Seeking Alpha
Profile| Send Message|
( followers)  

Nokia (NYSE:NOK) is the world’s market-leading maker of mobile devices, with close to 1.3 billion people worldwide using a Nokia handset. The company has seen margins squeezed due to low-cost competition and the lack of a high-end device to challenge Apple’s (NASDAQ:AAPL) iPhone and RIM’s (RIMM) Blackberry.

Nokia’s just-released N8 smartphone, which runs on the new Symbian 3 operating system, has received mixed analyst reviews and has suffered some pre-launch glitches. Nonetheless, pre-orders for the N8 have been the highest in Nokia’s history. There seems to be a reasonable probability of the phone outperforming low analyst expectations.

Our thesis does not depend on the success of the N8 in particular. Rather, our analysis suggests the market is undervaluing Nokia’s vast global distribution network and the place the Nokia brand occupies in the minds of ordinary consumers, especially in emerging markets. When Nokia comes up with a hit device, whether it’s the N8 or a future phone, the market will be ready to embrace it, in our view.

In the meantime, the company appears likely to maintain an “installed base” of well more than one billion users. Investors buying the shares at a 13% FCF yield (including 5+% dividend yield) should therefore have little fundamental downside while waiting for the substantial upside to be unleashed when a turnaround in business performance becomes evident.

SELECTED INFORMATION ON NOKIA'S MOBILE DEVICE SHIPMENTS

2006

2007

2008

2009

1H10

Mobile devices shipped (mn)

348

437

468

432

219

Change (y-y)

31%

26%

7%

-8%

12%

Mobile device average selling price

€ 96

€ 86

€ 74

€ 63

€ 62

Change (y-y)

n/a

-10%

-14%

-15%

-3%

Converged mobile devices shipped (mn)1

39

61

61

68

46

Change (y-y)

n/a

55%

0%

12%

49%

Converged as % of total devices shipped

11%

14%

13%

16%

21%

1 Comprises smartphones and mobile computers, including the services and accessories sold with them. "Converged" devices differ from "mobile phones" in that the latter are more basic mobile phones focused traditionally on voice capability and limited other applications. Converged devices, which enable Internet browsing and other sophisticated applications, have ASPs of ~€140 versus ~€40 for traditional mobile phones.

Sources: Company information, Manual of Ideas analysis.

The recent hiring of company outsider and former Microsoft (NASDAQ:MSFT) executive Stephen Elop to become CEO sends the message that the Board is determined to turn around the business.

Despite Nokia’s large size, the stock seems to lack a natural constituency: Growth investors apparently would rather own Apple at a market value of $250+ billion (Nokia is “worth” less than $40 billion). Meanwhile, value investors cannot seem to get comfortable with the technology aspects involved. In our view, the uncertainty caused by the difficulty of predicting future technology trends affects the magnitude of the upside in Nokia. The downside appears protected, as the company’s unrivaled distribution, global brand recognition and strong FCF [free cash flow] more than justify the recent market valuation. It will be interesting to see whether our value-oriented thesis proves correct, or whether the pundits, many of whom have written off Nokia, are right after all.



NOKIA -- OUR ESTIMATE OF THE EQUITY FAIR VALUE RANGE
(€ in billions)
Conservative
Base Case
Aggressive
Valuation methodology
Sum-of-the-parts valuation: Devices & Services valued at 12x normalized EBIT (based on 10% EBIT margin on trailing revenue)
Sum-of-the-parts valuation: Devices & Services valued at 12x normalized EBIT (based on 12.5% EBIT margin on trailing revenue)
Sum-of-the-parts valuation: Devices & Services valued at 12x normalized EBIT (based on 15% EBIT margin on trailing revenue)
Devices & Services
Normalized revenue1
€28.6
€28.6
€28.6
Normalized EBIT margin2
10.0%
12.5%
15.0%
Estimated normalized EBIT
€2.9
€3.6
€4.3
Fair value multiple
12.0x
12.0x
12.0x
Estimated enterprise value of Devices & Services
€34.3
€42.8
€51.4
Nokia Siemens Networks
Normalized revenue3
€12.1
€12.1
€12.1
Normalized EBIT margin4
2.5%
5.0%
7.5%
Estimated normalized EBIT
€0.3
€0.6
€0.9
Fair value multiple
8.0x
8.0x
8.0x
Estimated enterprise value of Nokia Siemens Networks
€2.4
€4.9
€7.3
Navteq
Trailing revenue
€0.8
€0.8
€0.8
Fair value multiple
0.5x
1.0x
1.5x
Estimated enterprise value of Navteq5
€0.4
€0.8
€1.2
Value drag of corporate overhead
Trailing corporate expenses
(€0.1)
(€0.1)
(€0.1)
Fair value multiple
12.0x
12.0x
12.0x
Estimated value drag of corporate overhead
(€1.5)
(€1.5)
(€1.5)
Total estimated enterprise value
€35.6 billion
€47.0 billion
€58.4 billion
Plus: Net cash6
€4.4
€4.4
€4.4
Less: 50% non-controlling interest in Nokia Siemens7
(1.2)
(2.4)
(3.6)
Estimated fair value of the equity of Nokia8
€38.8 billion
€48.9 billion
€59.1 billion
€10.45 per share
€13.20 per share
€15.95 per share
Implied trailing FCF yield
9%
7%
6%
Implied 2009 dividend yield9
4%
3%
3%
Implied trailing non-IFRS EBIT-to-EV yield
10%
8%
6%
Implied EV-to-trailing revenue
0.9x
1.1x
1.4x
Implied valuation ratios of Devices & Services segment:
EV-to-trailing revenue
1.2x
1.5x
1.8x
Trailing non-IFRS EBIT-to-EV yield
10%
8%
7%
EV-to-2008 revenue
1.0x
1.2x
1.5x
2008 non-IFRS EBIT-to-EV yield
19%
15%
12%
1 Based on trailing revenue for the year to June 30, 2010. Trailing revenue is ~25% lower than the peak revenue of €37.7 billion achieved in 2007.
2 Nokia targets Devices & Services non-IFRS operating margin of 10-11% in 2010 (1H10: 10.8%). This compares to a peak margin of 20% in 2007 and 13% in 2009. Non-IFRS margins exclude special items including intangible asset amortization, other purchase price accounting-related items and inventory value adjustments. Reported IFRS EBIT margin of Devices & Services was 10.9% in 1H10, 12% in 2009 and 20% in 2007.
3 Based on trailing revenue for the year to June 30, 2010. Trailing revenue is ~20% lower than the peak revenue of €15.3 billion achieved in 2008.
4 Nokia targets Nokia Siemens Networks non-IFRS operating margin of breakeven to 2% in 2010 (1H10: 1.1%). This compares to a peak margin of 4.9% in 2008. Non-IFRS margins exclude special items such as intangibles amortization, other purchase accounting-related items and inventory adjustments. Reported IFRS EBIT margin of Nokia Siemens was -7% in 1H10, -13% in 2009 and -2% in 2008.Our valuation assumes operating performance can be improved (Nokia's Networks segment prior to the Nokia Siemens formation in 2007 achieved 10+% EBIT margins in 2005/06 on ~€7 billion of revenue. Our valuation does not reflect the acquisition by Nokia Siemens of wireless assets of Motorola for US$1.2 billion in cash as announced in July. Closing expected “by the end of 2010.”
5 For reference, Navteq's enterprise value implied by Nokia's purchase price paid in 2008 was €5.0 billion.
6 As of June 30, 2010. Includes available-for-sale investments, current investments at fair value and other financial assets, as well as long-term loans receivables.
7 Assumes Nokia Siemens Networks is net cash/debt free. Non-controlling interest was €1.8 billion as reported on Nokia's balance sheet as of June 30, 2010.
8 Based on 3,709 million shares outstanding.
9 Based on the €0.40 per share dividend paid for the 2009 financial year.
Source: Company filings, Manual of Ideas analysis, assumptions and estimates.

Disclosure: No positions

Source: Why Value Investors Are Missing an Opportunity With Nokia