Soon to be flush with cash from the Microsoft (MSFT) purchase of Nokia's (NOK) devices and services business (complete with licensing deal), Nokia is ready to take on a whole new form. Left with operations in Nokia Solutions and Networks (a.k.a NSN), an armory of patents, and the HERE mapping platform; the company is for the first time, in a long time, alive and well.
Going forward catalysts for investors include profitability, a possible dividend announcement, improving margins, and growth in licensing revenue. We may also see the company put some of it's available cash to work.
Post Microsoft Deal Snapshot
Moody's and S&P both upgraded Nokia's debt after the acquisition was announced. Here are a few of the analyst revisions which followed.
|Date||Event||Price Target||Share Price|
|10/1/2013||Societe General Upgrade||EUR 6.2||$6.62|
|9/18/2013||Credit Suisse Upgrade||EUR 6.0||$6.71|
|9/11/2013||Bank of America Upgrade||$7.07||$5.95|
|RBC Capital Markets||$7.00|
Devices and Services + Microsoft
Profitability in "computer hardware" manufacturing is quite the challenge, as a majority of components are commoditized. Margins are derived from software, or software and hardware bundled. Since Nokia didn't choose Android, flopped with alternative OS's, and offered the Windows Phone OS, the sale of this division is a win-win. Microsoft can do more with it, and Nokia doesn't have to worry about a margin squeeze.
The devices and services business was forecasting negative operating margin for Q3 2013. Financially speaking, the sale yielded the biggest win for Nokia. For Microsoft, it was crucial for the survival of a Windows based phone operating system. Nokia will look to generate continued revenue from the deal and Microsoft gets the long-term prospects of a healthy growing mobile device ecosystem.
Microsoft and Nokia have a deeply integrated relationship, which I would expect to continue for many years. From an investment standpoint, Nokia shares got hammered while they built devices nearly exclusively for Microsoft. Now, Nokia just collects a check and will for years to come.
Nokia Solutions and Networks (NSN)
Given rampant mobile growth and usage worldwide, NSN is positioned to benefit from increasing demand in network infrastructure, mobile data, the software to support it all, and more. This segment of the business has historically struggled, but recent financials indicate change is coming.
Q2 2013 Year over Year Highlights
- Operating Expenses Down 12%, Margin Up 11.3%
- Free Cash Flow Up 61% (Back out restructuring cash)
- Profitable, Last Year - (260m)
While revenue declined year over year, revenue today isn't the primary catalyst for an increase in share price. Their ability to operate NSN profitably, among other things, is. This segment of Nokia's business has gone under a complete restructuring which has included massive lay offs, divestitures, and the buy out of Siemen's 50% stake in the venture. Total 2012 related costs were EUR 1.56 billion, significantly higher than 2011's at 544 million.
NSN is focused on profitably providing 1GB / user / day of mobile data, which is the source of 45% of the operating segments 2012 revenue.
HERE maps covers over 196 countries, and is quite popular outside the US. If you've ever took the "Bing It On Challenge", you might have seen HERE map data as tech giants like Microsoft, Amazon, Yahoo!, and more, leverage the platform. Fortunately, it's a small division of the company relative to NSN or devices and services... otherwise the declining revenue and margins would be a major red flag. But there should be plenty of opportunity to leverage the data with strategic partners and change the trend.
An interesting partnership to keep yours eyes on was announced on September 9th, with Mercedes Benz. Nokia and Mercedes will work together to develop smart maps for connected cars, offering "services that go beyond navigation".
In 2008, Nokia got access to virtually all Qualcomm's patents for a 15-year term. Total portfolio size is widely reported north of 20,000 patents across the entire mobile ecosystem. Recently, a U.S trade panel judge issued a preliminary ruling noting HTC violated two patents related to handsets - Reuters. A post from Intellectual Asset Magazine see's possible patent revenue in the range of $1 - $2 billion. If you care to dive further into the potential value of Nokia their IP read: Nokia Patent Portfolio An Untapped Goldmine.
Short Term Risks
Nokia does have itself in an interesting situation with the government in India. The Indian government wants a bit north of 300m in back taxes, and froze assets in the country recently. Ultimately this will get resolved, and while 300m isn't a small chunk, it doesn't change the underlying story.
Shareholders still must approve the Microsoft deal, but given Nokia's past it would be quite surprising to see many voting against it.
There are some rumors floating about a possible deal with competitor Alcatel-Lucent (ALU). If Nokia were to buy the company, they may have to repeat all the work invested in re-structuring NSN. If something materializes, hopefully the relationship supports Nokia's new path to profitability. Given Nokia's history, I'd be surprised to see them to take on anything with profitability concerns.
Going Forward Bets
With the devices & services business off Nokia's plate, the company has "bandwidth" to focus in new directions, while continuing the improving operating trend. I anticipate demand for products and services provided by NSN to remain strong in the coming years, as networks continue to get deployed or upgraded and data demand increases. 2014 developments with the HERE mapping platform may also form interesting catalysts for the company.
I'm most interested to see if Nokia makes any unexpected moves with their newly minted cash position. Listening to management's outlook for Q4 and beyond will be key to understanding how the rest of the story plays out.
For now, here's a plausible scenario:
Nokia reports profit, pays shareholders a dividend, gives forward guidance. Possible analyst revisions. More intellectual property litigation ensues, licensing revenue increases. NSN operating profit continues up-trend, company continues to land big infrastructure deals. (Insert future potential catalysts here).