Seeking Alpha
Long only, deep value, growth at reasonable price
Profile| Send Message| ()  

The dust has settled now after the earnings announcement of Nokia (NOK) and after the initial sell-off, the stock is on its way up again. The earnings announcement has been analyzed in great detail by me and some of my fellow SA authors - needless to say that majority had differing opinions. I would again go to the earnings announcement, mainly for the reference purposes as the main idea of this article is related to the performance over the past quarter. It was clear from the earnings announcement that the company was able to achieve targets in the main segment (high-end smartphones), indicating that the strategy is going according to the plan. However, mobile phone sales continue to fall, dragging down overall revenues of the company.

A decline in mobile phone sales means that the company is no longer the biggest player in some of the markets it used to dominate (i.e. India). However, it does not mean the company will be less profitable in the long run. In fact, it will have a positive impact on the earnings of Nokia in the long term. Let's see how it will happen.

Going Smart Brings in Higher ASP

Nokia's smart devices ASP was €191 ($250), compared to €28 ($36.6) for the mobile phones during the last quarter. Smart devices ASP is almost seven times more than the mobile phones ASP - the reason for negative operating margin? Sheer volume (55.8 million units) of mobile phones compared with smart devices (6.1 million units), brought down the overall margin. Last quarter's smart devices ASP is the highest in any of the quarters in the last three years. However, we might see a decline in ASP over the next quarter due to the launch of cheaper smartphones.

Nokia expects the growth rate in Lumia sales to be greater than 27% during the second quarter. I have taken the liberty of making some assumptions here in order to come up with numbers for the second quarter. These assumptions are mainly about the ASP, growth rate in smart devices and decline in sales of feature phones. If we assume that the growth rate in smart devices volume will remain between 25-30% and somehow, the company is able to maintain the current ASP, then we will be left with revenue of between €1.456 billion ($1.90 billion) and €1.515 billion ($1.98 billion). However, as I mentioned above, I expect ASP for smart devices to come down in the second quarter due to the launch of cheaper devices. Furthermore, BlackBerry (BBRY) will also be launching the Q10, which might force the company to offer discounted prices for some Lumia devices.

What will be the exact ASP is anyone's guess; however, if we assumed a range between ASP of €150 and €173, then we will end up with lowest revenue figure of €1.144 billion ($1.50 billion) and highest figure of €1.372 billion ($1.79 billion). Revenue for smart devices was €1.164 billion ($1.52 billion) during the last quarter. So, if ASP and growth in volume comes down at the same time, then we are likely to see miserable results for the company. However, if the company is able to reach 30% growth in Lumia sales; it will leave us with a substantial increase in revenues even if the ASP falls.

However, the decline in mobile phone sales is expected to continue and it will have net negative impact on the overall performance of the company. As a result, we are likely to see continuing losses or slim profitability in the short term. The company will have to grow smart devices sales faster than the decline in mobile phone sales in order to cancel the losses from mobile phones.

Nokia is Still Cheap

Too much focus is put on the mobile phone business of the company when the market values Nokia - as a result, poor performance of the segment has weighed heavily on the stock price. The market completely ignores Nokia's stake in Nokia Siemens (between $3.875 billion and $6.5 billion), its net cash position and strong portfolio of patents that will generate substantial cash flows in the near future. Even if we calculate Nokia's break-up value; we will end up with a higher number than the current market price. At current price levels, I believe Nokia shareholders do not lose anything.

On the other hand, fair value based on the going concern assumptions is also higher than the current market price. However, mobile business will continue to weigh heavily on the valuation until the segment stops being a drag on the company's cash. Nokia Siemens added €210 million ($275 million) in cash; if it was not for this addition, the company would have reported a decrease of €90 million ($117.7 million) in its net cash position. In my opinion, Nokia will have much better cash position in two years' time due to three reasons: first, I see a substantial recovery in mobile business; the company will not take back the throne from Samsung (OTC:SSNLF) or Apple (AAPL), but it will become an important player in the smartphones market, and the segment will no longer be a drag on the cash. Second, patent portfolio will generate considerable cash flows to the company. Finally, Nokia Siemens is returning to profitability, and with a recovery in the networking equipment business over the next two years, this segment will add substantially to cash flows. I strongly believe the stock is cheap, but investors should not expect miracles in the short term - the value is in the long-term investment.

Conclusion

Nokia will make a successful turnaround, in my opinion. I see a lot of positives for the company, and even if the worst happens, the business of the company is more valuable than the current stock price. Nokia investors need to be patient; the company operates in a highly competitive market where it is sometimes difficult to regain old status. However, Nokia does not need to regain its previous status to be an attractive investment - it only needs to show the true signs of recovery, and the stock price will start to move higher. In fact, Nokia might benefit from focused approach.

Source: Nokia Is Still Cheap