It's been 6 months since I wrote an article about how Nokia had significantly more upside than Apple (AAPL) and in that time the outperformance is staggering: Since September 14, 2012 Nokia (NOK) is up 25% while AAPL is down 38%. While it seems obvious in hindsight, take a look back at the comments in response to my article to see how hated this idea was at the time. Going forward, I continue to believe that NOK will outperform AAPL and by a wide margin.
Today NOK published its 20-F (annual report for a foreign corp.) and there are some very important takeaways from this report, primarily in the long-term guidance / targets section but also in the information it laid out regarding payments to / from Microsoft (MSFT), its main partner in its Devices and Services segment. After reading through this report I am moving up my assessment of the value of NOK based on the sum of its parts.
Devices and Services segment:
This segment includes handheld devices and smartphones. Nokia is now guiding for operating margins of 10% or more in this segment and for net sales to grow faster than the market. Let's take a look at how that compares with prior periods.
It looks like this guidance is roughly in line with figures from 2010. Keep in mind, though, that they also guided for 10% operating margins in 2011, right before the bottom fell out. While I'm not saying they won't meet this target, it's important to keep this in context. Having said that, a lot more is known now about the impact competitors are having on the smartphone business and it's likely that this guidance is a bit more reliable. If the segment is to grow marginally in terms of revenues (from the EUR 5.4 billion level in 2012), then applying a 10% operating margin to this division should add a good deal of value to my assessment of the sum of the parts of Nokia, which I have laid out at the end of this article. I previously assigned no value to this segment.
Nokia Siemens Network segment:
Guidance calls for long-term operating margins of this segment to be between 5% and 10%.
Per the 20-F:
In November, 2011, Nokia Siemens Networks announced its strategy to focus on mobile broadband and services and the launch of an extensive global restructuring program. Nokia Siemens Networks continues to target to reduce its annualized operating expenses and production overheads, excluding special items and purchase price accounting related items, by more than EUR 1 billion by the end of 2013, compared to the end of 2011. While these savings are expected to come largely from organizational streamlining, it has also targeted areas such as real estate, information technology, product and service procurement costs, overall general and administrative expenses, and a significant reduction of suppliers in order to further lower costs and improve quality.
During 2012, Nokia Siemens Networks recognized restructuring charges and other associated items of EUR 1.3 billion related to this restructuring program, resulting in cumulative charges of approximately EUR 1.3 billion. In total we now expect cumulative Nokia Siemens Networks restructuring charges of approximately EUR 1.3 billion by the end of 2013, virtually all of which have now been recognized. By the end of 2012, Nokia Siemens Networks had cumulative restructuring related cash outflows of approximately EUR 650 million related to this restructuring program. Nokia Siemens Networks expects restructuring-related cash outflows to be approximately EUR 450 million for the full year 2013, and approximately EUR 200 million for the full year 2014 related to this restructuring program.
In looking at the results for this segment, after backing out restructuring charges, the entirety of which (EUR 1.3 billion) was applied to 2012 earnings, earnings for this segment were EUR 500 million on sales of EUR 13.8 billion.
Payments to / from Microsoft:
Per the 20-F:
Our agreement with Microsoft includes platform support payments from Microsoft to us as well as software royalty payments from us to Microsoft. Under the terms of the agreement governing the platform support payments, the amount of each quarterly platform support payment is USD 250 million. We have a competitive software royalty structure, which includes annual minimum software royalty commitments that vary over the life of the agreement. Software royalty payments, with minimum commitments are paid quarterly. Over the life of the agreement, both the platform support payments and the minimum software royalty commitments are expected to measure in the billions of US dollars. Over the life of the agreement the total amount of the platform support payments is expected to slightly exceed the total amount of the minimum software royalty commitment payments. As of the end of 2012, the amount of platform support payments received by Nokia has exceeded the amount of minimum software royalty commitment payments made to Microsoft, thus the net cash flows have been in our favor. As a result, the remaining minimum software royalty commitment payments are expected to exceed the remaining platform support payments by a total of approximately EUR 0.5 billion over the remaining life of the agreement. However, in 2013 the amount of the platform support payments is expected to slightly exceed the total amount of the minimum software royalty commitment payments, thus the net cash flows are still expected to be slightly in our favor. In accordance with the terms of the agreement, the platform support payments and annual minimum software royalty commitment payments continue for a corresponding period of time. We have recognized a portion of the received platform support payments as a benefit to our Smart Devices cost of goods sold and the remainder as a liability as part of accrued expenses and other liabilities on our balance sheet.
Location and Commerce (formerly Navteq)
Nothing in particular sticks out here. Nokia's goodwill impairment testing did not result in impairment charges for 2012. An impairment loss was recorded with respect to their Location and Commerce division in 2011. However, no further impairment charges were recorded with respect to the other CGUs in 2011.
Nokia Sum of Parts:
In assessing the value of the sum of the parts of Nokia, I have updated a few things:
(1) I removed a zero value for the Devices and Services segment in light of the company's expectation of the group to not only grow faster than the overall market, but to also achieve profitability. In assessing the valuation of this division, I used the current market value of BlackBerry (BBRY) relative to sales and assigned a 50% reduction. BBRY currently trades at a price to trailing twelve months (TTM) sales ratio of 0.54 (using 6.81 billion market cap divided by TTM revenues of 12.6 billion). In applying a 50% discount to this valuation and assuming sales growth of 5% from 2012's EUR 5.4 billion, and also using a EUR to USD conversion rate of 1.3, I arrive at a valuation of $2 billion USD.
(2) I have updated the valuation of Nokia Siemens Network to account for updated 2012 numbers. I am using the valuation of Ericsson (ERIC) and assigned a 15% discount to their valuation. ERIC currently trades at a price to sales ratio of 1.16 and a price to forward earnings ratio of 17.27. For a valuation estimate, I am using 2012 figures of EUR 13.8 billion and operating income of EUR 500 million and applying a 30% tax rate to operating income, an assumed 3% and 10% growth rate in revenues and earnings (below ERIC EPS expectations), respectively, and using a EUR to USD conversion rate of 1.3. In doing this calculation I arrive at 2013 estimates of $18.5 billion in sales and $500 million net profit. Applying a 15% discount to valuation ratio of ERIC I arrive at a valuation of between $7.3 billion and $18 billion, which is a huge range. I have decided to take the average of the two and apply a 20% discount. This equates to a value of $10.2 billion.
(3) Patents - I haven't updated my valuation of this asset. 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). I'm maintaining a multiple of 12 times annual royalty income for this segment.
(4) I'm applying a further 20% discount to the value of Navteq just to be conservative. My valuation goes from $5.0 billion to $4.2 billion.
In summary, below is a calculation of the sum of Nokia's parts:
Nokia-Siemens: $10.2 billion
Patents: $7.8 billion
Navteq: $5.0 billion
Devices & Services: $2.0 billion
Net Cash: 5.0 billion
Total: $30 billion
Current Market Cap: $13.7 billion
In assessing the above figures, I recommend purchasing shares of NOK below $5. The sum of the parts of NOK equates to a valuation of $8 per share.