shares in Alcatel, a group worth about 11 billion euros based on Monday's closing share price, rose about 16 percent. Shares in Nokia, worth about 29 billion euros, fell as much as 7 percent in morning trade before paring back losses to end down 3.6 percent. France's Le Monde newspaper reported that a further announcement could come as early as Wednesday.
The pair are a good fit in terms of products and geographies, and bulking up would help them cut costs as they try to compete with mobile market leader Sweden's Ericsson (ERICb.ST) and low-cost powerhouse China's Huawei.
Nokia would expand its presence in the key United States market where Alcatel-Lucent is a major supplier to operators AT&T (T.N) and Verizon (VZ.N), and get access to the French firm's fast-growing, profitable Internet routing business.
But the track record of mergers in the industry is spotty, in part because of the difficulties of cutting costs in a R&D intensive business where companies cannot simply drop products that global telecom operators rely on.
The last round, which gave birth to Alcatel-Lucent and combined Nokia's networks business with Siemens about a decade ago, saw both firms lose value and market share as rivals went on the attack while they were busy integrating the businesses.
The French government, which has a record of intervening in major takeover deals and is sensitive about job cuts and keeping a French foothold in strategic industries, publicly backed the plan. Economy Minister Emmanuel Macron hailed it as an opportunity to reconquer lost markets and saying he had secured "clear undertakings" from Nokia that reassured him.
In May last year, France beefed up its power to block foreign takeovers, extending a 2005 law on defense and other industries to the telecoms sector along with energy, water, transport, and health. The move came as then economy minister Arnaud Montebourg battled with U.S. conglomerate General Electric (GE.N) over its plans to buy part of engineering group Alstom (ALSO.PA).
In sharp contrast to the combative style of his left-leaning predecessor, former investment banker Macron called the tie-up talks "a good move for Alcatel-Lucent because it is a move for the future, because we are building, with this tie-up, a new conquest for Alcatel-Lucent."
He spoke after a meeting with Nokia Chief Executive Rajeev Suri, Alcatel-Lucent boss Michel Combes and French President Hollande on Tuesday afternoon.
Alcatel-Lucent has around 6,000 employees in France out of a total of 52,000 worldwide. Nokia has almost 62,000 employees.
Macron said there would be no job cuts in France, and that the combined group planned to keep research and development operations on French soil.
NOKIA INVESTOR "HORROR"
In the same way that France was reassured though, some Nokia shareholders were unsettled.
“I’m reading this with quite some horror. Here we have these listed companies going to talk to France’s president," said Juha Varis of Danske Capital.
“This is an industry with not much growth in sight, so there’s no question the combined company must cut costs… The companies should be allowed to do exactly what they want without restrictions from any state.”
A statement from a group of unions said meetings would take place with management on Friday.
The companies' joint statement came in reaction to media reports that the two had revived tie-up talks that have been on and off for years in an industry that is seen by investors and sector executives as in need of further consolidation.
Nokia buying Alcatel-Lucent would transform the competitive dynamics in the telecom equipment industry, which has already been through a long price war sparked by the rise of low-cost Chinese players Huawei and smaller cousin ZTE Corp.
For Nokia, the deal would be a step to growing again. It sold its flagship handset business to Microsoft Corp (MSFT.O) last year after mishandling the move to smartphones and being left behind by Apple and Samsung.
Forty-seven-year-old Nokia chief Suri, born in India, has been hailed for turning Nokia’s network unit profitable through drastic cost-cuts, and has repeatedly said further consolidation in the industry is inevitable but that any large deal must be “wisely thought-out”.
In wireless, the combined group would have market share of 35 percent, compared with 40 percent for Ericsson and 20 percent for Huawei, according to Bernstein Research.
Clairinvest fund manager Ion-Marc Valahu expressed scepticism over the merits of the proposed deal.
"They could come up with some cost cuts, but just because you combine one weak player with another weak player does not necessarily mean that you will end up with a stronger player."
The combined company would have sales of around 26 billion euros ($28 billion), compared with 24.4 billion for Ericsson last year and 37.44 billion for Huawei, which also sells handsets so is not an exact comparison.
Asked on Tuesday for reaction to the deal news, Ericsson Chief Executive Hans Vestberg said companies in the sector were all searching for scale but added he did not foresee an immediate challenge to his strategy.
"I will, together with management, evaluate everything that this might mean," he said.
A counterbid for Alcatel-Lucent is seen by analysts as unlikely since Ericsson would run into antitrust problems if it got bigger, and Huawei would face strong political opposition in France and the United States where Alcatel-Lucent is a major supplier to operators AT&T and Verizon.
JP Morgan is advising Nokia, and boutique investment bank Zaoui & Co is working for Alcatel-Lucent, said a person familiar with the matter.
(Additional reporting by Sven Nordenstam in Stockholm, Andrew Callus, Matthieu Protard and Jean Baptiste Vey in Paris and Sudip Kar-Gupta and Sophie Sassard in London; Editing by Sophie Walker and Philippa Fletcher)