--> Upgrading Back to Buy As Risk/Reward Now Positively Skewed Post the Recent Downdraft; Price Target Remains Unch at €4.15
* Upgrading ALU back to Buy from Neutral after downgrading it 3 wks ago, as ALU traded lower on NOK’s Q1 earnings miss creating 33% upside to our €4.15 PT.
* We now believe there is a greater possibility NOK and ALU renegotiate the merger terms, as ALU stock has fallen 27% from the original €4.28/shr implied purchase price and others could join ALU’s #2 shareholder who publicly stated it does not plan to tender its stock under the current terms. We believe the probability Nokia sweetens deal by adding a cash component is now higher.
* We do believe ALU could miss Q1 Street estimates following in ERIC and NOK’s footsteps on slower US spending; however, we believe that is now largely reflected in ALU shares, which now trade with NOK due to the fixed merger ratio.
* On the flipside, ALU shares could also benefit should Nokia make a positive announcement, such as selling its HERE business or negotiating a new licensing agreement with Samsung. We anticipate both catalysts within the next year.
* Our Bear Case price for ALU is €2.90, based on a 1.0xEV/’15 rev for routing and 0.5x EV/’15 rev for others, equal to levels for distressed assets. We do not believe regulatory approval in the U.S. is guaranteed, which aside from shareholder backlash appears to be the biggest risk factor for the deal not closing.
* We also believe ALU would be in a better position than Nokia should the deal break, as ALU has a well-diversified business across optical, routing, fixed access, and wireless vs. Nokia’s exposure to just wireless – exactly the premise NOK gave for the deal in the first place. We believe ALU shares are also attractive on a standalone basis, and our €4.15 PT equates to a 13.8x P/E on ’16 EPS of €0.30, assuming normalized op margin of 10%, a discount to our NOK PT at 16x P/E.