Nokia's (Hidden) Value - Part 1: Restructuring

Oct.17.12 | About: Nokia Corporation (NOK)

Much has been written about Nokia (NYSE:NOK) since CEO Stephen Elop announced the company's decision to switch to the Windows Phone platform on February 11, 2011. Most of these articles have attached "embattled," "struggling" or "beleaguered" to Nokia's name - and for good cause. Nokia, for years the largest mobile phone maker in the world, has lost a significant amount of market share and money, and has seen its stock price drop from US $9.36 on that day, to below US $3.00 per share today. Gone are the days of Nokia's 40% worldwide market share and huge operating profits (EUR 7.985B in 2007), replaced with dwindling market share (19.9% in Q2 2012) and huge losses (EUR 1.34B in Q1 2012 & EUR 826M in Q2 2012 alone).

While many investors (and potential investors) are waiting to see whether the Finnish company will be able to turn its (mis)fortunes around, the value, and potential, of Nokia is there for anyone to see, if they are willing to wade through the doom-and-gloom numbers and analysis and dig a little. With Nokia about to release its Q3 2012 results, I will discuss the areas in which the company could see a turnaround. In this article, I will discuss Nokia's restructuring efforts, while in part two, I will discuss Nokia's potential for increased revenue.

One of the most commonly discussed topics surrounding Nokia is its recent quarterly losses that have resulted in dwindling cash reserves. While it is also often mentioned, alongside these reports, that Nokia is laying off staff and restructuring itself to prevent further losses, just what the cost (and benefits) of that restructuring entails is rarely examined in detail.

As mentioned already, Nokia lost EUR 1.34B in Q1 2012 and EUR 826M in Q2 2012. While most pundits focused on Nokia's shrinking cash reserves and counted the quarters until its insolvency, the details of the company's quarterly financial reports provided some insight into these losses. In Q1 2012, restructuring charges and other associated items for Nokia Siemens Networks (NSN) was EUR 772M, Nokia's Devices & Services unit was EUR 91M and the Location & Commerce unit was EUR 10M. All told, this totaled EUR 873M towards the EUR 1.34B loss. Q2 2012 also included similar, albeit lower, charges: EUR 190M, EUR 108M and EUR 10M respectively for each of the above mentioned business units, totaling EUR 308M towards the EUR 826M loss that quarter.

These are the expenses Nokia is incurring by reducing its workforce, closing/moving factories/offices and restructuring itself. In other words, over half of Nokia's total loss in the first half of 2012 was related to short-term payments - payments that, in the long run, are aimed at cost-savings for the company. Not just cost savings in terms of a reduced headcount, but cost savings associated with moving production from higher-cost areas such as Europe to lower-cost areas such as China. In other words, Nokia is spending (a lot of) money now to save (a huge amount of) money later. The company expects its restructuring of NSN to result in annual operating expenses and production overheads being reduced by EUR 1.0B by the end of 2013. It also expects its Devices & Services unit to reduce its annual operating expenses to approximately EUR 3.0B by the end of 2013, which would be more than EUR 1.0B in savings per year as well. That means Nokia expects to put together at least EUR 2.0B in savings per year from its restructuring of these two business units.

Looking at this simply, if you take Nokia's current quarterly losses and extrapolate them to the entire 2012 year, it could lose up to EUR 4.0B. However, when you consider that half of that loss is related to restructuring costs and that those restructuring costs themselves will eventually result in EUR 2.0B in savings, you see that the company is working to achieving a break-even situation. Some might consider that Nokia is not in a healthy state if after all those cuts it would only come out at the break-even point. But remember, this is all just from the cost-savings side. Without a single increase in sales, Nokia can put itself into a break-even situation.

Something else to note about Nokia's recent performance is that it actually had positive net cash from operating activities of EUR 102M in Q2 2012. The EUR 826M loss in the quarter can largely be attributed to the above mentioned restructuring charges and its EUR 742M annual dividend payment. So, if Nokia needs to, it can suspend its dividend temporarily (as it should really have done in 2012), to help it get back to profitability sooner. Even as an owner of Nokia stock, I will gladly take short-term pain for the long-term gain.

Another thing to consider is that Nokia is divesting parts of itself, be it business divisions (such as Vertu for a reported EUR 200M), property (potentially its own headquarters building for up to EUR 300M) or patents (including 500 recently to Vringo (VRNG) for US $22M) to name but a few. These sales can help Nokia by bringing in much-needed capital and reducing expenses without having to incur restructuring costs to do so (in the case of selling off business units, Nokia is able to transfer the employees to the purchasing company rather than laying them off and having to pay them severance and benefits), as well as possibly removing unprofitable parts of its business. These sales could potentially ease Nokia's restructuring costs and move it towards profitability sooner than expected.

There are those that might claim that even if Nokia is making all of the right moves, it doesn't have enough of a cash reserve and will run out of money before it can right itself. This is another area where Nokia's detractors have pointed to, with claims of Nokia's impending bankruptcy commonly bandied about. However, this is another area that bears examination for the facts.

After Q2 2012, Nokia had EUR 9.4B gross cash and EUR 4.2B net cash, both of which were higher than one year earlier according to CEO Stephen Elop. Many analysts look at the recent quarterly losses and compare them to the net cash and get worried. While Nokia's losses are concerning, as mentioned before, much of it is related to its restructuring charges and dividend payment. Since most of the restructuring is expected to be complete by the end of 2012 and the dividend payment can be suspended in the short term, most of the large losses will be gone once 2013 starts. In fact, many analysts (including Moody's (NYSE:MCO) who recently downgraded Nokia's debt ratings) peg the company to return to profitability by as early as the second half of 2013.

But even if losses continue longer than expected, or revenue decreases further, Nokia's net cash number is not quite as bad as it seems. Nokia's various forms of debt total EUR 5.2B, with about EUR 2.94B coming off the books by the end of 2015, and its remaining bonds not being due until 2019 and 2039, respectively. This means Nokia has a fair amount of time to right itself, as all of that debt is already accounted for (it's the difference between the gross and net cash). It has EUR 4.2B in net cash as a padding right now, plus almost EUR 1.7B not due until 2019 and later. Nokia also has access to a revolving credit facility of EUR 1.5B, which at this time in entirely undrawn and available through March 2016. This means in the short term, Nokia actually has closer to EUR 7.5B in cash than the 4.2B net cash reported. Yes, it should not overextend itself, and yes it pays interest on its debt, but since it has so much cash on hand before its crisis started, it is still in a very good position to weather the storm, and if it continues with divestments, it could even raise more capital to cover some of its short-term losses.

Slowness to react to a changing cell phone market led to decreasing sales, which put Nokia into the financial situation it is in today. But it has not been slow in taking the necessary steps to right itself and in such a way that it won't require stellar sales of its Lumia smartphones to put it back into profitability. As mentioned, many analysts expect Nokia to return to profitability in 2013, and that is even with it not having particularly strong Lumia sales. Once Nokia gets back into the black, the days of its current sub-US $3.00 shares will be at an end. However, if it does manage to achieve an increased smartphone market share (even if it is just with Windows Phone 8 achieving a reasonable third-place in the mobile phone operating system market), Nokia will see black for many years to come and so will its investors.

For more on Nokia's hidden value, please see part two of this article.

Disclosure: I am long NOK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.