Nokia (NOK) is set to announce its Q4 FY 2012 earnings on January 24. As the company has already indicated in its pre-earnings guidance, its debut Windows Phone 8 devices were off to a flying start during the holiday season. Lumia’s shipment volume of 4.4 million units was more than four times the same in the fourth quarter of 2011. While there seemed to be high demand for the new Lumia Windows Phone 8 smartphones with various retailers and carrier partners in the U.S., Europe and China reporting stock sell out throughout Q4, it wasn’t clear if the same was due to limited supply of the Lumias. The Q4 guidance lifted a fair bit of that uncertainty and with Windows Phones finally outselling Symbian and Meego models (by 2:1), a new era at Nokia seems to have finally begun. Moreover, as a result of the solid performance, Nokia expects its devices division to regain underlying profitability in Q4 2012.
The rising optimism surrounding Nokia’s comeback bid with Windows Phones, has lifted its shares by over 60% in the past three months, bringing it closer to our $4.90 price estimate. However, it still remains to be seen how much of the Lumia mix was driven by Windows Phone 8 volume, and if the shipment volume was propped up by some of the older Lumias that were deeply discounted. We will therefore be keeping a close tab on Lumia’s ASP (average selling price) figures during the earnings call.
Further, the coming months will be very important for Lumia since Nokia will need to work hard to ensure that the demand doesn’t fizzle out post the initial euphoria in order to stage a turnaround in its smartphone business. Still, we believe that even a small improvement in Nokia’s handset business, together with its patent monetization initiatives and the ongoing turnaround in the wireless infrastructure joint venture with Siemens, should help it at least sustain the value that the market is currently assigning to the stock despite the huge rally in recent months.
Carrier Support And Microsoft Partnership Key
Nokia’s strong start to its latest Lumia launch, especially in the U.S., is a good launchpad for the company to build it into a bigger success. The U.S. smartphone market is extremely crucial for handset makers since success here generally translates into positive consumer sentiment in other markets. However, Nokia has traditionally lagged rivals in this very important smartphone market due to a lack of strong carrier relationships. This time however, the company has aimed to set the record straight by launching customized variants of the Lumia with multiple U.S. carriers – a move that allows it to get the most marketing dollars behind the Lumia brand.
Further, Nokia is pushing Lumia hard in China, which is expected to supplant the U.S. as the world’s biggest smartphone market by the end of the year. Nokia has already launched the Lumia 800C, announced the cheaper Lumia 610 on China Telecom, and has roped in China Mobile as well for its WP8 plans. 3G penetration is still at a lowly 20% in China, and the carriers there are actively trying to transition their huge 2G base to 3G. With a billion strong mobile subscriber base and growing demand for 3G services, China presents Nokia with a huge opportunity to create a smartphone niche for itself.
Where carrier partnerships have not been hard to come by for Nokia, getting people to warm up to the Windows ecosystem has proved increasingly tough considering how well entrenched Android and iOS have become as mobile ecosystems. This is where WP8 offers both, Nokia and Microsoft, their best chance to find a place in the growing mobile market. While building Windows 8 and WP8, Microsoft ensured that both share the same kernel and therefore inherit the same rich feature set that has made Windows a household name in the PC industry. This will help integrate the two platforms closely, thereby making apps developed for either platform easier to port. Having a huge user base for its Windows PC platform will therefore help Microsoft generate significant support for the new integrated Windows8/WP8 user experience, driving the sales of Windows Phones in general and the Lumia in particular.
NSN Is The Dark Horse
While the spotlight has been mainly on Nokia’s smartphone business of late, its oft-ignored telecom joint venture with Siemens seems to be finally turning the corner. Nokia Siemens Networks (NSN) recently issued positive guidance for the fourth quarter 2012, announcing that its operating margins (non-IFRS) will exceed its previous guidance on the higher end by at least 100 basis points. This continues the good show NSN has put on in recent quarters with a good number of LTE wins in the Asia-Pacific, where Japan and Korea are driving a bulk of the LTE spend currently. What’s more, as the LTE transition continues in full swing, NSN has managed to snag a couple of important 4G deals with T-Mobile and U.S. Cellular in the U.S. – a region where NSN’s 4G prospects have been pretty dismal until recently.
Apart from revenue share gains, NSN is also benefiting from a major restructuring initiative which was announced in late 2011. As a part of the restructuring, NSN is aiming to cut around 17,000 jobs and achieve a total of 1 billion Euros in savings, by the end of 2013. Simultaneously, NSN is selling off non-core assets and increasing focus on wireless broadband which has strong long-term growth trends as opposed to the relatively stagnant landline market. As a result of the reshuffle, NSN has performed really well in 2012, returning to operating profitability in the last two quarters of the year, a big positive sign that the company’s cost-cutting initiatives are taking hold.
Consequently, the division has generated positive cash flows for four straight quarters now, and accounts for more than 35% of our price estimate for Nokia’s stock. Our price estimate is about 10% ahead of the current market price.