The Nokia Shorts Were Right All Along, And Fatally Wrong At The Same Time

Sep. 8.13 | About: Nokia Corporation (NOK)

Nokia (NYSE:NOK) held a press conference on September 3rd 2013 discussing the deal in which Microsoft (NASDAQ:MSFT) bought essentially all of Nokia's Devices and Services operations, i.e. Nokia's mobile and smartphone businesses. In this event, Nokia Chairman Risto Siilasmaa provided board's rationale for this deal. In the following I will highlight and analyze the key statements made by Siilasmaa during the press conference, as they clearly describe and emphasize the predicament Nokia was in, and why the sale indeed was a right decision.

The official webcast recording (but no transcript) of Nokia's press conference, including the Q&A part, is available on Nokia's press site. A transcript of the key part that starts at 1:55 is available on this author's Instablog.

The shorts were right, and fatally wrong at the same time is evident that Nokia alone does not have the resources to fund the required acceleration across mobile phones and smart devices...

That is, at the cash flow and technical level the shorts were right. Nokia did not have the resources to successfully execute and turn around the Devices and Services ship, particularly from a marketing point of view. Nokia's balance sheet was not OK, and the turnaround was not working fast enough. The Nokia board of directors realized this early this year at the latest, and needed to come up with a solution.

Contrary to the above, the short interest in Nokia has actually dropped substantially on the Helsinki Stock Exchange this week, by roughly 192M shares (5.12% points of the float) from at least 311M shares (8.31% of the float) as of August 15th to at least 119M shares (3.19% of the float) as of September 8th. On the NYSE the short interest was also very high at 213M shares (5.7% of the float) as of August 15th, and it is very likely that there has been substantial short covering on the NYSE last week as well (we do not yet have updated, post-announcement, short interest for the NYSE, as it will be available only around September 23-24th). What happened? The short side was right, but still got burned?

The shorts were fatally wrong in not understanding the bigger picture, the business side of Nokia, Microsoft ($MSFT), and their relationship. They did not consider the Plan B, the 'limited downside risk' that Nokia, as a company, had since 2011 when the Windows Phone collaboration started. The limited risk was finally solidified in late 2012/ early 2013 when it became clear that Lumia, for all practical purposes, equaled Windows Phone. The shorts never understood that Windows Phone and mobile devices was such a big and important segment for Microsoft that it could not allow it to fail.

When the Nokia board realized that it would not have enough cash to wait and execute the Devices and Services turnaround, it spent months vetting all possible options where D&S could still be part of Nokia. But none of these options worked, and Nokia had to agree to Microsoft's courtship and allow it to step in and buy D&S. On the other side of the coin, Microsoft / Ballmer have their own additional reasons to own Nokia's D&S, in short, to make Microsoft a D&S company as Ballmer publicly declared in July.

Based on Siilasmaa's account, Nokia simply ran out of time and cash to execute the turnaround at high enough and simultaneously rapidly increasing volumes and marketing efforts. They were forced to do the deal now, got the additional 1.5B EUR bond financing from Microsoft (that they also immediately executed), and unfortunately could not wait until, for example, next summer when the sale price very likely would have been much higher or perhaps the sale would not have been necessary in the first place.

On a personal note, I have learned a valuable lesson, the analytical bears, bulls and quants are likely to be right from a technical / numbers point of view (putting aside all the message manipulation, timing of news releases etc that both side constantly do), they know and crunch the numbers better than I ever can. But they do not necessarily understand the non-quantifiable, the bigger picture and business side of things. And that is where retail investors still have a chance.

As a side note, for further details regarding the timeline of events, see this interesting article in AllThingsD.

Nokia was a victim of its own success

..We cannot expect other device vendors to significantly invest as Nokia has grown to dominate the Windows Phone ecosystem...

The second remarkable observation is that in a sense Nokia was a victim of its own success. Nokia managed to get more than 80% market share in Windows Phones, which in itself was a great show of force. But precisely due to this victory Nokia was, besides Microsoft, alone in advocating and marketing for the Windows Phone ecosystem and could not actually carry this burden on its own.

One could speculate that if Nokia had not crushed its competition within Windows Phone vendors, there might have been a larger total pool of marketing, etc., monies available for the Windows Phone ecosystem from several OEMs, and Nokia might have ended up in a financially more sustainable situation. But in that case Nokia Lumia also would not have been equal to Windows Phone, and it could have been that Microsoft would have never stepped in to save Nokia.

Microsoft had (conveniently) reached the limit of Windows Phone freebies

...Microsoft does have the resources but they lack a business model that allows them to gain an improved return on significant incremental investment...

Third, it is interesting to note that Siilasmaa says that Microsoft did not have a good business model to support Windows Phone more within the current arrangement. Perhaps Microsoft had reached some internal limit with regard to how much money it was comfortable pumping into Windows Phone, given the approximately $1B annual in support payments, and its own marketing efforts etc., without a more substantial and concrete return for its investment, i.e. actually obtaining the hardware side of the equation as well. This situation where Microsoft did not in a sense fully, no-questions-asked, commit to supporting Windows Phone on the marketing side in particular was also convenient from Microsoft's point of view, putting margin pressure on Nokia, and eventually allowing it to snatch Nokia's D&S this fall.


...The Nokia Board of Directors believes that this transaction creates significant economic value to our shareholders. We expect it will be significantly accretive to earnings, it will clearly strengthen our financial position and it will provide a solid basis for future investment in Nokia's continuing businesses...

Again, as it has done already several times during its nearly 150 year history, Nokia has fundamentally changed direction. This time switching from a pie-in-the-sky risky undertaking with huge potential upside to a safer solid solution with solid balance sheet in hand, and back pocket full of goodies and ideas to be leveraged in the future.

This is not pleasant for those shareholders (myself included) who were originally looking for that do-or-die multi-bagger, but it is certainly the only sensible and responsible thing for any management team to do. Nokia's board could not and should not have put the whole existence of the huge multinational company on the line chasing the pie-in-the-sky while facing heavy odds and a dwindling balance sheet, given that the company did have safe alternatives available.

Fundamentally, I am OK with this turn of the events. I sold 40% of my long position for a very nice profit after the announcement, having started accumulating and trading the volatility at around $2.60 a year ago. I plan to hold on to the remaining 60% for the time being with a stop loss in place to secure the profits if needed, while waiting to see how Mr Market values the new Nokia.

Disclosure: I am long NOK, MSFT. 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.