Nokia's (NOK) shares have had a roller coaster ride over the past few weeks, rising to a high of over $4.70 on expectations of a strong Q4 before a series of negative developments pulled the stock down below the psychological $4 mark last week.
While the initial sell-off was triggered by an unexpected dividend cut and a cautious next quarter outlook, most of the recent nervousness seems to be on account of unsubstantiated rumors coming out of India regarding a tax-evasion case filed by the IT department there. Quoting a "secret source," Economic Times, an Indian daily, claimed that Nokia would have to pay about $2.45 billion in IT charges before March 31, of which over $550 million are for tax violations and the rest ($1.9 billion) for transfer pricing issues.
While the sum quoted is a big figure and could shave almost 13% off our $5 price estimate for Nokia, it is important to take note of what has happened in a similar dispute between Vodafone and the Indian government. The carrier is accused of owing the Indian IT department over $2.2 billion in taxes with regard to its purchase of Hutchison Essar in 2007. Early last year, the Supreme Court ruled in Vodafone's favor and dismissed the government’s case. However, the tax laws were then amended retrospectively to override the SC’s ruling. Amid criticisms over the government’s approach in this case, India seems to have now agreed to settlement talks with Vodafone. Nokia's case may not be exactly the same but the precedent shows that damage may not be immediate and, if any, could be limited.
Turnaround Story in All Divisions
Moreover, all of Nokia's business divisions seem to be recovering well. The company's latest Windows Phones, which were off to a flying start during the holiday season, seem to be sustaining their success in Q1 2013. At Verizon, the white Lumia 822 is one of the top-selling smartphones and the red colored one is back in stock ahead of Valentine's Day. In the U.K., Germany, and Japan, Lumia is performing extremely well reaching Expansys' top-seller lists in each of these countries. In the world’s largest smartphone market, China, Lumia 920 models seem to be off to a very good start, selling out at multiple China Mobile stores.
Furthermore, the company has been successful in monetizing its treasure trove of patents quite well with wins over Apple and BlackBerry in recent years. We estimate that Nokia's patents could be worth about $4 billion in value (at the current royalty run rate), more than a quarter of its current market capitalization (see "RIM Settlement Shows There Is Value In Nokia's Patents").
Nokia's infrastructure JV with Siemens, Nokia Siemens Networks, is also turning the corner after a restructuring that has not only helped operating margins improve but also restored focus on its wireless business. As a result, NSN is fast emerging as the leader in the ongoing LTE transition around the world and has taken share away from competitors recently (see "Nokia Gets A Boost As Its Infrastructure JV Returns To Strength On LTE Wins"). We estimate this division to account for about 35% of Nokia's fair value.
Navteq, Nokia's navigation business that it is leveraging to provide location-related services on its smartphones, is also returning to strength as can be gleaned from the company's financials. Operating margins were close to 14% for last year, having recovered well from 2011's 4.4%. Moreover, Nokia continues to win new mapping contracts with car manufacturers, the latest being Toyota which will install the Here Local Search in European vehicles from 2014. Last year, it was Ford which chose Nokia's mapping content over Google's. Nokia notes that almost 80% of all cars that come with pre-fitted navigation systems use HERE maps. This is a small division for Nokia and constitutes only about 11% of Nokia's fair value by our estimates. But, going by the increasing efforts by Apple and Google towards differentiating mobile ecosystems through location services, it has a much bigger strategic importance for Nokia.
Overall, the risk from the ongoing tax investigation in India is overshadowed to a large extent by the ongoing turnaround in all of Nokia's business divisions. We believe that even a small improvement in Nokia's handset business, together with its patent monetization initiatives and the ongoing turnaround in Nokia Siemens Networks, should help it realize what we estimate to be fair value for the stock.
Disclosure: No positions.