For the investor or potential investor in another company the result Microsoft presented is great news. This other company is the Finnish telecom producer Nokia (NYSE:NOK). The underlying reason is not that Nokia is short in Microsoft shares. But that in the result Microsoft presented was a quadrupled sale of their smartphone platform Windows Phone. As Nokia is the prime company using the Microsoft platform in its smartphones, this indicates a hefty increase in the sales of Nokia Lumina model WP sales.
Nokia was until a few years ago the dominant producer of cellular phones having at its peak a 40% market share. This while upholding a 30% profit margin, something rarely seen in consumer products. The company still holds a firm grip on the cellular phone segment but missed out on the next generation item in this segment, the smartphone. Apple (NASDAQ:AAPL) instead became the dominant producer in this segment. As margins diminish for producers of cellular phones they are still high for those making smartphones.
As Nokia saw revenues diminish and unsuccessfully took a first try at the smartphone market it became a high cost firm selling low cost products and losses mounted. After trying its own hardware and software it finally declared defeat and hooked up with Microsoft. Nokia is what many would call a company born with a golden spoon, in other words it is lucky as well as having a good sense of what consumers want. The luck bit is taking the flagship smartphone to the market at the same time its biggest competition struggle to perfect their own product and engage in fierce legal battles with each other. The skill bit is choosing a good partner in Microsoft and (re)establish its brand as the next best thing. Be it by necessity or by choice, Nokia has in Microsoft gained access to one of the most important partners there is for the future of this market. As the integration between items of communication goes further, having access to the Windows platform is likely to show itself integral to this process, as most employers and most employees use Windows software.
Returning to today, Nokia is currently valued below fire sale value which for a producing firm is quite rare. The value of the firm taking only cash assets and income from non-production (licenses etc.) is between €2.81-2.98. Going concern valuation is €4.25-5.1. In other words if Nokia fails in the smartphone segment and goes bankrupt this would yield at minimum a return of 8.49 % of invested assuming Nov. 29 closing price. Assuming Nokia sold as many phones as Microsoft sold WP platforms, this indicates around 3 million smartphones sold. Taking the breakeven level based on Nokia estimates of 1 million and the segment average profit-margin of 35%, the profit generated at worst would be €255 billion, at best € 511 billion.
Worst case scenario would be a Q4 EPS of €0.03, best case €0.31. In any case a loss is unlikely and as the share is priced below what an investor would gain from a bankruptcy, it is a quite risk free investment at the moment.
Valuating the future value of the share is fairly complex as the numbers of variables are extensive and the consumer market is volatile. As stated above I believe that as demand for integrated access increases, the demand for Windows integrated phones will follow. Not implying that the Windows platform is better or worse than any other but as Windows is the predominant platform used, users likely will have an increasing demand on phones compatible with their operating system. The assumption is thereby that demand for WP platforms will increase. Nokia is in the process of trimming the cost structure to be able to pay its operations by sales of regular cellular phones; this will likely have a negative effect on licensing income as R&D investments will be reduced.
In the scenario where the effort on smartphones fail, Nokia will become a mass producer of cheaper cellular phones mostly sold to developing countries. Likely in this scenario much of the production will be transferred to low cost countries and cost-effectiveness will be the management's priority. This scenario should have little effect on shareholders as the revenue-cost structure will be in line with the company's new business model.
In the scenario where the smartphone segment succeeds, the valuation of the company will likely drastically change. Having a business where other segments' revenue matches costs gives freedom to invest profits accordingly. Companies that have experienced a brush with failing also tend to be highly efficient long after.
The scenario where an investor will lose is one where the company sticks to believing it's the world's best while it's the world's worst. This scenario means that the liquidity is drained and the gains are non-existing.
The three scenarios and/or a mix will be the likely future of Nokia. The one I believe the least in is the last. Nokia spent five years going with this assumption and utterly failed, therefore I would see a return to that business model as unlikely.
Most likely is that a shareholder will own a company producing low-margin products focusing on cutting costs, becoming a company with ok return. If succeeding on the smartphone segment of the market, they'll be returning a yield to shareholders. With the valuation today an investment is going to give a positive return, but the question is how big.
Investing in Nokia today can be compared to finding a Monet at a garage sale for €1. If it's authentic the buyer will be rich, if it's false it is at least sellable as a replica. Either way the buyer gains, the only question is how much.