Forecasting a company's earnings is a hazardous business. For Nokia (NOK) it is unusually hazardous, as each of its 3 divisions is currently going through seismic change. To support this point, I browsed through the +200 articles written on Nokia on Seeking Alpha this year, and although there was an abundance of valuable information, none focused on this central issue-- namely the company's earnings power when things stabilise.
I'm not surprised, as any attempt has one certainty: it will be wrong. In fact, I would wager that even the (shrinking) accounting team at Nokia's headquarters in Espoo, Finland - with all confidential information at hand (and of course, all the anxiety of the restructuring) - wouldn't bet their future job security on getting this number right.
However, the unpredictability in forecasting Nokia's earnings doesn't detract from the need; there is enough information available now to piece together an earnings model that will be in the right ballpark. Read on if you're interested in my attempt at this elusive number: Nokia's earnings for 2014. I focus on each division and my main assumptions therein, followed by a short consolidation and conclusion. All numbers in euros unless otherwise stated.
Devices and Services
This division, which encompasses feature phones, smartphones as well the income derived from Intellectual Property Royalties (IPR) has the most leverage in the earnings recovery. This article does not dwell on the attributes of Nokia's Lumia smartphones or Asha feature phones - there are numerous articles on Seeking Alpha that do that. I make two main assumptions in my model:
- Nokia will have 10% of the global smartphone market in 2014. Although this seems like quite a stretch from the 2% held in Q3 2012, the transition from the (now defunct) Symbian platform to Windows Phone 8 (WP8) is complete. Although there appears to be some disenchantment with Windows 8 for desktops, reviews indicate there is every likelihood that Microsoft (MSFT) will achieve meaningful penetration in smartphones with WP8. It's an imperative for Microsoft, as a last line of defence to remain ubiquitous as the user moves further away from the desktop to the smartphone as his preferred portal to the digital highway. Remember, the mobile operators will encourage and support a third mobile ecosystem, in order to prevent being unduly dependent on the two dominant incumbents today. (Note that 80% of the Windows phones sold today are Nokia's; I assume this stays constant into 2014, meaning Windows Phone 8 would have 12.5% of the smartphone market, for Nokia to have a 10% share)
As further evidence that the above assumption is not outlandish, here is a recent article (1 April) from the Guardian that has Nokia's CEO, Stephen Elop, affirming his short term target
- The gross margin Nokia delivers in both mobile and smartphones stays the same as it was in Q4 2012, namely 18.8% for smartphones and 22.2% for mobile or feature phones. (pages 9-10 of Nokia_results 2012 Q4 earnings.) With regard to smartphones, there will be two opposing forces at play in 2014: a reduction in selling price as lower-priced models increase in the mix; a declining cost per unit as production ramps up. The assumption of these two forces netting off may be simplistic, but the imminent release of Q1 2013 figures will shed further light. As for feature phones, I have Nokia holding the Average Selling Price (ASP) constant (30 euros or $39 US), and increasing its market share slightly, moving from 32% in 2012 to 35% in 2014 to reflect the extended and revamped Asha range.
In terms of the size of global smartphone and mobile markets, I use a modification of Gartner's figures, a summary of which can be found here.
Feature phones units 'million
Smartphones units 'million
Total units 'million
The source of most operating numbers in this article is from the Nokia disclosure linked above. You will find few earnings disclosures with more restructuring charges and one-off items, as the entire company rescales to its current challenges. But within the statement the devices' gross margins are outlined on pages 9-10. Nokia then apportions operating costs between the two divisions. For my purpose, the split is not relevant, but this statement on page 4 is:
"Nokia continues to target to reduce its Devices & Services non-IFRS operating expenses to an annualized run rate of approximately EUR 3.0 billion (US$ 3.9 billion) by the end of 2013."
Also within this segment, Nokia includes the IPR received from its patent portfolio. On page 6 it states:
"Devices & Services: Both year-on-year and sequentially, Devices & Services Other net sales were lower in the fourth quarter 2012 primarily due to the divestment of Vertu. Following the divestment of Vertu, Devices & Services Other net sales are comprised of IPR income and sales of spare parts. In the fourth quarter 2012, Devices & Services Other net sales benefitted from non-recurring IPR income of approximately EUR 50 million (US$ 65million). Within Devices & Services Other, we estimate that our current annual IPR income run-rate is approximately EUR 0.5 billion (US$ 0.65 billion)."
Using the above, an estimate for operating results for the division can be derived.
2014 Operating Profit for Devices Segment in Euros
Smart Devices Units 'million
Mobile Devices Units 'million
ASP Smart Devices euros
ASP Mobile Devices euros
Sales Smart Devices euros 'million
Sales Mobile Devices euros 'million
Gross Margin Smart
Gross Margin Mobile
Gross Profit Total euros 'million
Operating Expenses run-rate euros 'million
IPR Income euros 'million
Operating Profit of Division euros 'million
The earnings potential is staggering (after all, in 2012 there was an operating loss) and skepticism may be warranted. However, note that this company once enjoyed 40% of global mobile phone market share, and earned 1.07 euros ($1.39 US) per share as recently as 2008. Moreover, the figures above are consistent with Nokia's assertion made in the March 7 Announcement where the company stated the long term financial objective of this division: "Devices & Services non-IFRS operating margin to be 10% or more." In the above table the operating margin stands at 11.7%.
Caveat: The model postulates Nokia delivering 127 million smartphones in 2014. In the 4Q of 2012, the company incurred difficulties in selling 6.6 million units - there was often no stock to meet demand for the new Lumia range! It's monumentally disappointing that after a huge marketing campaign which set the stage for its 'comeback', the company performed so poorly. I sincerely hope that the organisational difficulties of downsizing are behind Nokia, that the presence of Lumias on retailer shelves in 2014 is guaranteed, whether it's on the High Street of London or the cellphone kiosk in the remote backwaters of Kerala, India.
Location and Commerce Segment
I am assuming the run-rate in 4Q 2012 (about 40 million euros (US$ 52 million) operating profit) continues here. Nokia introduced HERE, the new brand for its location and mapping service, which is used as the preferred navigation device for 4 out of 5 new cars installed with a vehicle navigation system. Although there was a dip in revenue in 2H 2012 as Symbian was phased out, the uptake could be impressive once we have increased penetration of WP8 on smartphones.
Nokia Siemens Network
The restructuring in this division is nothing short of seismic. The restructuring and associated charges are largely behind us, but the new target is to reduce its non-IFRS annualized operating expenses and production overheads by more than EUR 1 billion (US$ 1.3 billion) by the end of 2013, compared to the end of 2011. The workforce has been shrunk significantly: at the end of 2012, Nokia Siemens Networks had approximately 58 400 employees, a reduction of approximately 15 300 compared to end of 2011.
As for the outlook, the company is well positioned to capitalise on the evolution to LTE (Long Term Evolution) networks. As per the recent earnings disclosure linked above (page 35),
"Nokia Siemens Networks continued its mobile broadband deal momentum, adding commercial LTE deals in the fourth quarter, including: delivering a large, multi-city, TD-LTE deployment for China Mobile; preparing O2's network in the UK to deliver LTE services across London and the south-east of England, ahead of an anticipated rapid launch of 4G in early 2013; completing the first 4G pilot with TD-LTE technology in Southern Europe for COTA, a new player in Spanish telecoms, and Wimax Online; and helping Vodacom become the first operator to introduce voice and SMS alongside LTE in South Africa."
Abstracting for the restructuring costs, the division seems to be profitable and stable. In the 4Q 2012, the operating margin was 14.4%, the highest level of underlying operating profitability since its formation in April 2007, primarily due to an increase in gross margin. It delivered 251 million euros (US$ 326 million) profit. In the model below I conservatively assume the same profit per quarter in 2014. Note that Nokia has a 50% share in the division.
The Simple Consolidation
Consolidated Profit for 2014
Location and Commerce
Nokia Siemens Network
(50% share of 1bn op profit)
Excluding restructuring and including interest
Tax at 15%
(massive operating losses to offset)
Net Profit euros 'million
Shares Outstanding fully diluted million
Earnings per share, euros
|Earnings per share US$||1.29|
As stated on the outset, this forecast may certainly be wrong. But I have increasing conviction it's in the right ballpark. Judging by the initial reception of the Lumia 520 in emerging markets, it could easily be the bestselling smartphone in 2014. As for Nokia shares, at $3.40 US for the ADR, this would place it on a 2014 PE of 2.6X. In turn, Nokia shares could easily be one of the top performers in the next 12 months, if the company can ensure successful production and delivery of Lumias across the globe. I am long Nokia, and after producing this simple earnings model, I have increasing conviction in the share's upside potential.