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Nokia (NYSE:NOK) has long been at the losing end of the smartphone market dominated by Apple (NASDAQ:AAPL) and Samsung (OTC:SSNLF). The slumbering giant has recently woken up to the ever-changing dynamics of the industry by targeting the Asha series at the price sensitive emerging markets like India, Eastern Europe and Latin America, and the Lumia series at the developed markets. Thus far, the two-pronged strategy seems to be working well for Nokia.

This is evident from the fact that Nokia shares have surged forward by nearly 70% since the release of the Lumia, and rose by 25% in the past 3 trading sessions, while the rest of the technology sector has witnessed little or no change. During the same period, Apple has dropped almost 4%.

Business Overview

Nokia has a market capitalization of nearly $17 billion, and employs more than 130,000 people across Europe, Asia and the Americas. Nokia has three operating segments: Devices & Services; NAVTEQ, and Nokia Siemens Networks.

Devices & Services is responsible for developing and managing the Company's portfolio of feature phone and mobile phones. This division generates the bulk of the revenues (61%) and brings in the lion's share of the operating profits (86%).

NAVTEQ offers context and geographical services through Ovi Maps and forms a miniscule 3% of the total business of Nokia. Nokia Siemens Networks is a provider of telecommunications infrastructure hardware and is responsible for the remaining 36% of the business.

Key drivers

  • Nokia's future is banking heavily on the performance of the Windows Phone 8 platform as it holds between 50-70% of the Windows Phone market.
  • Budget smartphones are going to provide the next growth phase in the mobiles space, and the growth will be primarily fueled by the developing markets.
  • The combined advertising budget of Nokia and Microsoft running into billions of dollars for their Lumia series and Windows 8 platform is sure to have a huge impact on the sales of Lumia series.

Positives

  • Budget smartphone growth

Nokia has ideally placed its Asha series to take advantage of the booming demand for budget smartphones. Nokia already derives nearly 20% of its revenues from China and India, where it primarily sells feature phones and budget smartphones. Nokia sold a total of 15.9 million smartphones, including 9.3 million Asha full-touch phones.

  • Colorful and peppy Lumia 920 sell out

News was abound about Lumia 920 smartphone selling out within the first 20 minutes of going on sale in some markets, showing the rejuvenated buyer interest in the Lumia series of smartphones. It sold upwards of 16 million smartphone is the previous quarter.

  • Strong app market for Windows 8

The Windows 8 platform already has a 200,000 strong apps marketplace, and is continuing to attract developers from other ecosystems.

  • Device (mobile) division in the green

Nokia has declared an operating profit for the most recent quarter for the mobile devices division, though the Nokia group continues to net a loss.

  • Positive free cash flow

Nokia is expected to have a positive free cash flow to the tune of $1.4 billion, in spite of having a negative operating cash flow of $360 million.

  • Low valuations

Nokia is currently trading at a price to sales (P/S) of 0.4, compared to the industry average of 0.95. The price to book value (P/B) is also lower at 1.65, while the industry average is 1.96.

Investment Risks

  • The key risk is the difficulty in getting customers to migrate from Android (Google) and iOS (Apple) platforms to the new WP8 platform in considerable numbers.
  • Operating loss: Nokia is expected to continue experiencing operational losses well into 2013, before turning positive in 2014. The total operating loss for 2012 is expected to be in the vicinity of $900 million.
  • Diminishing cash position: Nokia's cash position has considerably depleted over the past 2 years from $9.3 billion in 2010 to $4.8 billion at the end of 2012.
  • Reducing dividend payout.

Competitive Environment

Nokia faces severe competition from Apple and Google (NASDAQ:GOOG) for the smartphone market share, and from RIM (RIMM) for providing a third alternative to customers. RIM is a more realistic competition than either the much larger Apple or Google. They also operate at much higher margins of upwards of 30% compared to -3% for Nokia. Even on the trading multiples front, Apple and Google trade at a much higher P/S of 3 and 5 respectively compared to just 0.4 for Nokia, making it a very attractive proposition if Nokia continues on its current course.

Recommendation

Despite the negative financials, it is clearly visible that Nokia is making steady inroads into the market dominated by Apple and Samsung, aided by its partnership with Microsoft. Considering the increasing Lumia sales, and the booming market for the budget Asha smartphones, the author sees a great opportunity to lap up a strong company at cheap valuations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Nokia: Driven By Lumia And Asha