Seeking Alpha
Long/short equity, deep value, special situations, contrarian
Profile| Send Message|
( followers)  

First of all, several days ago I wrote that even if Nokia (NYSE:NOK) sold its NSN stake (Nokia Siemens Network), it would not mean much for Nokia, because its balance sheet is still not in the best of health (please consider: Nokia's Divestiture Of Nokia Siemens Networks Does Not Mean Much). At best, selling NSN would give Nokia some financial breathing room.

However, selling Nokia's NSN stake is easier said than done. To begin with, selling to Huawei is almost out of the question, because regulators would never allow it. Besides the anti-trust issues, most Chinese companies are persona non grata both in the U.S. and Europe. Especially when it comes to vital infrastructure sectors.

Another reason has to do with the fact that there are no buyers for NSN. A comment from a reader in the article above hit the nail:

The core issue with the M&A route for NSN is that few parties want to be in this cyclical business, which faces continual margin pressure from low-cost Chinese competitors, and fewer still want to buy the asset at the height of the LTE deployment cycle.

If private equity is buying, it's because there is no strategic bid, as the strategic bid is always higher than P/E valuations. If the valuation is low, then Nokia will not be selling. If Nokia is not selling then, there is no deal because private equity will not buy without control and a clear path to liquidity longer term.

In other words, Siemens are negotiating with themselves in the public sphere just like VZ was on VOD. We are only hearing about it because there is an impasse between the partners that Siemens are hoping might be influenced through public market pressure.

I totally agree with the above statement. In reality, if NSN was worth the money many people think it's worth, Siemens (SI) and Nokia would have no problem divesting of it. But in reality there is no strategic bid for the reasons mentioned and they can't find a buyer, unless they accept a rock bottom price.

This creates a problem if someone would want to buy Nokia. See Nokia and NSN do not complement each other in any way. They are two different businesses and hardly have any contact with each other, other than the fact that Nokia consolidates NSN's balance sheet. So in order for Microsoft (NASDAQ:MSFT) to be able to buy Nokia, Nokia would first have to find a way to divest of NSN. For the time being, this is almost impossible.

Several months ago I wrote that it would be a good idea for Microsoft to manufacture a smartphone of its own, instead of relying on third parties to license its own WP8 operating system (please consider: "Should Microsoft Make A Smartphone?"). For some reason very few agreed with me then (judging from the comments).

As the WSJ reported just several days ago, Microsoft was in discussions with Nokia for doing exactly that. See, Microsoft wants to get in the business of making its own phones because the money to be made comes from a whole lot more than simply licensing the operating system. The question is, why would Microsoft be interested in Nokia instead of doing it themselves? I mean Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) both started from scratch. Why does Microsoft need to buy Nokia?

If you think about it, Nokia is nothing else than a pretty good engineering firm. Sure they have a map division but so what, everyone has maps these days. Nokia is like the BMW of the smartphone space. They design and make very good high quality phones that people are willing to pay extra for. I think it is this engineering culture Microsoft is after. However, even if Microsoft would be willing to pay a premium for that, it will not do so unless NSN is out of the picture.

From Nokia's recent 20F filing under risk factors:

Other manufacturers also produce competing mobile products which are based on the Windows Phone operating system. We may face increased competition from other manufacturers, including Microsoft, who already produce or may produce competing Windows Phone based products. Increased competition within the Windows Phone ecosystem could result for instance in lower sales of our devices or lower potential for a profitable business model.

And if Microsoft decides to manufacture their own devices, that's exactly what will happen to Nokia. Besides the increased competition, they will be left by Microsoft to the wolves without WP8.

The people at Microsoft are not dumb. They know they need to take control over the hardware and software part of this business, like Apple has always done, and like Google is doing now. Sure, licensing is great, but look at all the money Apple is making without licensing. Would you rather be an Apple or a Microsoft in this business? Sure, Google is the exception, but I think that will change in time.

So given that we now know that Microsoft was in talks to buy Nokia, it is probably safe to conclude that Microsoft is trying to find some way to take 100% control of the hardware side of the business.

What does all this mean for Nokia

Nokia shareholders are in a real difficult spot. On the one hand NSN will be a burden until they can get rid of it, and on the other, at any particular time Microsoft can decide to make its own devices -- or even stop licensing WP8 to Nokia -- and that will be the end of Nokia (good luck selling Asha to the western world).

So the best thing that Nokia shareholders have going for them, is to try to find a way to divest of NSN and sell themselves to Microsoft. I am pretty sure Nokia's management thinks the same, just that its NSN division is an obstacle.

Bottom line

A while ago in another article I said Nokia has to be discounted, because they do not have control over their ecosystem. Today I am putting another discount on the stock, because at any time, Microsoft might enter the hardware side of this business, and I think that might be a detrimental blow to Nokia.

So unless Lumia phones sell like hot cakes in the future, I think that Nokia's current stock price is probably as good as it gets.

Source: A Microsoft Buyout Is Nokia's Only Chance For Survival