The New Nokia Has At Least A 20% Upside Potential

Sep.12.13 | About: Nokia Corporation (NOK)

In the following I will summarize recent analyst upgrades, showing significant upside potential for Nokia's (NYSE:NOK) share price. I will then present my understanding why this potential has not yet materialized. In the third part I will highlight some positive technological developments that Nokia has in the pipeline.

Baseline/updated analyst opinions

In the last few days there have been several revised analyst opinions on Nokia, looking into the value of New Nokia, i.e. Nokia Group after it has sold its Devices and Services division to Microsoft (NASDAQ:MSFT):

  1. JPMorgan puts the enterprise value of New Nokia between $26.9B to $34.8B, corresponding to approximately $6.5 to $9 per share. Notably JPMorgan puts a lot of value in IP, ranging from $5.3B to $10.6B, whereas HERE is valued 'only' at $1.3B. NSN's enterprise value ranges between $8B and $16B in the models and parameters used.
  2. Bernstein analysts Pierre Ferragu et al value the New Nokia at $6.5 per share. They assign $2.1 to cash, $3.2 to NSN, $0.4 to HERE, and the IP at $0.8. Multiplying these by the number of shares outstanding we get the following rough estimates for the market capital value of these components: cash $8B, NSN $12B, HERE $1.5B, and IP $2.9B.
  3. RBC analyst Mark Sue values the New Nokia at $7 per share. Sue points out that after the deal Nokia will have $10.7B in net cash, will collect $670M annually from Microsoft, and will have potential to collect another $670M annually from non-Microsoft entities.
  4. Bank of America / Merrill Lynch analyst Didier Scemama has upgraded Nokia from 'Neutral' to 'Buy', raising the price target to $7.07 per share. He sees limited downside risk to $5.3, and upside potential to $8.90. He estimates that New Nokia would have larger than $0.47 per share earnings power.
  5. Berenberg has updated its price target from $2.0 to $7.7.

All of the above major analyst firms and banks indicate new valuations that are substantially higher than the current share price of $5.95 (as of this writing, 09/11/2013 at 4PM EST.) Taking a simple average of all the estimates we get ca. $7.3, presenting ca. 23% upside compared to current market valuation.

Notably the above price targets assume that the New Nokia 'conducts business as usual', and that the Microsoft-Nokia deal actually materializes.

Risks

In my estimation the main risk factor for Nokia's share price at the moment is if for some reason the Microsoft-Nokia deal fails. Possible reasons can be rejection by Nokia shareholders, regulatory issues, or Microsoft or Nokia simply bailing out. We also should not forget the macroeconomic situation where general historical market dynamicsClick to enlarge, end of QE, or e.g. war in Syria might provide a push for more substantial market correction.

Regarding risks specific to this deal, my estimation is that the shareholder revolt is the biggest, although at the moment not that huge a risk. Here on Seeking Alpha several authors and commentators have been arguing that Nokia got the short end of this deal, and there has been a lot of discussion regarding the 'lost upside potential' due to this deal. On the other hand Nokia's board has clearly articulated that,

"...this transaction creates more value for Nokia than could otherwise be realized...".

In my opinion rejecting this deal in the hopes of gaining some even larger future, non-materialized gains, while risking the existence of the whole company is not responsible ownership. A 150-year-old company deserves better from its shareholders. Also, just from a personal stock market gain point of view I'd rather take and secure the current substantial, and already materialized, gains while looking forward to any additional gains the New Nokia has in future.

If the deal is rejected by the shareholders on November 19th, I expect the share price to immediately drop drastically below the pre-announcement price of $4. At that point there would be a major lack of trust between the board and the shareholders, while the board already has publicly stated that Nokia does not have the resources to support the growth in Devices and Services division (that Nokia would still be stuck with), and while the Plan B (Microsoft bail-out) would have been taken off the table or at least jeopardized substantially. Of course, as has been speculated, if the rejection would be due to some spectacularly good numbers in Nokia's forthcoming Q3 earnings report, Nokia and the share price might be able to sustain the damage.

Regarding traditional business risks, NSN has shown non-IFRS profitability for several quarters, whereas HERE and IP are not a huge part of the New Nokia on the expenses side. Based on this simplistic helicopter view, I do not see that the business risks would push the valuation of New Nokia down substantially in the short term, particularly in the light of the massive cash hoard, i.e. a stabilizing cushion e.g. allowing further restructuring etc. that Nokia will gain as the deal closes.

In summary, the main reason why Nokia's share price has not yet reached the new consensus is the perceived risk of the deal failing. On that note, one should follow the small investor sentiment here on Seeking Alpha $NOK Stocktalks, Yahoo Boards, and in Finland on Kauppalehti's investor forum.

In reality this deal will be rejected only if large institutional investors decide to go against it. For an updated list including institutional ownership as of end June 2013 both in NYSE and Helsinki, please see the list the author has compiled here. Additionally, at least the major Finnish pension funds Varma and Ilmarinen seem to be happy with the deal since they have increased their ownership in Nokia during the last two weeks by 25M shares from 50.3M to 75.3M shares, and by 8M shares from 56.4M to 64.4M shares, respectively.

Prospects

Nokia's Chairman Siilasmaa gave a good high-level overview of the New Nokia at Nokia Conversations on September 11th. Post-deal, Nokia will have three main business units, Nokia Solutions and Networks, HERE, and Advanced Technologies.

NSN is a massive operation and worthy of its own article. It has gone through a massive restructuring and cost cutting in recent years, and has been profitable (non-IFRS) for several quarters already. As a recent positive development just a few days ago Reuters reported that Telefonica had secured a $750M loan deal for the purpose of buying network equipment from NSN. Nokia plans on letting NSN operate as a semi-independent unit within the Nokia Group.

HERE is Nokia's mapping and location based products and services unit, employing over 6000 people in over 56 countries. Interestingly AllThingsD reported that Microsoft wanted to buy HERE, and Nokia absolutely refused, to a degree that this point was almost a deal breaker. Eventually Nokia agreed to license HERE to Microsoft as 'owner equivalent' for 4 years. On the other hand, per Nokia's earnings reports, HERE has nearly always been in the red. The important question is why would Nokia insist on keeping a unit that has not been profitable?

Looking at Nokia's earnings reports closely, one notices that HERE revenue is dependent on the internal license pricing that Devices & Services division has paid to HERE. My opinion is that Nokia has intentionally kept HERE as a loss-leader in order to maximize D&S profits. Once the Microsoft deal closes, I expect HERE to immediately show profitability as the mobile device licensing revenue is recorded at a more realistic level.

The HERE unit is also working on several interesting new products, targeting other businesses, including a cloud based HERE Connected Driving solution for car manufacturers. Just recently HERE announced a new collaboration with Mercedes-Benz, Magneti Marelli, and Continental Corporation.

Advanced Technologies is the name of Nokia's new intellectual property and research and development unit, consisting of Nokia's existing Chief Technology Office (CTO), Nokia's IP / patent portfolio and e.g. Nokia Research Center (NRC). Currently Nokia's IP portfolio is already creating roughly $670M annually.

In my opinion AT has the best potential for substantial short and midterm revenue and profit growth within the New Nokia. Nokia has over 10,000 patent families with patent average lifetime of over 12 years, and is planning on monetizing this asset more aggressively in the future. Additionally, as Nokia will not be manufacturing devices itself, it can go after other manufacturers more aggressively, not having to worry about counter litigation. In Chairman Siilasmaa's words (keeping in mind that Finns are modest to a fault):

"...We've already established a successful patent and technology licensing operation, which we will expand to continue to drive revenue and profit for Nokia through the new Advanced Technologies business..."

Or, in less modest terms, it has been estimated that Nokia could collect $3.5B annually from Android manufacturers alone.

At the moment PureView is perhaps the most interesting technology that New Nokia could immediately license to other manufacturers besides Microsoft. Unfortunately the status of PureView is not clear in this deal. According to a tweet on 09/03/2013 by Juha Alaharju, as a part of Devices and Services division, the PureView team is moving to Microsoft. On the other hand Nokia's official 6K filing states that Nokia will keep all technology patents and will only license them to MIcrosoft. The 6K also does not explicitly mention Devices and Services product development operations at all.

Nokia therefore might be in a position to license PureView to 3rd parties. On the other hand since PureView is perhaps the main differentiator the Lumia line has against competition, I would assume that Microsoft wants to keep the brand and technology limited to Microsoft Windows Phones. In short, the status of PureView is still speculative, and since it can be a source of relatively quick and good earnings potential in New Nokia's IP portfolio, one should pay close attention to any information regarding PureView when Nokia releases more details on the deal later this month.

In addition to leveraging its existing patent portfolio, I see Nokia's AT developing relevant new technologies that it can then sell or license to mobile device etc. manufacturers. Nokia has always been an engineering driven technology company, so this is what they do best. Nokia has an excellent reputation in the industry and I am quite sure some mobile manufacturers would be interested in outsourcing some R&D to Nokia. Just to give an idea of the work NRC is doing, recent research highlights include superhydrophobic stain-resistant phone that repels water like a lily pad, and Nokia indoor navigation technology, allowing one to move from outdoors to indoors while following precise (down to 30 cm / 12 inch accuracy) navigation instructions.

For additional points regarding New Nokia's upside potential, see e.g. this recent article by Chris Lau on Seeking Alpha.

Summary

New Nokia will be a 'real', profitable company, and the share price has at least 20% additional short-term potential upside, with a variety of interesting advanced technologies and substantial IP assets to be monetized further. The main, although relatively small, risk besides general external marketwide risks, for this potential upside is a major shareholder revolt resulting in cancellation of the Microsoft-Nokia deal, leading to substantial decline in Nokia's market cap and share price, and decline in Nokia's future prospects.

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.