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Up until not too long ago, Nokia (NYSE:NOK) comprised a major part of my portfolio (approximately 10%-12%). Though not a typical value investor's pick, I was convinced the Finnish giant will adapt itself to the rapidly growing smartphone market, as well as successfully execute its announced restructuring program. I estimated the market was giving Nokia's mobile devices division a near-zero value, whereas I was convinced it could go back to profitability in less than two years; hence a serious deep turnaround value was on the table.

At the time (during 2012), Nokia-Siemens Network was gradually turning its EUR 14B business into a profitable one, and without getting over optimistic I roughly valued Nokia's 50% stake (at the time) in the JV at around EUR 3-4 Billion.

At the same time, Nokia's location based services' segment - HERE - showed steady revenues of between EUR 250M and EUR 300M per quarter, and I thought it could easily be worth around EUR 1B, which I added to the NSN value.

You can see where I'm heading. My valuation was that this business was worth roughly EUR 4-5 Billion before even considering the mobile division (neither feature phones nor smartphones) and the net cash. Given Nokia's strong net cash position (around EUR 4.5B during 2012 and first half of 2013), the entire business was trading for an EV as low as EUR 2B in the low point of 2012, and EUR 4B-6B for a significant part of the last two years.

Below is a table that details how I viewed Nokia's valuation six month ago, as it released its Q1 2013 financial results (April 18, 2013):

Nokia Valuation

18/4/2013

Stock price (EUR)

2.42

Stock Price - ADR (USD)

3.17

Shares out

3.71B

Market cap (EUR)

8.98B

Net cash (EUR)

4.81B

Enterprise Value (EUR)

4.27B

NSN estimated value (50% stake, EUR)

3.5B

HERE estimated value (EUR)

1B

Implied value of mobile division (EUR)

-0.23B

Remember that this is before Nokia decided to purchase Siemens' 50% stake in NSN. That deal occurred in July 2013 and valued Siemens' 50% of the business at only EUR 1.65B, which is significantly lower than the value I was giving it. Assuming the deal was done based on fair value, Nokia's adjusted valuation following it (based on the updated stock price) should have been as follows:

Nokia Valuation

1/7/2013

Stock price (EUR)

2.95

Stock Price - ADR ($)

3.86

Share out

3.71B

Market cap (EUR)

10.95B

Net cash (EUR)

3.16B

Enterprise Value (EUR)

7.27B

NSN value (based on buy-out price)

3.3B

HERE estimated value (EUR)

1B

Implied value of mobile division (EUR)

2.97B

What the above implies is that either the market was valuing NSN significantly higher than Siemens was (considering they agreed to sell their stake for that price), or that the mobile division was actually valued much higher than I initially thought.

If the first scenario is true, then my investment thesis was still standing, and even firmer than before (as Nokia was able to execute the Nokia-Siemens buy-out at a bargain price). If not, and the Nokia-Siemens deal was indeed based on fair value and this was priced accordingly in the share price, then the mobile division was worth EUR 3B more than I initially valued, and my expected return should be lower than I was aiming for.

I obviously believed the mobile division was worth considerably more than the negative EUR 0.2B or even the EUR 3B, and I saw a huge upside in the case that Nokia will ultimately be able to not only stabilize the deteriorating financials of this division, but to also become once again a top player in the smartphone market, once the hysteria around Android will calm down (just as the hysteria around the iPhone is beginning to slowly descend). I bought the American depository shares in several occasions during 2012, in an average price of $2.95, implying EV of approximately EUR 4B for the entire business. I saw myself tripling my investment within 2-4 years seeing most of the upside in the turnaround of the mobile division.

Then came September 3, and even though it was not a huge shock, I was surprised to read Nokia was selling its mobile division to Microsoft (NASDAQ:MSFT) for EUR 5.44B. As I already thought the market has given the mobile division a value of between zero and EUR 3B, I expected a spike in Nokia's market cap of somewhere between EUR 2.5B and EUR 5.44B (the entire deal price), or maybe even a bit higher.

What actually happened to Nokia's market cap on September 3 and beyond can be seen in the below table:

EUR

2/9/2013

3/9/2013

11/9/2013

1/11/2013

Stock price

2.96

3.97

4.42

5.72

Market cap

10.98B

14.73B

16.42B

21.22B

Change since deal announced

-

3.39B

5.44B

10.24B

Market cap increased by EUR 3.4B on the announcement day, which is in the range I've expected. Just over a week later, on September 11, the entire deal value was already added to the market cap, implying a valuation of exactly zero for the mobile division prior to the transaction. At this point, I sold my American depository shares for about $5.9 as I did not think there is a lot of upside in the divisions that remained in the company following the transaction (NSN and HERE). What I did not expect is the continued increase in the stock price, even after the addition of the entire deal value to the market cap.

A little less than two months later, and without any improvement in NSN or HERE's results, the company has added almost twice the deal value to its valuation. This actually implies that prior to the transaction, Nokia's mobile division value was a negative EUR 4.8B, while NSN and HERE combined value was EUR 12.5B. Given the fact that Nokia has just purchased 50% of NSN for EUR1.6B a few months ago, this seems seriously overvalued.

I understand that investors are relieved that the bleeding smartphone business will no longer hurt Nokia's results and be a burden on its cash flow; on the other hand, I also believe the smartphone business was the company's main chance for a significant upside in the near-term future. As one of Nokia's biggest bulls in the last couple of years, even I could not justify its current valuation assuming that the Microsoft deal takes place as planned. As it is very unlikely that NSN and HERE divisions will be able to provide the necessary fundamentals to support current EV, shorting the stock at these levels could turn out to be a good idea.

Source: The Delusions Of Nokia's Valuation