Nokia's a Juggernaut, But What's Left to Conquer?

Nokia is not an "official" Magic Formula stock, but a foreign company with high earnings yield and return on capital as identified by the Magic Formula Investing Europe screen. A review is provided for those interested in applying the strategy's precepts to add international diversity to their portfolio.

Nokia (NOK) is the biggest maker of mobile devices in the world, with nearly 40% global market share of the handset market, which dwarfs that of competitors Motorola (MOT), Samsung (SSDIF.PK), and LG (LGERF.PK). The company is exceptionally strong internationally, with a #1 market share in nearly all markets it serves, and sells over 90% of units outside of the North American market.

The Nokia Siemens Network Group contributes nearly 35% of revenues by supplying equipment and infrastructure to network providers to implement cellular standards such as GSM, and data standards such as EDGE and 3G protocols. The recent acquisition of GPS mapmaker NAVTEQ added about 2% of recent sales at operating margins exceeding 20%.

Nokia's growth will primarily come from new cell phone purchasers in emerging economies like China and India. The company's exceptional scale allows it to produce a commodity product (low-end cell phones) at much cheaper prices than its competitors - a key advantage. Nokia's scale advantage here is so dominant that it allows the company to earn over 15% profit even on these entry-level units, while its most profitable competitor, Samsung, earns slightly above 13%. As prices continue to drop, only the firms able to produce at low enough prices will remain viable, and Nokia is clearly in the driver's seat here.

The company is also trying to grow its service offerings, expanding into music and games, and adding a big bet on location based services with the acquisition of NAVTEQ. In addition to earning incremental revenue from these services, it's also a good way to build brand loyalty (or, more to the point, customer lock-in), as users become accustomed to Nokia's services and opt to replace their existing phone with another Nokia model instead of jumping to a competitor.

Financially, Nokia is rock solid. The balance sheet has about EUR 5.5 billion against about EUR 4.4 billion in debt, about 70% of which are in short term notes (long-term debt is just EUR 860). Return on capital is very impressive. Since 2004, MFI ROIC is over 160%, amazing for a company of this size, and standard return on capital is equally impressive at 75%. Margins have been solid as well. Operating margin 5-year average is 13%, free cash flow margin 9%. Nokia also pays a solid dividend yield of close to 4% at current prices. The dividend was cut about 20% in January, but payout ratio with the new rate is in pretty safe territory.

Those margins and return on capital figures are a testament to Nokia's competitive moat. Most of this we covered earlier, as Nokia's economies of scale and dominant market share allow it to be the low cost producer in a commodity market. However, there is some question as to the durability of this moat. The cost advantage applies to purchasers of low-cost models, mainly in emerging markets, but it does not apply to the cell phone market that is emerging in the more developed economies of North America and Europe. Which brings us to the biggest risk...

Nokia is clearly facing some serious and effective competition in the high-end "smartphone" category, the fastest growing sub-sector of the market. While Nokia is still the world's biggest smartphone maker, competitors Apple (AAPL) with the iPhone and Research in Motion (RIMM) with the Blackberry have quickly gained market share and are now threatening Nokia in foreign markets as well.

Nokia's software solution was to fully acquire Symbian and open-source it, hopefully allowing a development community to fashion a smartphone operating system for them. This plan is risky, as Symbian is not inherently a smartphone OS like Apple's or RIM's. Smartphones are a very important niche to watch, as they clearly represent the future of mobile devices and provide significant lock-in potential for both consumers and developers. If Nokia falls behind here, it will be very difficult to catch up.

Nokia's current earnings yield is about 12.6% (about a 10 EV/E), quite cheap for such high margins, return on capital, and dividend yield. There are no serious competitors in the low-end market, and it's unlikely any new competitors will emerge here to challenge Nokia's dominance. Moreover, there should always be a market for people who want "just a phone!". Also, the network equipment group is in good position to benefit from constant upgrades to boost data transfer speeds (EDGE to 3G to 4G and beyond). This makes Nokia look like a good buy at current prices. However, it would certainly not be a Top Buy consideration due to a poor longer term outlook that will likely put a low ceiling on the earnings multiple.

Disclosure: Steve owns no position in any stocks discussed in this article.

Quick Look

Date: Apr 13, 2009
Growth: C
Competitive Moat: C+
Management: B+
Financial Health: B-
Opinion: Scale advantage, organic growth potential, fairly cheap.

Comments

[Fighting Yoda:]

Nokia will not be able to make any significant dent in teh smart phone market, with dominant presence of RIMM and Apple, and other emrging players - Samsung, HTC, Palm, etc. Also Symbian strategy is risky at best.
Smart phone is the growth and profitable sector, low end phones will have less growth and lesser margins in the current environment.

I will not be a buyer of Nokia.

Apr 17 02:45 AM

[metoo:]

Can you explain what you mean by "Symbian is not inherently a smartphone OS like Apple's or RIM's" and why those of Apple and RIM are ?
I am not aware of any technical reasons why one of them is not for true smartphones.

Apr 17 02:56 AM

[Zoltan L. K...:]

Smartphones are game changers and only partially a phone. As a manufacturer you will need more than just a nice brand a phone making experience. Apple is probably the best positioned player in this field. Rimm can go after business clients for a while.

Apr 17 06:41 AM

[Robert DiAl...:]

I am still long Apple. I took some profits finally. Held through the last drop though and that was rough.

Apr 17 07:13 AM

[Steve Alexa...:]

> Can you explain what you mean by "Symbian is not inherently a smartphone
> OS like Apple's or RIM's" and why those of Apple and RIM are ?<br/>I
> am not aware of any technical reasons why one of them is not for
> true smartphones.

Apple and RIM both designed their operating system to handle smartphone activities like email, internet, and so forth, and have structured them to be expandable through third party applications that utilize QWERTY keypads and other hardware features.

Symbian was historically developed for phone hardware - number keypads that could perform some tasks like text messaging. Trying to shape and mold this into a good smartphone OS will be a challenge. You need to have a lot of low level features like memory management, task switching, data protection, power management, and so forth. Symbian was not developed with these in mind and adapting an operating system can take as long as creating a new one.

Apr 17 10:01 AM

[Jon T:]

I find it incredible that this article can gloss over the marketshare falls that Nokia has experienced in the smartphone (ie most profitable) sector..

Nokia's days as a juggernaut are well behind it I'd say.

Apr 17 10:16 AM

[.crazylegs..:]

Difficult to recommend a stock that you, yourself don't have high regard for. The opinion and article contents don't seem to match your "Quick Look" stats.

Quick Look

Date: Apr 13, 2009
Growth: C
Competitive Moat: C+
Management: B+
Financial Health: B-
Opinion: Scale advantage, organic growth potential, fairly cheap.

Apr 17 10:28 AM

[mollytjm:]

Apples OS and Safari are geared toward complicated manipulation of large graphics programs, which is why a lot of major, commercial movies these days are being made on a Mac and why major news companies, like AP, use Macs. This all translates to a great 'phone' for gaming. Add an amazing screen, 25,000 apps and counting, and you have a smartphone for gamers that's ahead of the pack. I don't think Nokia will find it easy to develop an OS of this quality.
Long APPL

Apr 17 10:47 AM

[Martinta:]

Yoda - Gartner group states that Nokia had 44% of worldwide smartphone sales to end users in 2008 (check Gartner press release web site), which is more than the next four competitors, including RIM, Apple, HTC, and Sharp possess combined.

In the U.S., Nokia smartphones have negligible share, but internationally, where most smartphones are sold, they are dominant.


On Apr 17 02:45 AM Fighting Yoda wrote:

> Nokia will not be able to make any significant dent in teh smart
> phone market, with dominant presence of RIMM and Apple, and other
> emrging players - Samsung, HTC, Palm, etc. Also Symbian strategy
> is risky at best.
> Smart phone is the growth and profitable sector, low end phones will
> have less growth and lesser margins in the current environment.<br/>
>
> I will not be a buyer of Nokia.

Apr 17 02:56 PM

[Martinta:]

Thanks for the reply, but hasn't Nokia already made the necessary changes to the Symbian OS? How else are they able to produce the touchscreen Xpress5800, the E71, and the N95/97 which perform all of the popular smartphone features. Nokia has will also introduce the Ovi system, which I believe will include the ability to download applications.


On Apr 17 10:01 AM Steve Alexander (MagicDiligence) wrote:

> > Can you explain what you mean by "Symbian is not inherently a smartphone

Apr 17 02:59 PM

[JamesApple:]

An OS is a particular collection of executible programs that does 2 things: 1) to control and communicate with the hardware this OS is controlling, without this OS the hardware are totally unusable. 2) to provide services to other programs so that people can use the hardware through interfacing with programs. Of course, programs also provide services, or consume services of other programs.

Some programs are designed to be smart, some are designed for more mundane tasks. We would be the judge of what 'smart' is or is not.

Before Apple releases the IPhone running the iPhone OS on 29th of June 2007, there was no word 'smartphone'. As of 17th of April 2009, the world has only one de facto 'smartphone', and that is the iPhone, because of the iPhone OS it runs upon, other phones are not smartphones, whatever people say otherwise.

The world as of 17th of April 2009, do not understand what is a smartphone. The effort by Apple is not understood, thus cannot be appreciated by the world. People would simply call any phone a smartphone when they can know nothing about what it does and how it works differently than a dumbphone.

Sigh. It's really not that difficult.

iPhone is smart in 6 ways so far, to start;
1) iPhone OS has programs that keeps your internet always ON, wherever you are, whatever you do, iPhone keeps your Internet ON without you having to do anything; that is smart.
2) iPhone OS has programs that conserve energy without you doing anything. For example, when you hold the iPhone up to hour face to talk, the iPhone turns the screen light off, and when you finish talking and put the iPhone away from your face, the iPhone turns the light of the screen back on. Now that is smart.
3) iPhone is self aware of its geograhic location
4) iPhone is self aware of its screen orientation, whether if it is wing held upright or sideways
5) finger input instead of mouse, stylus, spin wheel or trackball, and multitouch allows you to expand or pinch the screen sizes.
6) iPhone output using intelligence makes the display sensible a d pleasing to you instead of rigid and unreadable. Now that's smart.

iPhone OS is built on one of the most robust and mature, solid OS running many of the world's largest corporate servers - Unix. Other phone vendors cannot compare with Apple. But then, who know, and who cares?

Apr 17 06:14 PM

[ArtfulDodger:]

Something left out of the article is that Nokia's management keeps its nose to the grindstone building its products, its balance sheet, and its marketing—not concerning itself with what its competitors are doing.

Unlike other companies, when you hear its management speak, they speak of their products and what they're doing—they refrain from commenting on their competitors'.

I like this about Nokia. I think it's a Finnish thing.

Truly, Nokia is a "juggernaut" everywhere but in the US, but I'm not giving up on the US market for Nokia.

Very good points in the article, SA. Thanks.

Long Nokia for the long haul.

Apr 18 08:33 AM

[Hayweed:]

In less than 2 years is apple now the most profitable cell phone provider in the world

Based on last quarter (Apple - using iphone nongaap earnings)

Apple $699 million
Rimm $518 million
Nokia $161 million
Sony Ericsson <$0
LG ?
Samsung ?

Apr 18 10:46 AM

[metoo:]

Steve Alexander wrote:
"Apple and RIM both designed their operating system to handle smartphone activities like email, internet, and so forth, and have structured them to be expandable through third party applications that utilize QWERTY keypads and other hardware features.
Symbian was historically developed for phone hardware - number keypads that could perform some tasks like text messaging. Trying to shape and mold this into a good smartphone OS will be a challenge. You need to have a lot of low level features like memory management, task switching, data protection, power management, and so forth. Symbian was not developed with these in mind and adapting an operating system can take as long as creating a new one. "

Answer: I think you have misinterpreted what Symbian is. In fact that was the first smart phone platform which was optimised for mobile phone platforms including task (inc. multi tasking) and power management. This is where e.g. Microsoft failed at the beginning ; mainly how the platform was optimised for real time operations of a smart phone and user experience. However, when you look at Apple's iPhone it still lacks a nr of very basic phone features which are even in the most basic phones these days (e.g. messaging). I do not understand your claims about the expandability: 3rd party applications, QWERTY support, internert, email etc. do exist as the basic platform features in Symbian (when combined with e.g. Nokia's S60 or UIQ; soon to be merged into Symbian Foundation platform).
I do not mind you preferring e.g. Apple's OS but let's keep the facts right. I am sure all these platforms mentioned will do eventually whatever designers want them to do. It is more about HOW they do it to please the end user (and that is less of a technology than a user experience design topic) and how affordable those products are for the mass market users (not only for those in the higher end price brackets).
BTW: "Smart phone" as a term has been in the industry for quite some time. It was not invented by Apple when launching iPhone. However. the iPhone launch (as well as RIM's products) prompted US market to finally wake up to the existence of higher end phones after the market was mainly populated by sub 200 USD mobile phones. It is good US is finally enjoying what the rest of the world have had for some years....

Apr 19 10:58 PM