As a Nokia (NOK) shareholder, it might seem perverse that am arguing as a shareholder we need to be rescued. However on further reflection I believe Microsoft (MSFT) is massively underpaying for Nokia's Devices & Services (D&S) business. The fact is Microsoft is purchasing this business just as the green shoots of recovery are coming through and as Nokia's key partner it very much knows this. I believe Devices & Services is on the cusp of generating huge value for shareholders over the next few years. Microsoft purchasing this asset for E3.77bn is a steal and the judging by today 6% fall in the value of Microsoft stock the market has not realized this.
Nokia's Devices & Services business has an installed base of over 1.3bn customers. The large balance are obviously feature phone customers, however these customers are in the process of upgrading their feature phones to smart phones. This is why 42% of all new Windows Phone customers are upgrades from feature phones. As the smart phone upgrade cycle gathers pace especially in emerging markets, Nokia's Lumia phones are positioned in the sweet spot and set to grow exponentially over the next few years.
Lumia is showing the green shoots of recovery. The problem is the stock market was not recognizing this as most analysts were looking in the rear view mirror. This is why Microsoft is making its play now. It is likely after investors saw the Q3 & Q4 volume growth numbers the Nokia's Lumia range would be producing, the stock would have moved significantly higher, denying Microsoft of such a steal. Nokia has produced new Lumia phones at incredible speed, including the Lumia 1020 which is arguably the best piece of hardware on the market. The Lumia 52x is tracking as a blockbuster product. I expect Lumia volumes to be over 10m in Q3 2013, which would be 200% YoY growth in Lumia volumes. Those are serious green shoots.
The Devices & Services business has significant potential to drive huge value for shareholders. My position in Nokia was predicated on it having multi-bagger potential, rather than a deal driven upside scenario. Consider that Nokia as of Q2 2013 only had 3.3% of the Smart Phone market. The D&S business is now finding its stride and the scope for market share catch up is considerable. Am sure the bears will say D&S was loss making & it being bid for at E3.77bn is amazing for shareholders. However Devices & Services was only loss making to the tune of E33m in Q2 2013. Also please don't forget even Apple was loss making in Q4 2002 & Q1 2003 during its' transformation. The Nokia Lumia line is shining bright, volumes are exploding and profits and cash in Smart phones will come through within the next few quarters. Microsoft realizes this and so has acted accordingly. Even under Microsoft's own forecasts, it expects Nokia to achieve $45bn of revenues in 2018. Assuming a 20% Gross Margin that generates $9bn of gross profit per annum versus the approximate $5bn purchase price.
That is why Mr. Icahn, as a shareholder of Nokia we need a shareholder activist who will help us get the real value for Nokia's Devices & Services business. Microsoft has made a very smart play and is trying to get D&S for a steal. The sell side likely won't recognize this viewpoint, as up until yesterday they largely thought D&S was worth zero (hence 5 major houses had to upgrade to a neutral today). As such to now argue E3.77bn is a woeful undervaluation is too big a leap for them to make. We need a shareholder activist or even another corporate to come and help us get true value for this business. Microsoft has to buy Nokia's Devices & Services business. It is a sitting duck to come and push them for a higher price. Come on Mr. Icahn, come and take a look!