Many of you may be familiar with the term Net Tangible Assets [NTA]. It is basically the value of a company if it were to be broken up into pieces and sold off. When a company trades at NTA, it's a sign that the market believes the balance sheet will deteriorate over time. This could be for various reasons, including the lack of profitability. Companies that are losing money will have to absorb those losses somehow. Cash will be burned and debt may rise, both of which negatively impact the balance sheet.
I wanted to break down the balance sheet for Nokia (NOK) and show that the company has a maximum value of $2 per share based on optimistic estimates. Realistically, the company should be worth much less than that.
In order for us to understand NTA for the smartphone manufacturer, we need to look at a similar company with a similar situation. Research In Motion (RIMM) has been following a similar path to Nokia. RIM is seeing market share dwindle and profitability fall as competitors such as Apple (AAPL) and Google (GOOG) are beginning to control the smartphone market.
Sounds similar to Nokia, right?
Well it is, except for a few things. RIM is trading under its NTA. RIM's current market cap is $5.6 billion, while its NTA is $6.5 billion. Unlike Nokia, RIM is still profitable. The market has priced in much more pessimism into RIM than Nokia. However, Nokia loses money, but the stock trades at a 26% premium to its NTA.
I expect Nokia's balance sheet to deteriorate considerably, and the market will more than likely recognize that. So lets start breaking down some of the major items on the balance sheet.
We will be looking at the following items:
- Accounts Receivable
The balance sheet of Nokia can be found here.
Currently, Nokia has $2.4 billion in cash. This is down from the previous quarter by $90 million. Analysts are expecting that Nokia will lose $2.5 billion of its cash in the next three quarters. Nokia lost $1.7 billion just in Q1. So a $2.5 billion loss in cash reserve is a fairly reasonable estimate. Even if Nokia burns through $1.5 billion of its reserve, that's still a significant chunk. Now compare this to Apple or Google, both of which have fortress balance sheets.
Now if we take a look at accounts receivable, they have been in decline for the past four quarters. Accounts receivable is basically the money owed to Nokia by customers. Once accounts receivable is paid off, then it is converted to cash. However, just by looking at the statements above, cash has been decreasing and so has accounts receivable. Consumers owe less money to Nokia because they are not purchasing Nokia phones. Accounts receivable should continue to fall over the next few quarters.
The next item to look at on the balance sheet is inventory. Nokia's management is trying to make sure that inventory does not build up, but it seems that may begin to happen. Moody's downgraded Nokia in April, and one of the reasons was because of an ongoing inventory build up for the Nokia Lumia 900. I expect inventories to rise from the current $3.12 billion to around $3.5 billion. Even though inventory levels have been flat since the introduction of the Lumia 900, I believe inventories will now rise. The reason is that the promotional offers for the Lumia 900 have ended. Nokia offered a deal through AT&T, where AT&T customers got a $100 rebate for a Lumia 900. This would basically make the phone free. So if the inventory was flat with the deal, imagine it without the deal. Inventories will more than likely rise.
The last balance sheet line item I want to go over is intangibles. The reason intangibles are important in Nokia's case is because the company has been brought up as a potential buyout candidate. Microsoft (MSFT) is seen as a potential acquirer, but Microsoft would still have to look at the value of intangible assets to see if the acquisition is appropriate for the company. Technology companies tend to have high intangible assets. This is because they tend to value items such as patents, trademarks, and even brand name.
Nokia's intangible value has been falling dramatically. The value of intangibles have fallen 38% in the past four quarters. Now if Microsoft was to look to buy Nokia, then the company would see that Nokia's market share is dwindling, so the value of patents are falling. Now if we look at companies like Apple and Google, we see that intangibles are rising, because the value of the patents for both companies are worth more. Apple and Google also control the majority of the smartphone market, so their brand value has risen as well. As Nokia's losses continue and market share falls, the company's value of intangibles will fall as well.
Based on current NTA, Nokia is valued at $2 per share. However, we also need to take into consideration the lack of profitability. This will deteriorate the balance sheet further, and since the market is forward-looking, the stock should fall based on that estimate. I don't expect a company like Microsoft to acquire Nokia for such a premium. Microsoft most likely knows Nokia will continue to fall as the balance sheet weakens. In addition, Microsoft already has a deal with Nokia to use its OS. Based on the balance sheet, Nokia seems like it is overvalued. The maximum worth of the company is $2 per share based on the current NTA of $7.3 billion. However, I estimate that the company will be worth much less than that over time.