Nokia: A Highly Speculative $3 Play?

May.11.12 | About: Nokia Corporation (NOK)

By Robert Gordon

In a cell phone world dominated by big consumer electronics makers like Samsung (SSNLK.PK), LG (NYSE:LPL), and Apple (NASDAQ:AAPL), there are two well-known companies that still focus on cell phone manufacturing. What they have in common is declining market share and a ceding of the technological dominance they both held a decade ago. I am going to look at Nokia (NYSE:NOK) and Research In Motion (RIMM) to see how they are managing their businesses in response to current conditions.

It saddens me what has happened to Nokia. Not so long ago, I would not even consider buying a phone that was not a Nokia; today, quite the opposite. This company, for years a symbol of Scandinavian technology at its finest, is a shell of its former self. Does it have a plan in place to turn itself around? That will be the focus of this article.

While Apple iPhones and a myriad of phones featuring Google's (NASDAQ:GOOG) "Droid" system heavily dominate the American marketplace, Nokia is still a leading manufacturer of cell phones in the world. In fact, Nokia had been the number one worldwide manufacturer for 15 years before being overtaken by Samsung in the first quarter of 2012.

To no one's surprise, since Nokia had warned of this in mid-April, the first quarter of 2012 was a disaster. The company reported a net loss of ten cents per share, slightly worse than the seven cent a share loss that analysts had predicted. The revenue side of the income statement was pretty awful, smartphones running on Nokia's proprietary, yet antiquated Symbian operating system. Sales of Symbian driven smartphones in the first quarter of 2012 were off by 58% from the year ago quarter, and 40% from the sequentially linked fourth quarter of 2011. The new series of Microsoft (NASDAQ:MSFT) Windows operated Lumia series smartphones sold about 2 million units in the quarter, a modest but promising amount. Nokia sold over five Symbian smartphones, for every one of its Windows phones.

Yet, taking a broader look at Nokia, it is a sinking ship. The revenue trend has been down since its all-time high, $75 billion sales year in 2007. 2011 sales came to $50.2 billion. Operating margins have been in a decline from the 22% range a decade ago, to 6.5% last year. And things look even worse in 2012, as it is all but certain the company will report a loss for the year.

The new Nokia Lumina 900 has gotten positive reviews here. Microsoft had searched for years to find a cell phone partner. Nokia's worsening condition in recent years made it the perfect choice. Apple iPhone users are notoriously loyal to the brand, and a Microsoft system is not going to steal away Apple customers. If I am the average Droid user, I have no interest in learning another phone operating system, as I am happy with not just the operating system, but with the many different phones out there that utilize the system.

The Lumia line makes a great deal of sense to Nokia. It is getting some $250 million cash per quarter from Microsoft, which completely offsets the cost to Nokia for utilizing the Microsoft operating system. That price advantage is helping Nokia to hold prices low, to compete against the lower end of the Droid market. The Lumia line is offered in different color options, and has a distinctly different look to it. Time will tell if the model can be truly enough to turn around Nokia's fortune. And time is one thing Nokia does have, as there was $14 billion of cash and cash equivalent on its balance sheet at the close of 2011.

Nokia stock has lost over 90% of its market value since 2008, and from today's price there is surely far more upside than downside. This may be a unique opportunity for the speculative investor looking for a big hit. But for those of us with a more fundamental outlook, Nokia has not yet delivered substantial evidence that it can compete profitably in the current cellphone climate worldwide. Until Nokia provides that evidence, I will be on the sidelines.

Most of Nokia's competitors, such as Sony, Apple, Samsung, and LG, are parts of larger, more diversified electronics and / or appliance makers. The one company out there whose bread and butter is the manufacturing of cell phones is Canada's Research In Motion, the owner of the Blackberry franchise. Much like Nokia, Research In Motion has apparently done little more than watch as the as its competitors built phones that in my opinion have surpassed in design and performance anything coming out of Research In Motion.

Unlike Nokia, Research In Motion has remained solidly profitable of late, albeit not as profitable as it used to be. 2011 full year revenue of $18.4 billion fell from 2010's $19.9 billion. Not helping was that the income statement shows cost of goods sold actually rose by nearly $800 million to $11.9 billion. Research In Motion's 2011 gross profit margin plummeted, from 44.3% in 2010 to 35.7% in 2011. With lower gross volume and margin, profit fell, even excluding a myriad of one time, mostly non cash costs, to $2.2 billion, or $4.20 per share. GAAP earnings came to $1.16 billion, or $2.22 per share.

Research In Motion is coming out with its next generation BlackBerry Operating System 10, and its management is concerned with its existing inventory, particularly in the United States. Management, noting that business will continue to shrink for the next two fiscal years, declined to give any earnings guidance. Analysts foresee earnings declining precipitously, from the adjusted $4.20 in the just concluded year to $1.92 per share in fiscal 2013 and $1.75 per share in 2014.

What is an investor to do? Research In Motion does not offer a dividend, and its mean analysts rating is a pessimistic 3.4. I can think of no logical reason to put any money into this equity, other than of course selling it short.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.