Nokia: A Surprise Short Play

Sep.23.13 | About: Nokia Corporation (NOK)

Nokia's (NYSE:NOK) headquarters in Espoo overlooks a lake. I guess it's beautiful, but I saw it in March, when it was still covered in snow. There was a small boat in the middle of the lake frozen into the ice. I thought it was very symbolic of a situation that the company found itself in. I hoped the company would find a way out of that trap, and I waited for the right moment to step in. Two years later, I bought a Nokia phone (Lumia 920) and became a believer.

Two weeks ago, after a deal with Microsoft (NASDAQ:MSFT) was announced and shares rallied, I sold my Jan 14 calls at almost 3 times my cost, and I was a very happy man for a few days - until the price moved close to $7 per share. Nobody likes to leave money on the table (a lot of money in my case), so I started to second-guess my decision to sell early. What did I miss? Let's try to figure it out.

At the end of August, Nokia was worth $14.5 billion. It consisted of the devices unit, $5.6 billion in net cash, and Other Assets (where I include everything that Microsoft is not buying). Last Friday, the company was worth $24.4 billion, attributable to $12.8 billion in cash (after Microsoft pays up) and Other Assets. This is what caused my confusion: I can't explain this jump in valuation. I did read how some analysts justify the new price (or even higher) - I just could not find any logic there.

In my view, the Other Assets were not greatly affected by the deal with Microsoft. Why should Nokia's networks business, location services or patent portfolio suddenly become so much more valuable just because Nokia is not making phones any more? Assuming that Microsoft paid 50 percent more relative to what Nokia investors were expecting, the Other Assets were valued at $5.3 billion before the deal. Why should the same assets be valued at $11.6 billion three weeks later? Even if you think that Nokia investors expected a zero dollars from Microsoft for the devices unit, a clearly absurd assumption, it still values the Other Assets at $8.9 billion - almost $1.7 billion lower than their current valuation.

Analysts who justify $7 or even $7.75 share price for "new" Nokia, make two very strong assumptions:

1. Folks at Siemens were totally clueless, and they sold their share in NSN (Nokia-Siemens Networks) to Nokia at a price which was much lower than the "real" value of the company. Never mind that Siemens was a 50 percent partner in NSN for many years and knew this business inside out.

2. Folks at Microsoft were equally clueless when they decided not to buy the entire Nokia, and therefore left billions of dollars on the table. Never mind that Microsoft was Nokia's closest partner for almost 3 years, that it had access to all of Nokia's books and projections during their negotiations and due diligence, and that Microsoft is uniquely qualified to evaluate both Nokia's location services and its patents portfolio.

I don't buy these assumptions. I believe that as nerves calm down and the remaining shorts are covered, Nokia shares will go down to $5 - $5.50, where they belong.

Disclosure: I am short NOK. 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.

Additional disclosure: I had discussions with Nokia in 2010, but they did not lead to any business relationship.