Focus Article: Nokia Corporation (NOK)

Nokia Corporation (NOK) $1.80

The Company:

Given the dearth of good candidates based on a review of insider data last week, I decided to do something different and write about a potential turnaround stock for this week’s weekly focus article. While discussing Nokia with my analyst last week, I remarked that it was incredible that Microsoft (MSFT) paid $8.5 billion to acquire Skype and Google (GOOG) paid $9.6 billion (enterprise value) to acquire Motorola Mobility,  yet Nokia trades for an enterprise value of below $1 billion. It was a little ironic that we were having this conversation on Skype and not on Nokia phones.

There is little doubt that Nokia (NOK) and Research In Motion (RIMM) have been playing catch up with the Apple iPhone and Google’s Android OS and that both stocks have been classic value traps that looked great in the rear view mirror. To add to the competition, Amazon.com (AMZN) is said to be planning to build a Foxconn-made smartphone. As someone who has used multiple RIMM products, various versions of the iPhone and several Android phones, I have no delusions about either company catching up anytime soon and hence have avoided both Nokia and Research In Motion except for some call spreads on RIMM.

I did however starting nibbling on Nokia a couple of weeks ago and plan on adding more this week. The primary reason is the value of Nokia’s patents and the potential of a turnaround. Given Nokia’s current state where Apple and Google are eating Nokia’s lunch in the rapidly evolving smartphone market and Chinese manufacturers are eating Nokia’s dinner in the low end feature phone market, it is easy to forget Nokia’s history and innovation.

Founded in 1865, the company started as a paper manufacturing company and was involved in many other industries like car and bicycle tires, footwear, communications cables, televisions and other consumer electronics, personal computers, electricity generation machinery, robotics, capacitors, military communications and equipment.

Nokia became involved in the telecommunications industry in the 1970’s by developing the Nokia DX 200, a digital switch for telephone exchanges and introduced one of the world’s first handheld phones in 1987. Nokia was one of the key developers of GSM (Global System for Mobile Communications) and was involved in the development of several wireless technologies including GPRS, EDGE, W-CDMA, HSPA, LTE and Wi-Fi technologies, which are seen in most 3G mobile handsets.

Having spent almost $62 billion in R&D in the last two decades, the company has one of the strongest patent portfolios in the wireless industry with 30,000 patents and around 10,000 patented innovations. We have discussed the potential value of these patents in the business statistics section below.

Nokia launched four Lumia devices last year, the latest being the Nokia Lumia 900 which runs on the Windows Phone 7.5 Operating Software. Reviews for Nokia Lumia 900 on Amazon.com have been very positive and the phone has managed to stay on Amazon’s top 10 phones for AT&T several months after launch. The phone has also managed to generate a lot of interest in India (based on Google Trends data). India is the second largest market for Nokia after China, generating nearly $3 billion in annual revenue.

Business Statistics & Financials:

Attempting to value Nokia based on traditional valuation metrics would be a fool’s errand. The stock is undeniably cheap based on trailing metrics as the company is trading for less than 1 times EBITDA and just 0.16 times sales. However, the business landscape for Nokia is very challenging right now with Q1 revenue for the devices and services division down 40% Year-over-Year. The company reported negative operating margins for both its devices division and the Nokia Siemens networking division.

Instead of attempting to use standard metrics or building a DCF model, we are considering the potential value of Nokia’s patent portfolio below.

Value of Nokia’s Patents:

Applying this average acquisition price of $470,198 to Nokia’s 30,000 patents give us a value of $14.1 billion for Nokia’s patent portfolio. Using the low end of the deals listed above of $220,588/patent, we get a value of $6.62 billion and using the high end of this range at $750,000/patent, we get a value of $22.49 billion. Based on the close on Tuesday, Nokia has a market cap of $6.68 billion and an enterprise value of just 507.37 million.

Nokia’s patent portfolio is not a passive asset and generated royalty revenue of 450 million Euros or $587.65 million in 2011 (using the Euro to US Dollar conversion rate of 1.3059 from the end of 2011).

Beyond Nokia’s patent portfolio, the company has  other valuable assets and divisions such as their location and commerce division that generated operating profits in Q1 and saw 19% revenue growth Year-over-Year. The Nokia Siemens networking division generated over $18 billion in annual sales in 2011, accounting for more than a third of total revenue.

Competitors:

Risk factors:

1. Last month Microsoft introduced the Windows Phone 8 operating system to developers but also made it clear that devices currently running on Windows Phone 7 cannot be upgraded to Windows Phone 8. This news has come as another challenge to the company just when the Lumia 900 was selling well.

2. Microsoft has indicated that it wants to focus more on hardware in the years ahead and this could mean that the partnership between Nokia and Microsoft is not as strong as the market was initially led to believe.

3. On June 15, 2012, Moody’s lowered Nokia’s bond ratings from Ba1 to Baaa3. The company continues to post operating losses and there is a good chance it may burn through existing cash before it can turn the ship around.

Conclusion:

The competitive environment for mobile devices looks very bleak for Nokia and the company is clearly struggling to find direction. Positive reviews and strong initial interest aside, the Lumia 900 might not be enough to save the company as it is losing revenue on both the high end and the low end of its market. That said, the company does have several financial and business options including conserving cash by suspending its dividend, selling its patent portfolio, selling certain divisions, splitting the company and adopting a dual strategy by building both Windows and Android smartphones.

The market is essentially pricing the stock for bankruptcy despite the fact that the company has nearly $6 billion in net cash on its balance sheet. Given the company’s cash rich position and the different options it has to conserve cash or increase the strength of its balance sheet, I believe the company has sufficient runway to either turn itself around or find a suitor.