I've written a few articles on why Nokia (NOK) will outperform Apple (AAPL) starting back in mid-September. Since my first article, indeed NOK has vastly outperformed AAPL -- NOK is up 21% while AAPL is down 16%.
My argument all along has been that the sum of its parts makes NOK a strong buy. My focus hasn't been on the smartphone business, where NOK is getting its clock cleaned by the iPhone and Android phones. However, I did say that if the Lumia phones were to gain any traction, then NOK could be worth significantly more than my calculation of the sum of its parts. Let's revisit my initial computation of the sum of its parts and compare it to where NOK is currently trading.
The company has an expansive patent portfolio, and there is a steady stream of payments to Nokia for the use of its patents to the tune of 500 million euros per year (around $650 million, assuming a conversion rate of 1.3 dollars per euro). Nokia owns over 10,000 patent families after investing more than 45 billion euros over time.
Nokia has one of the strongest and broadest patent portfolios in the industry, extending across all major cellular and mobile communications standards, software and services, hardware and user interface features and functionalities. Nokia's patent portfolio has been estimated to be worth as much €6B to an acquirer (or roughly 12 times annual royalties).
Typically, when you are calculating the value of a company the patents are the hardest to value because most patents lie dormant and are not monetized -- except NOK already generates $600 million in royalty income annually. A multiple of 12 times annual royalty income isn't that insane of a valuation.
Nokia Siemens Networks
Nokia Siemens Networks (NSN) is a joint venture between Nokia and Siemens. After third quarter 2012 it is now the third largest telecom equipment manufacturer other than Ericsson (ERIC) and Huawei. NSN serves evolving needs of network operators from GSM to LTE wireless standards, a base of over 600 customers in more than 150 countries serving over 2.5 billion subscribers. The company's global customer base includes network operators such as Bharti Airtel, China Mobile, Deutsche Telekom, France Telecom, Softbank, Telefonica O2, Verizon, and Vodafone.
NSN recently generated profits for the thirrd consecutive quarter and is benefiting from the build-out of high-speed wireless technology networks, a trend that will continue for the foreseeable future. NSN generated roughly $18 billion in sales in 2011. Ericsson generated $33 billion in revenues. The market cap of Ericsson is roughly $30 billion, or one times sales. If we assume a 0.33 multiple for NSN, you arrive at a market cap of $6 billion for the NSN division.
Navteq was purchased by Nokia in 2008 for $8.1 billion. The technology behind Navteq is based on user-observed geographic features as opposed to maps provided by the government. That is, the technology is more open source and provided by users similar to Google Maps in a way. Navteq's digital map data not only enables door-to-door routing throughout Europe and North America, it also contains millions of points of interest (POIs), making it easy to locate everything from restaurants to hospitals and gas stations. It holds a 90% market share in the car manufacturers industry and it has been selected by Garmin, Magellan, Sony, LG, and other important PND vendors to enable their devices.
Navteq is a high margin business and, in my opinion, it should be valued at around three times sales. Navteq's 2010 sales grew 50% from a year ago to 1 billion euros, while its operating loss narrowed to 225 million. A valuation of three times sales would be around 3.9 billion euros.
Nokia continues to invest in its mapping technology, as evidenced by its recent purchase of Earthmine, and it continues to gain traction in the enterprise market. Oracle (ORCL) recently signed a deal with Nokia that will expand the usage of Nokia's store of map data and location services to its enterprise customers. Additionally, Amazon (AMZN) is using Nokia Maps and Groupon (GRPN) Local Deals are being added to Nokia Maps.
The Oracle deal is important because it expands Nokia's reach to business customers, who can use the location services to map out things specific to their own needs. Companies can now integrate Nokia's mapping technology with Oracle-based software. The biggest advantage Nokia Maps has over Google Maps or Apple Maps is that it is not reliant upon a data connection. This is very important and is a major reason why Nokia navigation technology owns 90% of the automobile market. Again, I'm only using a valuation of 3.9 billion euros, or 3 times sales, which I believe is conservative given its market share and revenue growth.
Below is a calculation of the sum of Nokia's parts:
- Nokia-Siemens: $6.0 billion
- Patents: $7.7 billion
- Navteq: $5.0 billion
- Net Cash: 6.3 billion
- Total: $25 billion
- Current Market Cap: $13.2 billion
But Nokia Is Still Losing Money
This is true -- Nokia is still not operating at a profit. However, the cash losses per quarter are roughly $200 million. It would take a long time for NOK to wipe out its net cash of $6 billion. Right now the business is worth 100% higher than the current valuation of the company based on the above sum of its parts. If you assign a 25% discount to patents/Navteq and assume it loses $2 billion more restructuring the business, you still get $20 billion, which is 50% higher than the current market cap.
What About the Smartphone Business?
I always believe it's important to be extremely conservative in your calculations of the valuation of a company, because a variety of things can go wrong at any time and you want to make sure that you are buying something with a huge margin of safety. To this end, I have assigned $0 valuation to the smartphone division with good reason.
Nokia's market share in this segment has fallen from third overall to seventh. While Microsoft has put a lot of marketing muscle behind Windows 8, I still believe its safe to assume no value to this division. Any traction in this segment will only add more value to an undervalued stock.
In conclusion, I believe NOK is conservatively worth 100% more than what it is currently trading at. This valuation assumes significant write-downs in all segments of NOK's business. I believe analysts and the investment community are too focused on its cell phone business, which now is only a small part of its overall business. Instead, investors should focus on the sum of NOK's parts. Then they will realize how cheap it is.