Nokia's Turnaround May Be Successful After All

Jul.20.12 | About: Nokia Corporation (NOK)

Nokia (NOK) reported its quarterly earnings. The company was expected to report a loss of 9 cents per share and it ended up reporting a loss of 8 cents per share excluding one-time items. Initially, the company's stock price saw a 13% rally; however, profit taking took place in the afternoon, reducing the size of the rally. On a side note, the share price ended the day up 12% in the Helsinki Stock Exchange, and there was no effect of profit taking there.

Nokia was able to sell 4 million Lumias in the last quarter compared to 2 million a quarter ago. The analysts were expecting the company to sell an average of 3.8 million of these phones. Lumia phones were introduced to many markets very recently and these phones are not available in many markets. In US, the phone is only available for AT&T (T) customers and it will be offered to Verizon (VZ) and Sprint (S) users in the next quarter or so. There are countries that will not get the company's flagship phone until after Windows 8 (MSFT) launch. Considering the market exposure of these phones, selling 4 million items in a quarter is not a bad start. Also, when one keeps in mind that many consumers are holding off until Windows 8 is launched, the case becomes stronger. I expect Nokia to sell many more Lumias in the next quarter as it introduces the product to more markets under a larger number of carriers. Many people expect Nokia to introduce the Windows 8 version of its phone during Nokia World in September, however the company's CEO Steve Elop didn't give any hints regarding the matter during the earnings announcement.

While the company reported a net loss of $1.7 billion for the quarter, its cash holdings only decreased by a little less than $1 billion. This is mostly due to royalty and licensing fees Nokia collects from its patent portfolio. In addition, Microsoft pays Nokia $250 million per quarter for participating in Windows Phone project. Nokia's total cash and assets are worth $9.4 billion and the company's cash bleed is expected to slow down significantly in the next 2 quarters. In fact, if it wasn't for the company's dividend payments during the last quarter, it would have come nearly even in cash flow for the quarter. This is certainly good to know because many people claim that Nokia will run out of cash and go bankrupt within a couple years. Nokia's current share price reflects that investors are 99% certain of the company's bankruptcy as the company trades for less than how much its patent portfolio is worth.

Next year, the company will be "more conservative" about its dividend rate. As an investor of Nokia, I welcome this. At the moment, the company should hold onto every dollar it can keep so that its transition will be as painless as possible. This is something I have been advocating for a while. Nokia will continue to lay-off employees and close excess plants and facilities until at least the end of 2013. The cost cutting measures will play a major role in company's struggle to return to profitability. Furthermore, the company will probably see growth in royalty and licensing fees it collects from the competition in the following quarters as it aggressively chases those that infringe its patents.

Nokia will continue to lose market share as it becomes leaner and meaner. It will be a while before the company is a major player in the mobile phone market again. This is not much of a concern though. The company's share price is so cheap that it doesn't need to become a major player in the market to see a rally. Currently, anything short of bankruptcy will be bullish for the company as it trades far below its book value.

I most definitely liked in Nokia's earnings report was the fact that the company's other business units showed improvement. The Location and Commerce posted an operating profit of $33 million and Nokia Siemens Network posted an operating profit of $34 million excluding one-time items. These numbers aren't very large; however, it is encouraging seeing that these business units will be contributing to the turnaround of the company rather than burning cash. Nokia's mapping business has attracted a lot of interest and secured partnerships with Flickr (YHOO), Bing and Ford (F).

On a negative note, the company's mobile phone margins will continue to be bad for the next quarter. The company did not provide a clear guidance for the second half of the year as there is too much uncertainty. Also, Nokia admitted that the fierce competition will continue to pressure the company for the foreseeable future.

In the next couple months, there won't be anything that can drive the stock price sharply in either direction. The volatility should be lower than the usual. The next catalyst for the stock's price will be launching of a phone that can run on Windows 8 operating system. Nokia is a very large company and it was obvious that the turnaround would take a while. The investors have been very impatient with the company and they oversold the stock out of fear. As I had mentioned before, turning around a large multi-national corporation that is facing fierce competition in a rapidly evolving market will take more than a few months. Once Nokia comes near ending its cash burn, many of the company's investors will be coming back for value hunting. For the time being, anything short of an immediate bankruptcy is bullish for Nokia.

Disclosure: I am long NOK, MSFT, T, VZ, F.