New Profit Sources Provide Nokia With Major Upside

Mar.11.14 | About: Nokia Corporation (NOK)

Summary

More than $2 billion of base profit for the new Nokia.

Near-term potential to monetize IP for the entire Android Ecosystem.

Expanding capex by wireless providers provides substantial upside for NSN.

HERE to provide $500 million in operating profit.

More than $5 billion in profit attainable annually.

It is a fortunate thing for one to get the chance to make money in the market. We live in a time where one can save a portion of his or her earnings, develop a sense of where value lies in a stock or stocks, and easily open an account with which to make trades. It was with this set of actions that I followed a path toward the treasured "financial independence" of lore by stumbling upon the company Nokia (NYSE:NOK) less than a year ago. For many readers of Seeking Alpha, this path is one that is both well-traveled and highly volatile, yet nevertheless worth the time and effort, for this company has provided a profitable route from the past and may continue to do so well into the future.

How did we get here?

The recent past of Nokia is one that is as tragic as it is well known. As recently as 2007, the corporation that had come to be known in tandem with the words "cell phone" was at its apex. Its stock price had climbed to nearly $40 per share and its share of the smartphone market pegged above 50%, but the reality of new products and worthy competitors from such names as Research In Motion (now BlackBerry (NASDAQ:BBRY)) and Apple (NASDAQ:AAPL) would lead to a steep descent, one that has continued to this day. In 2012, Nokia traded for under $2 per share, and its credit rating reflected its non-investment grade. The sharp edge of the market had harshly dictated that in the world of tech, you are only as good as your next product or technology.

This crash of confidence and share price actually served the interests of savvy investors in a very striking way. The certainty of a former giant skirting bankruptcy tends to make minds think alike when pondering an investment. The fact that Nokia was bleeding billions in red ink, while at the same time signing a deal with Microsoft to build its phones exclusively, made its prospects seem dim in the vibrant market for smartphones. This willful disinterest in pursuing a "dead" product is what the drove market capitalization of the company to woeful levels, but it also created and presently still offers the opportunity to make a great deal of money. The reason for this is as simple as it is obscured by the Nokia brand: There are three profitable parts remaining to the company following the sale of its Devices and Services (D&S) to Microsoft (NASDAQ:MSFT) , and their potential is immense.

So, what is left and what is it worth?

One thing I have always noted in reading financial analysts and their attempts to value Nokia is how often have been spectacularly wrong. In order for me to make a relatively accurate attempt in my own right, I will follow a simple path of logic. That is, I will strip out the device business from the last calendar year, and then make some assumptions about its future. I will do this for only 2013 as it is particularly more salient to the effort at determining value to stay with the most recent of results. All of the numbers listed are from Nokia's 2013 annual report.

NSN, which was formerly known as a Nokia Siemens Networks but has now assumed the name Nokia Solutions and Networks, is easily the biggest portion of the three remaining divisions. Its numbers are pretty straightforward for 2013, and they are good. In 2013 they made a non-IFRS operating profit of €1.089 billion, or approximately $1.51 billion. NSN carried an operating margin of 9.7% for the whole year, which is probably going to be similar to this year's margin -- as per the conference call in the first quarter from Nokia.

HERE, the division that is the biggest competitor to Google's map division, and whose products are in four out of five cars that are sold with navigation, had a somewhat less-impressive result. It totaled an operating profit for the year of only €48 million, or approximately $66.6 million. HERE had an operating margin of only 5.2%, but it is worth noting that it had gross margins of 75%-82.5% for the whole year, so it has a great deal of room for profit if it invests less.

Advanced Technologies, the portion of Nokia that as of recently has been set up to house its patents and research divisions, had an operating profit for the year of €329 million, or $456.6 million, with an operating margin of more than 60%. This division is going to be the brains of research in the future, and is vastly smaller due to the large numbers of people in research transferring to Microsoft when the deal closes.

Using the simple calculation of last year's operating profit, what we have for the new Nokia after the sale of its D&S division is a yearly profit of $2.03 billion as a starting point. To this I would add the income that is to come from the sale of HERE licenses for the Lumia phones at Microsoft, which are to be paid separately and are not part of the more than $7 billion that Microsoft is paying Nokia for its phone division. Because that number is not known, I will assume that it is approximately $4 per handset, which would mean another $160 million per year for HERE if Microsoft makes 40 million phones, and would increase substantially if they are able to increase their phones sold by a factor of three or four.

For future assumptions, the picture is one of great promise. With the exception of the recent deal with HTC after two years of successful litigation, there is no other Android manufacturer that I know of that pays Nokia for its non-SEP patents. This is a simple way of saying that the entire Android system, which I believe is extensively infringing on Nokia patents, is going to be paying Nokia for the benefit of using its intellectual property in the future. It is roughly estimated that Android system comprises 800-900 million phones a year (and growing), so it is not a stretch to say that if Nokia gets $3 per unit on average, then this will mean more than $2.7 billion a year in extra revenues. Furthermore, as Nokia is not making phones in its own place, its current cross-licensing deals for its SEP licensing should also increase revenue due to having no reduction for Nokia handsets.

Additionally, I believe that capex spending is going to increase substantially this year and the next, and NSN will be a big benefactor of the ramp by wireless providers. All over the world, mobile broadband is due to expand because of the proliferation of mobile devices and the added data that they require. With recent large wins last year in China and the more recent split of business at Vodafone with Ericsson, I think it is likely NSN will increase profits by 20% or more year over year.

For HERE, the future is a little trickier, but it is evident that they have big plans in the way of mapping with cars and the "Internet of everything." Due to the aforementioned deal with Microsoft, it is fair to estimate that HERE could manage $500 million per year in operating profit from its various activities, with more possible if a new application arrives that makes its products a must-have. There is also the possibility they will be bought for a large sum due to the fact they are a unique asset in today's market.

It should be increasingly clear that Nokia is a vastly underpriced company, particularly since it has been pruned of its handset division. From the last year's profit numbers -- and assuming that the company is able to monetize the Android ecosystem, in addition to seeing an increasingly profitable NSN -- it is not a stretch to posit that yearly profit can reach $5-$6 billion and more. And that isn't counting the possibility of a new or set of new consumer products that may issue forth from Nokia. The truth is that these numbers will necessitate the increase of market capitalization to a total of three times where we presently stand. It may take a couple of years, but remember where you heard it when it happens.

Disclosure: I am long 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.