Nokia (NOK) has made many mistakes over the last few years and rarely made a positive headline. While it is easy to be negative it offers little for a constructive evaluation of the company and its prospects. Nokia's Symbian platform surely was a failure but capitalism works based on companies making capital allocation decisions and take risk. For Nokia, the smartphone trend brought its devices segment down: Nokia-produced phones lacked in innovation and market acceptance and as a consequence caused sequential revenue and earnings declines: In 2012 the y-o-y decline in device revenues fell 36% which is a staggering percentage for a large-cap company that once struck out to define the mobile phone industry in the early 2000s. The sequential decline in revenues, operating profit and EBT shows how severely competitive pressures from Samsung (SSNLF.PK) and Apple (AAPL) hit Nokia:
I established a position in Nokia in July because I believed the market extremely discounted Nokia's device unit (Nokia can book an estimated $3.2 billion gain on the transaction) as it was highly loss making. However, Nokia sits on a portfolio of valuable patents and operates other business segment that are set to create value for shareholders. Nokia Siemens Networks posted solid y-o-y growth in revenues and was cash flow positive. It just happened that the market defined Nokia as a device maker and derived company value from its performance in its core-market phone manufacturing. Hence, Nokia's 2011 partnership with Microsoft (MSFT) was of mutual benefit: Nokia's Symbian platform didn't gain any traction and Microsoft's Windows Phone OS offered a valid alternative to Google's (GOOG) Android and Apple's iOS. Partnering with a dominant software maker was not a bad idea.
The partnership from 2011 actually evolved such that Microsoft made a transaction proposal acquiring Nokia's device unit for $7.2 billion in an all-cash offer (transaction closing Q1 2014). This represents roughly $2 a share in additional value. Nokia shares traded around $4 pre-announcement and are now quoted at $6.71 giving the stock an additional 12% premium over the cash value of the offer.
While I do not think Microsoft entered into the partnership with the intention to purchase Nokia's device unit, it was clear from the outset that Microsoft desperately needed a successful manufacturer alliance to not lose out to competitors on the all important mobile phone software market. With Nokia's device unit up for grasp, Microsoft complements its software driven business with mobile phone manufacturing capabilities while Nokia rids itself from a loss-making entity. Win/win.
With the existing cash position and the proceeds from Microsoft, Nokia can achieve between $9-10 billion in cash post-transaction. This equates to $2.70 per share or put differently: 40% of Nokia's market valuation could be comprised of cash once the transaction closes limiting the downside risk of Nokia's remaining business segments NSN and HERE (Location & Commerce). As fellow SA contributor Jacob Steinberg has correctly pointed out, Nokia's patent portfolio creates licensing revenues that should not be discounted by the market. In his article Nokia: Another round of restructuring he points out the relevance of Nokia's patents:
Nokia currently enjoys 30,000 utility patents and 8,500 design patents. These patents generate for the company close to $1 billion in net revenues. Until now, Nokia added patent revenues to its mobile phone revenues and used them in calculation of average sale prices. Now that the company will not be building phones anymore, it will probably announce its patent earnings separately. In addition to the recurring royalty payments, the company will be getting about $2 billion from Microsoft in order for the latter to have access to Nokia's patents for the next 10 years. This comes down to $200 million per year.
The sale of Nokia's devices unit radically transforms the company and the market will have to adjust its perception of Nokia as a mobile phone manufacturer with a side business in mobile broadband and services. This leads to a number of catalysts which offer huge upside potential for Nokia shareholders:
- "Prospective Nokia" is not fully understood by the market: It will take time for the investor base to see Nokia as a service provider with a patent portfolio and instead of a hardware business
- Nokia has to deliver a roadmap for how to capitalize on its existing patent portfolio and how to develop the remaining business segments HERE (Location-based services) and NSN which adds fantasy to the stock
- NSN offers opportunities in providing 4G LTE network infrastructure and has had operating losses in 2011 and 2012. It will be up to management to deliver a credible strategy of how to develop the segment or even to sell it off
- Nokia will hold substantial amounts of cash post-transaction limiting the risk of an investment. The market capitalization could be comprised of up to 40% in cash providing a meaningful floor value
Investors who believe in a revamped Nokia which just rid itself from its loss-making hardware business might be interested in purchasing Nokia shares. Uncertainty regarding Nokia's future business model and its segment strategies remains high though the stock price seems to have settled in the $6.70 range for the time being. Nokia continues to own valuable patents which will derive royalty streams in the future. Given the opportunities ahead, I am determined not give any Nokia shares away.