Nokia Siemens Networks may not exist in its current form for much longer. Just days before the expiry of an existing six-year old agreement between the partners in April, Nokia (NOK) and Siemens (SI) got together to carve out a new plan for their telecom infrastructure joint venture last week. According to the new agreement, both partners have the freedom to do as they please with their respective stakes in the company without the danger of being vetoed by the other party. While both companies plan to run the JV as usual in the short term, Siemens, which has only a non-controlling stake in the JV and has also been looking to shed its non-core assets in recent years, will most likely reduce its stake or exit the JV completely in the coming months. Nokia, on the other hand, faces a tricky situation.
The joint venture has been the lone bright spot for the handset maker over the past year as its smartphone sales plummeted amid a tough transition to Windows Phone. Due to the ongoing restructuring process as well as the transition to 4G LTE taking place in many parts of the world, the venture not only returned to operating profitability last quarter but also generated cash for four quarters in a row. At a time when Nokia is conserving cash by suspending dividend payouts and leasing its headquarters instead of owning it, NSN is proving highly valuable with its steady cash flows despite not being a core asset. Last quarter, the company managed to strengthen its cash position by 800 million Euros, more than 80% of which came from NSN.
As a result, we estimate that NSN is Nokia’s biggest value contributor currently accounting for almost 34% of our $5 price estimate for the company. This essentially means that Nokia won’t part with such a valuable asset easily. It would look for an enterprise value of around $6 billion for its half of NSN to cash out or reduce its stake in the company. However, given that NSN hasn’t been profitable on an ongoing basis, it might be tough for the JV to command a good valuation right now. And Nokia won’t likely settle for anything less considering the ongoing turnaround at NSN and valuable cash flows it is generating. Therefore, while Nokia will eventually look to exit the JV considering it is not its core focus, we don’t see this happening until the handset business has sufficiently turned around and NSN has achieved sustained profitability for a few quarters. Until these two conditions are met, we expect Nokia to look for a partner to replace or acquire a part of Siemens’ stake in NSN.
The likelihood of NSN sustaining profitability is reasonably good. Over the past year, Nokia Siemens Networks has increasingly shown signs of turning the corner as a result of an ongoing restructuring that has not only helped improve its operating margins but also restored focus on its wireless business. As a result, NSN has fast emerged as the leader in the ongoing 4G LTE transition around the world and is taking share away from competitors. As of Q3 2012, NSN had succeeded in increasing market share to about 20% share of the wireless infrastructure industry, only 2% behind #2 player, Huawei. It now expects to reclaim its #2 spot behind Ericsson by the end of 2013. Most of these gains should come on 4G LTE – a market NSN managed to capture almost 22% of in Q3 2012, up from 13% the previous year.
Apart from revenue share gains, NSN is also benefiting from the streamlining of operations and the ongoing job cuts. By the end of 2013, NSN aims to cut around 17,000 jobs and achieve a total of $1.35 billion in savings as part of the restructuring initiative announced in late 2011. Simultaneously, NSN has been 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 Q4 2012. As a result, we estimate NSN’s EBITDA margins in 2012 to have doubled over the previous year. This is a big positive sign that the company’s cost-cutting initiatives are taking hold – a trend we expect to continue this year as well.
Disclosure: No positions.