There has been much discussion about Nokia's (NOK) sale of its handsets business to Microsoft (MSFT), and the possible implications on both companies. In our last report on Nokia, we put forward our analysis on this deal with the perspective for both companies. Microsoft can accelerate sales of Windows smartphones only if it accelerates the Windows app marketplace to compete against Google's (GOOG) free android platform and Apple's (AAPL) iOS.
On the other hand, Nokia managed to unload its ailing device and services business and will now be in a better position to focus on its profitable NSN and HERE segments.
Possible merger on the cards
After the highly talked about Nokia sale of its handsets business to Microsoft last month, Nokia is now concentrating on its core business, NSN and Advanced Technologies. It assumed full control of its Nokia Siemens Networks, now known as Nokia Solutions Networks, or NSN, after buying 50% of its stake from Siemens in July 2013. Further, it is contemplating the acquisition of Alcatel-Lucent's (ALU) wireless division as a part of internal discussions for its future business strategy. This merger would have both positive and negative implications for Nokia.
By acquiring Alcatel-Lucent, Nokia will be in a better position to compete against the market leaders in the network infrastructure market, Ericsson and Huawei Technologies. The combined entity of Nokia and Alcatel-Lucent could make Nokia the second-largest player just behind Ericsson's 36% share and ahead of Huawei's 32% in the network infrastructure market. The deal will also bring operational synergies as Nokia has a strong technical expertise in mobile broadband infrastructure and 4G LTE networks, and it is the leading IP system integrator. An IP system is used to transmit telephone calls over the Internet through Internet telephony. Alcatel-Lucent has supremacy in IP-based products, fixed broadband network, and optical networking, and it is the primary supplier to AT&T, Verizon and Sprint. The significant installed base of Alcatel-Lucent will help Nokia boost its market share.
On the other hand, Alcatel-Lucent is still suffering and has shown losses in four of its last five fiscal years. The net loss has increased to $1.20 billion in the second quarter of 2013 from $480 million in the first quarter. It has also been going through a restructuring plan to reduce cost by $1.35 billion from 2013 to 2015, and Nokia may have to spend on its restructuring. We believe that Nokia will face a challenge in running two different platforms, and if it decides to merge them into one, it would be a costly business. In the past, a three-way merger between Alcatel, Lucent and Nortel created similar problems. This, along with other issues, could put pressure on Nokia to go ahead with the merger.
Finding its way with mapping service
In all the discussions related to Nokia, much of the emphasis has been given to the NSN segment that contributed 45% of Nokia's total revenue in 2012. Its other segment, HERE, a mapping service, has been largely ignored as it only contributes 5% of the company's revenue. HERE is present in more than 190 countries and has major clients such as Ford Motor, Toyota Motor and SAP. The main revenue generation happens through providing location-based products and mapping services to automobile manufacturers and Internet services providers.
HERE is one of the few mapping databases that dominate the market. The three large-scale mapping databases are Google maps, Tele Atlas database, and HERE database. Leveraging this opportunity, Nokia is planning to expand its mapping service to more cell phones, cars and companies that don't own a mapping database right now.
With Google acquiring Waze in June, and more recently Apple acquiring Embark in August, companies are continuously looking for ways to strengthen their location assets and capabilities through both organic and inorganic means. Given the value of maps in mobile devices, the automobile industry, and Internet-based services, we believe Nokia's HERE business also has a strategic value in the industry, as mapping is key to offering location-based services.
Can mapping service revive Windows phone
After the sale of its handsets business, Microsoft will have to pay a license fee to Nokia for using its HERE platform for four years, becoming one of HERE's top three customers. The license fee will include usage of HERE on the Microsoft website, Windows phones and tablets. Microsoft now wants to compete against Google to build a better mobile phone through mapping services. As part of the acquisition, Microsoft will have access to different mapping and location services, including HERE maps, HERE Drive and HERE Transit. Through offering these services, Microsoft intends to enhance the user experience on both Windows smartphones and tablets.
We believe that Microsoft's plan to take on Google through mapping services may be a bit aggressive, considering Google's dominant position in mapping services and its phones. Google Maps and Apple maps are considered the industry standard for mapping services. Though HERE maps may have to be updated and now include off-line features, it still lags behind Google maps. There is no doubt Nokia's maps run very smoothly on Windows phones, but competing against Android phones based on mapping services alone will be a daunting task.
The sale of Nokia's loss-making handset business will definitely give it a chance to revamp and re-brand itself as a leading network infrastructure provider. The revival is solely up to the management. It can adopt an inorganic route through the acquisition of Alcatel-Lucent's Wireless division or through organic expansion.
Total Cash (mrq)
Cash per share
Nokia (post sale of handset business)
Nokia's cash at the end of second quarter was $12.64 billion. If the Microsoft acquisition and Nokia's acquisition of 50% of NSN would have happened before the end of second quarter, Nokia would have gross cash of $20.22 billion.
If we look at the above table, Nokia's cash per share was already highest among its peer in the second quarter of 2013, and post-acquisition cash per share will swell up to 5.45 per share. Cash per share is a percentage of a firm's share price that is accessible for spending on research and development, acquisitions, and paying down debt. Nokia's debt payment and NSN acquisition is already factored into the given ratio. Therefore, Nokia is likely to use these proceeds on acquisitions, which could be Alcatel-Lucent, or giving special dividends to shareholders. We remain bullish on this stock and recommend it as a good investment option.
Additional disclosure: Fusion Research is a team of equity analysts. This article was written by one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.