In the last 4 years, Nokia (NOK) generated total revenue of $172.80 billion. This averages out to $43.20 billion per year. This is 4 times the company's market value - which stands at $10 billion - at the moment. Out of all this revenue, the company gets to keep very little, if anything. This is mostly because of the high costs the company has been enduring. Cutting costs will be a major factor in Nokia's turnaround.
One of the biggest costs in front of Nokia is research and development. Obviously this is an important aspect of Nokia's business, given the harsh competition it is facing from Apple (AAPL), Samsung, Research in Motion (RIM), Google (GOOG) and many others. The mobile phone industry is evolving very fast, there are patent wars going on, and Nokia can easily justify the high spending bills of its research and development department. Still, the company could be more efficient in designing and researching new products. Maybe Nokia could move some of its R&D department to China where high-skill labor is cheaper. Now Nokia will get $250 million per quarter from Microsoft (MSFT), which should help the company with some of the R&D costs. Currently, the company spends about $4-5 billion annually in research and development and Microsoft's money will cover about 20% of this cost.
Another heavy item for Nokia is the manufacturing of the phones. For example, Apple outsources its manufacturing whereas Nokia operates multiple plants where the company builds its own products. Recently, the company decided to open a new plant in Vietnam and I see this as a positive development for the company. At the moment Nokia needs cheap labor desperately in an effort to cut its costs. I believe that Nokia will take its hands off the production side completely over time. Gradually the company will learn to trust other companies enough to outsource this aspect to them. One of Nokia's biggest strengths is the company's ability to produce really high quality mobile phones that can last for years. The company might not want to give up from its reputation of building phones with lots of endurance, and as a result, it may not feel comfortable about handing this job to other companies.
One-time fees will also make a large chunk of Nokia's expenses. The company will offer severance package to thousands of employees it will be laying off. Also, the company is spending money on the new plants and projects that will be in use in the future. All the costs associated with restructuring of the company will - hopefully - be one-time costs and will not come back to haunt the company. For example, in the last quarter, the company had one-time expense of $873 million. If it weren't for this expense, the company's loss in the quarter would have been a much more manageable $56 million as opposed to $929 million. Restructuring a company always costs money and the only way to keep such costs minimal is to get the job done as quickly as possible.
One thing to note, though: Nokia wasn't expecting to be profitable in 2011 and 2012. The company was planning to go through a restructuring between these two years. Therefore, it is no surprise that the company isn't making a profit right now. The company's executives are not in deep shock; this was already expected. While Nokia is currently burning through its cash reserves, many of its costs are very manageable, and as the company gets leaner and more efficient, this will be less of an issue. The company will continue to close some facilities, lay-off some people, cancel some costly projects and move its operations where it's more cost efficient in 2012. Last year, Nokia recognized that its business is very cumbersome with over 130,000 employees, and it is taking action to make things right.
In 2010, Nokia employed 19,810 people in Finland, 11,243 in Germany and 3,859 in the UK. By the end of 2011, it employed 16,970 people in Finland, 10,992 in Germany and 3,232 in the UK. These are the three countries with highest wages where Nokia operates and the company reduced its head count in all these three countries. Similarly, the company increased the number of people it employed in China, Brazil, and Poland and kept its headcount steady in India. By the end of this year, the company will add incumbents from Vietnam, China and India while reducing headcounts further in the continent of Europe. Last year, Nokia spent $8.16 billion on its employees in shape of wages, bonuses and benefits. This averages out to $62,400 per employee. Each 1,000 employees laid off by the company will save it an average of $62 million annually. Keeping all the numbers constant, reducing about 15,000 from Nokia's workforce of 130,000 would make the company profitable as of last quarter.
There are also other costs which are getting under control as we speak. For example AT&T (T) helping Nokia with some of the marketing costs whereas T-Mobile (DTEGY.PK) is paying the company $4 billion to have some of its networks updated. Nokia is receiving a lot of outside help as major players in the mobile phone service business want Nokia to stay in business as a third major player. If Nokia went out of business, this would hurt companies like AT&T who have to give in the price pressures of phone providers such as Apple.
In 2012, the company will probably generate revenue of $40 billion, similar to the last year. If the company cuts enough of its costs, it can easily become profitable. All Nokia needs to do right now is to generate positive cash flow, and the company is already headed in the right direction in terms of cutting costs. I believe that Nokia will return to profitability starting the third quarter of this year.
Disclosure: I am long NOK.