There was a time in the late 1990s when Nokia (NOK) and Ericsson (ERIC) stocks moved in lockstep. Much has changed since then and Nokia has become primarily a mobile handset company, while Ericsson has consolidated its position as the world leader in mobile infrastructure. This divergence in strategic focus explains the different recent performance of the two stocks. Nokia is up 75% this year, while Ericsson is about flat. (Nokia trades in Finland while Ericsson trades in Sweden, but both have US-listed ADRs.)
In addition, analysts are falling over themselves pushing Nokia to new heights, while consigning Ericsson to the shame and neglect of a Hold recommendation, proving once again that analysts are more adept at reinforcing a trend (can you say momentum investor?) than they are at identifying outstanding value. And outstanding value is exactly what Ericsson offers at SEK27 per share ($1 = SEK6.4) or $42 per US-traded ADR.
Do the Math
During the early part of this decade, Ericsson created a 50-50 joint venture in handsets with Sony (SNE), creatively christened Sony-Ericsson, in which it parked its entire mobile handset business. This activity has essentially recovered from the dead and is now quite healthy with global market share approaching 10% and ASP (average selling price) per phone at 120 Euros. Revenues for the full year 2007 are expected to exceed SEK120 billion. Nokia in comparison has a dominant global market share of 40% but a flaccid ASP around 90 Euros.
Assuming conservatively an EV/Sales ratio of 1.5x for the valuation of Sony-Ericsson, we get SEK90 billion for Ericsson's stake in the venture. (50% x 120 x 1.5 = 90).
Furthermore, Ericsson has a net cash position that is likely to exceed SEK30 billion at the end of 2007. Ericsson has a market value of SEK434 billion and its revenues, excluding Sony-Ericsson, are expected at SEK194 billion in the current year. This yields an EV/Sales for the core infrastructure business at 1.6x, very low when you consider this same core business has an EBITDA margin of 20%. A low EV/Sales ratio is justified for a company with a low operating margin, but this is clearly not the case here.
EV/Sales = (Market Cap - SonyEricsson stake - net cash) / Sales
EV/Sales = (434 - 90 - 30) / 194 = 1.6
Nokia has a higher EV/Sales, in excess of 2x, despite a lower EBITDA margin of 18%. The higher EV/Sales could be explained by Nokia's higher topline growth rate, which brings us to the next point.
Do you Love your iPhone?
All but the blindest of telecom observers would agree that Apple's (AAPL) iPhone is a game-changing device. There is the mobile phone as we knew it Before-iPhone and there is the mobile phone as we know it now in the iPhone-Era, B.iP. and iP.E. in biblical terms. After the June 29 introduction of the iPhone, the snazziest cutting-edge mobile phone from the B.iP. era looks like a lame and disgraceful piece of plastic, a waste of battery juice.
There will be many more versions of the iPhone and there will be other strong competing products from the likes of Nokia and Sony-Ericsson. All these new phones of the iP.E. era will have new functionalities and applications that we cannot even imagine today. But we can be certain of one thing, which is that data usage over mobile infrastructure is about to explode.
Ericsson is in the sweet spot of this growth since it enjoys a growing 33% market share in mobile systems, and a dominant position in GSM and in WCDMA/HSPA, the leading 2G and 3G standards worldwide. The company expects global mobile traffic to grow 10-fold by 2012, equivalent to a 60% CAGR, driven by broadband and TV/video. These developments come at a time when US and European operators have cleaned up their balance sheets and are ready to boost their capex spending.
As with any value investment, patience is key and while the near term can be opaque, the longer-term perspective for Ericsson is highly positive.
Disclosure: Author has a long position in Ericsson stock