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The past three months have not been the best for Nokia (NYSE:NOK). Along with slashed prices for its Lumia 900, Nokia's bond has been downgraded to junk by the top three rating agencies. The company reported a $1.7 billion loss for Q2, which is more than double what analysts were expecting. Despite a bleak financial outlook, the stock has appreciated by 22% since Q2 results came out. This appreciation can be attributed to strong Lumia sales and rumors of a possible takeover by Lenovo (OTCPK:LNVGY). Despite Lenovo's detraction of such rumors, the possibility of a takeover remains in the cards, considering Nokia's hefty patents portfolio, which more than makes up for its current market value. On the other hand, any possibility of a turnaround remains dependent on the success of the Nokia-Microsoft (NASDAQ:MSFT) partnership. Therefore, we recommend a hold position on Nokia's stock.

Business Overview

Nokia is a Finland-based technology giant with three operating segments, namely Devices & Services, Navtaq, and Nokia Siemens. The Device & Services segment is the largest contributor to Nokia's revenues. This segment has suffered heavily in the last few years, both in terms of reduced margins and unit sales. The market leader in cell phone sales since 1998, Nokia is currently holding the number two spot, with a 22.5% market share. This segment is depending on its new Lumia series to trigger a turnaround. In a bid to diversify its device's heavy sales portfolio, it has also announced an alliance between Navtaq and Groupon (NASDAQ:GRPN). Nokia will allow Groupon to promote deals on its map, through a green G button. The company has not disclosed the financial expectations from this venture.

Q22012 Performance

Nokia's share price continued its downward trend during the second quarter. The share price was almost cut into half from $3.79 to $1.79 per share.

click to enlarge

The quarter low of $1.69 was reached on July 18 due to adverse expectations from quarterly results. The company reported a $1.7 billion loss for the second quarter, which is double the $784 million that analysts expected. The high losses reported have increased investor fears that the company might be in more trouble than was initially expected. Liquidity is another area of concern keeping in view the high amount of Capex that the company intends to make in the next year. NOK reported that it had ended the month of June with cash of $5.2 billion, which was more than the market estimate of $4.5 billion. The difference can be associated to prepayment of royalties. In an effort to reduce stakeholder fears of diminishing liquidity, the company announced that it has acquired $1.834 billion revolving credit facility through March 2016.

Nokia was able to meet unit sales targets of 4 million for its Lumia devices. Keeping in view the heavy reliance of Nokia on its Microsoft alliance to rescue its diminishing cell phones sales, this was positive news for investors. If we look at units sales of smartphones from April to June, total unit sales fell by 38.9% YoY to 10.2 million units. Samsung (NYSE:SE) remains the clear market leader with sales of 50.2 million units and YoY growth of 172.8%. The lucrative North American market remains the key to success for Nokia's smart phones. The unit sales from North America for the quarter were 600,000, but revenues were up 38% to $128 million, which was an encouraging sign for stakeholders.

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Q2 2012 Sales Value by Geographical Area

Vendor

2Q12 Unit Shipments

2Q12 Market Share

2Q11 Unit Shipments

2Q11 Market Share

yoy Change

Samsung

50.2

32.60%

18.4

17.00%

172.80%

Apple

26

16.90%

20.4

18.80%

27.50%

Nokia

10.2

6.60%

16.7

15.40%

-38.90%

HTC

8.8

5.70%

11.6

10.70%

-24.10%

ZTE

8

5.20%

2

1.80%

300.00%

Others

50.7

32.90%

39.2

36.20%

29.30%

Total

153.9

100.00%

108.3

100.00%

42.10%

Top Five Smartphone Vendors, Shipments, and Market Share, Q2 2012 (Units in Millions)

Turnaround

Nokia's turnaround strategy is dependent on its Lumia series, its partnership with Microsoft, and North American sales. North America is the most lucrative market in terms of margins and units. As of Q22012, only 11.67% of Nokia's sales are coming from North America. The future of its partnership will be the key to any possibility of a turnaround. A significant update in this regard is the recent launch of Microsoft's Surface Tablet. The non-involvement of Nokia in this venture has brought serious concerns over the future of this alliance. Microsoft has already announced that all Nokia-based Windows 7 phones will not automatically upgrade to Windows 8. Instead, all such devices will be given an update patch. Windows 8 has already created a lot of buzz, and Nokia's access to this new OS will be the key to future Lumia sales.

Acquisition

Last week, rumors about a possible takeover of Nokia by Lenovo sparked investor interest, resulting in a 17% price hike. A senior Lenovo executive laid all the speculation to rest by saying that Lenovo had no interest in any such venture in the near future. Considering Lenovo's heavy PC business model, this acquisition seems highly unlikely in the future as well, due to a lack of synergy between the two companies. The most likely candidate to go for possible takeover seems to be Microsoft . The software giant has already launched its own Windows 8 tablet, indicating its interest in competing with Android and Apple (NASDAQ:AAPL). Nokia's shares are currently trading at $2.38, which is still lower than the estimated value per share of Nokia's patents i.e. $2.61. Combined with a strong brand name, Nokia can be a potential target for Microsoft, which has the cash to buyout a company valued at $8-9 billion. At the end of September, Microsoft had a $6.938 billion ending cash balance.

Conclusion

According to sales estimates, Nokia will not be able to bring about a turnaround until 2014. The primary catalyst for the company remains its Lumia series and any future collaboration with Microsoft. Access to the much hyped Windows 8 can prove to be an important factor in case of a possible turnaround. Its shares are trading near the value per share of Nokia's patents, which makes it a very attractive acquisition target. However, taking into account the uncertainty surrounding its future sales, a hold position is recommended for Nokia's stock. The stock has already rallied big time and we would want to see more certainty on Lumia sales front before we recommend a strong buy rating. However, those investors who are already long should not sell.

Source: Lenovo Is Not Buying Nokia, Should You?