The Nokia Problem Remains Broadly The Same But There's Some Hope

Apr.18.13 | About: Nokia Corporation (NOK)

As Nokia (NYSE:NOK) reported Q1 2013 earnings, it registered another massive miss in terms of revenue. This happened because of a problem I had identified in my update on Q4 2012 earnings: The Lumia segment is not growing fast enough to compensate for the loss of revenue from the rest of the device segment.

This is easy to see. The Lumia segment increased sales by 27% quarter-on-quarter, from 4.4 million to 5.6 million devices. Yet the "Devices and Services" segment, where Lumia is just a part, saw revenue decreasing by 25% quarter-on-quarter. Even the sub-segment "Smart Devices", where Lumia is the largest part by far, saw a 5% drop in revenue quarter-on-quarter, meaning that the Lumia growth was not enough to offset the drop in revenue from Symbian smartphones, whose sales are now basically gone.

This massive problem is not going away soon. Nokia still sold 61.9 million devices during the quarter, out of which only 5.6 million were Lumias. So it's likely that the erosion will continue for several quarters more and Nokia will end up being a much smaller company in spite of Lumia's growth.

A quick fix

It would be easy for me to say, here, that there isn't a quick fix for Nokia. That it can't do much but fight and fight some more, to try and re-establish its market position using the Lumia line. But I'd be lying. There is, indeed, a quick fix for Nokia. One that should be growing ever-larger in Nokia's windshield.

As I said in my last article on Nokia, "Nokia Will Probably Launch Android Phones," Nokia could conceivably turbocharge its Lumia growth simply by launching Android-based Lumias. Overnight, Lumia's sales could conceivably grow two, three, four … maybe even five times. This would instantly be enough to compensate the remaining loss of business in the "Devices and Services" segment. It would quickly stop Nokia's bleed.

Obviously, this still faces two major hurdles:

  • The first is Stephen Elop's position at Nokia's helm. He staked his position on the Microsoft alliance, so now he finds it hard to backtrack;
  • The second is that we don't know the terms of Nokia's agreement with Microsoft, and those might make it impossible for Nokia to quickly launch Android phones.

The trends

There are three other trends, which will now work against Nokia, making it even more urgent for a radical solution - such as launching Android phones -- to be undertaken:

  • One is the ongoing move from feature phones to smartphones. With Nokia selling 61.9 million devices in the quarter out of which only 6.1 million are smartphones, this trend's impact on Nokia is massive;
  • Another is that carriers are trying to move toward less subsidization for smartphones and longer update intervals. This can slow down smartphone adoption as well and might already be a factor in Apple's travails. Even though Nokia is presently a small player in the field, its hopes rest on it gaining ground in smartphones. If the smartphone market gets constrained, Nokia's hopes also get more distant;
  • Finally, the smartphone market looks increasingly crowded. At this point Apple and Samsung have almost the entire profits in the segment, and there are many players trying to take a bite of the supposedly fast-growing segment. This doesn't bode well for ongoing profitability selling smartphones, for either Nokia or anyone else.

In short, not only does Nokia need to take radical measures to overcome its situation, but the overall market Nokia depends on is getting ever more difficult.

Still some value

At the same time, it looks as if Nokia still has some value in its HERE segment (location services) and in the Networks segment. HERE looks to be around a $1 billion euro per year business, and Networks might be as much as a 12 billion euro per year business. Both should have positive margins.

If we speculate on ongoing operating margins of 12% for each of these businesses, a 30% income tax rate and apply a 15x multiple to the resulting net profit of HERE and 10x to the Networks segment, this would give us a value of 1.3 billion euro for HERE and 5.0 billion euro for the Nokia Siemens Networks (already discounting the fact that Nokia holds just half of it).

Since Nokia also has a net cash position of 4.5 billion euros, this means that we can readily justify 1.3+5+4.5 = 10.8 billion euro or $14.1 billion of Nokia's value. Nokia has around 3.711 billion shares outstanding, so at the $3.20 it currently trades, this gives it a market capitalization of just under $12 billion. In short, the "Devices and Services" segment is being carried at less than zero value.


Although Nokia continues to perform ugly due to the Lumia line of phones not growing fast enough to compensate the loss of revenue from the remaining mobile phone line, at this point the market is already discounting the mobile phone segment as a zero. And indeed, this segment faces great challenges both due to Nokia's reliance on Windows Phone alone, and due to the market's move from feature phones towards smartphones, the carriers' desire to reduce subsidization and the crowded nature of the smartphone market.

Nokia could probably improve its fortunes greatly by launching Android phones. At the same time, using reasonable expectations for the two remaining segments (HERE and Networks) seems to show that Nokia might eventually find valuation support at the levels it trades at today ($3.20). Still, the risk does exist that the market might over-emphasize the problems being felt in the "Devices and Services" segment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.