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Simply put, Nokia (NYSE:NOK) is a mess. Where once this was the world's best cell phone maker and the owner of a high-quality balance sheet, now the company is struggling to stay relevant and stem the loss of market share to Apple (NASDAQ:AAPL) and Samsung (OTC:SSNLF). Although the company's feature phone business in North America looks as though its in shambles, the company does have enough liquidity and time to make what may be a last stand around its Microsoft (NASDAQ:MSFT) Windows-powered Lumia.

A Nasty Quarter, With a Touch of Irony

Nokia warned us all about a week ago that this quarter would be pretty ugly, and so it was. Although the company did eke out 3% sequential revenue growth, overall revenue was down 19% and core devices and services revenue fell 26% from last year and 5% from the first quarter.

Margins continue to erode, as overall gross margin fell by about seven points. If there was good news, it was that margins in the D&S business fell just 80 bp if you exclude a EUR 220 million inventory write-down, and smartphone gross margin actually improved slightly. By the same token, given that this write-down is due in part to an inability to move phones at the intended price, perhaps backing that out really isn't so appropriate. Likewise, the D&S unit showed a negative operating loss whether one uses the reported (negative EUR 474 million) or adjusted (negative EUR 365 million) number.

And now for the irony -- Nokia Siemens Networks (NSN), a longtime albatross for both Nokia and Siemens (SI), was actually profitable this quarter. In a carrier equipment world where Alcatel Lucent (NYSE:ALU) continues to flounder, American vendors like Adtran (NASDAQ:ADTN) are still struggling, and even Chinese manufacturer ZTE is having issues, NSN produced an operating profit and a third straight quarter of positive operating cash flow.

Plenty of Bad News in Volumes

Nokia reported flat sequential phone shipment numbers to North America (600,000 units), but that also represents a 60% year-over-year decline. Although the higher-end Lumia 900 is doing relatively better, ASPs weren't great in smartphones (up 6% sequentially), and there's nothing to suggest that the company is taking advantage of this lull before the next major iPhone launch. So while Nokia held on to a little more share than expected this quarter, there's little doubt that the company is still losing out to Apple and Samsung, even with other entrants like Research In Motion (RIMM) struggling as well.

As that inventory write-off would suggest, investors can't completely dismiss the threat of channel-stuffing. Nokia is still planning to launch some entry-level Windows Phone 7 Lumias later this year, but that feels like throwing good money after bad. On the flip side, a Lumia running Windows Phone 8 should be on the market later this year, and both Nokia and Microsoft know that they have a lot riding on this one (though Microsoft will survive even if the launch fails and can always find another partner or go it alone if need be).

And then there's that old dichotomy between Nokia's higher-end North American/European smartphone business and the more traditional cell phone business that's larger and stronger in areas like Asia. Revenue certainly fell off less here (sales were down 13% year-over-year on a 17% increase in volume and flat sequentially) and this business is still marginally profitable and cash flow positive.

Where Is the Bottom?

Kids (and adults) are always told never to dive into murky waters, because you never know where the bottom is. That would seem to be good advice as it applies to Nokia and its ability to rebuild a high-end cell phone franchise.

Nokia ended the quarter with over EUR 4 billion in net cash (though boosted by about EUR 400 million through IPR prepayments). Unfortunately, it sounds as if the company's restructuring efforts are going to consume nearly EUR 2 billion of that cash by the end of 2013, and that's assuming the cuts don't go deeper (as the recent trend has been). At the same time, the company is likely looking at operational deleveraging from ongoing sales erosion, and all of this may make that cash balance pretty tight before the presumed improvements in 2013.

While on the subject of restructuring, Nokia is trying to cut its cost base within to D&S to about EUR 3 billion by the end of 2013 (vs. EUR 5.35 billion in 2010). Even if management succeeds, Nokia will need about EUR 12 billion in D&S revenue to break even and probably EUR 20 billion to see double-digit operating margins again. Maybe that doesn't like a lot given the run-rate of about EUR 16 billion in revenue, but it's clear that Nokia cannot afford to lose much more share.

Speaking of share, it may help to remember the Motorola example. Motorola was once in a position not too dissimilar to Nokia, a one-time market leader that had been badly outmaneuvered in the market and that couldn't translate extensive R&D spending or patents into a market-leading product. While Motorola never regained its former glory -- and Google (NASDAQ:GOOG) bought it for patents as much as anything else -- it did give brave investors a good return on the turnaround, and its market share dropped considerably lower than where Nokia is at today.

The Bottom Line

Through my models, I see a 15%-20% chance that Nokia doesn't make it and roughly a 40% chance that company muddles along, hamstrung and toothless. That leaves a reasonable chance (maybe 40%), though, that the company can build itself back into a worthwhile name. I don't believe Nokia will ever unseat Apple, but if this restructuring goes right perhaps it could threaten Samsung again.

Right now I see a risk-adjusted fair value of about $2.50 for Nokia shares. If you exclude the possibility of bankruptcy, the fair value jumps to about $3.50 or so. Clearly, if the turnaround works Nokia's shares will exceed that level, but at present investors should first hope for a successful Windows Phone 8 launch and a stabilization of cash flow before the end of 2013.

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