Sunil Shah's  Instablog

Why Apple (AAPL) should suck Nokia (NOK) onto its map

The recent fiasco on Apple's mapping software may possibly be the company's biggest blunder in the company's unchequered past over the last five years. Their current solution is to attempt to beef up maps in-house. This will take months. In my opinion a company with Apple's reputation for excellence in design, user-friendliness and innovation cannot afford to take months. Their supreme franchise, along with their unparalleled margins are at stake.

There is a much better solution. Buy Nokia.

First let's examine the intrinsic appeal of Nokia's mapping division, Navteq. It's currently installed as the GPS system on 4 of 5 new cars with a Global Positioning Satellite system. Not only does it use GPS co-ordinates for mobile telephony, but also refines its accuracy using cell masts to better locate a shop or restaurant in a large building. In other words, for a mobile experience, it's the best out there.

In my opinion a smartphone has four essential functions, the non-negotiables: making calls & sms's, a camera, a browser facility and an accurate mapping function. The supplementary functions are bells and whistles, that are nice to have and clearly, Apple excels at them. However, for the world's best-selling, premium-priced phone not to possess one of the four essential legs is anathema, a grave risk to their dominance and ascent.

As for price, Nokia purchased Navteq for $12bn about two years ago. The entire market cap of Nokia currently stands at $10bn with $4bn net cash on Nokia's balance sheet. Simplistically all else cancelling out, Aapl would bag it for $6bn at today's price. Even if AAPL paid a 100% premium for Nokia, maps (along with a lot else - see below) would be theirs for a net $16bn, net of Nokia's cash.

In other words, for a paltry 3% of the company's market cap, Apple would solve their mapping fiasco immediately and definitively. There would be a number of other significant benefits . . .

Why would this be a stroke of genius?

What this would also do is eliminate a potential threat in the form of Nokia's resurgence. The Lumia series has received excellent technical reviews. Despite some marketing blunders and delays with Windows Phone 8, there is a very real threat that Nokia's new smartphone range will tarnish the IPhone's eminence. In one fell swoop, this threat would be eliminated.

There would be another major coup: Microsoft's plans to develop into the third mobile ecosystem would be seriously scuppered. Nokia is a major partner in Microsoft's herculean effort to prevent their displacement, as the user shifts further and further away from the desktop to the smartphone as his/her preferred interface with the digital world. Without Nokia, Microsoft's efforts would be enormously hampered - Nokia is their preferred partner, and hey presto it disappears!

Nokia has 30,000 cellphone-related patents developed and licensed over the last two decades. Apple's recent win over Samsung over patent infringement must mean that patent portfolio is very valuable. Can you imagine the other cellphone manufacturers quaking in their shoes if these patents now belonged to Apple, a company with the time and money to pursue them relentlessly? I certainly can.

The Hurdles are not insurmountable

This is not a simple transaction. Nokia has many divisions, 114,000 employees and there will be complications:

Anti-trust Veto unlikely

Remember Nokia's market share in smartphones has fallen to 2% recently, as they abandoned their Symbian operating system and transition to Windows Phone 8. This per se, would not pose a regulatory hurdle.

As for their 'dumbphone' division (number 2 globally), that's not Apple's business and they can commit to divesting it in a year.

What about the 114,000 employees?

Divest the businesses or lay them off. Capital markets are not a branch of moral philosophy. It's not Apple's core business to manufacture low-margin products. A policy of a blanket redundancy program could be introduced, where each employee has to then prove they belong within their new parent. I'm willing to bet there are lots of engineers and design staff within Nokia that would have decent prospects at Apple. As for 'dumbphone' manufacture and the Nokia-Siemens-Network division: goodbye.

One must also note that Nokia has already begun the path of restructuring (the pension is already fully funded and mostly of a defined-contribution nature). Yes there may be additional unforeseen costs, but I'm sure SA readers will point them out!

Remember, it's location, location, location. Apple needs maps now.

Disclosure: I am long Nokia and indifferent to Apple

Disclosure: I am long NOK.

Using real operating cash flow: excluding cash received for shares issued, and related tax effect; including deferred commission cashflow; subtracting real capex on servers, furniture etc (there's more for acquisitions but not a certain figure given a voracious acquisitive appetite):

Here's my spreadsheet.

Note fully diluted shares outstanding are now 149m, up by 14m in 1 year;

Table lets you impute a cashflow multiple, add back net cash on balance sheet.

I assume cashflow growth of 35% for f13 to jan13.

Cashflow for yr to jan12			368			""=591-229+6			excluding shares sold and tax effect
less capex			91			capex ex acqtn
Net cashflow			277
Grow at 35%	35%		373.95
What multiple?	15X	20X	25X	30X	40X
Value	5609.25	7479	9348.75	11218.5	14958
Cash	777	777	777	777	777	cash + mkt securities less conv debtas at jan 2012
Total value	6386.25	8256	10125.75	11995.5	15735
Per share
149	42.9	55.4	68	81	106		for 2011 sh 136 m, then moved to 149m!! For f13

To summarise table below, a 40X operating cashflow multiple delivers a price target of 106$. 40x is ludicrously generous.

I prefer a 30X and this delivers a price target is $81

In other words, even after the slide on Thursday May 10th, there is ample downside risk once cloudy euphoric dreams are replaced with a dose of reality.

Disc: short and relieved!!

Disclosure: I am short CRM.

so in summary stx have secured 1bn cash flow per quarter. on a 5x cash flow its going to 20bn mkt cap very quickly. Already big jump, but a lot more to come.
But where's the opportunity Now?
WDC after hitachi will make 90m HDDs, whereas stx will make 70-80m.
They will get higher prices, have less oem in the mix. They have a better track record in operations,
Far better.
And all this will happen after Hitachi is consummated. The big news for WDC is the cashflow after merger. Market is still asleep!

IMO they could easily make a 1bn per qtr too! Put that on a 5X cash flow you get 20bn market cap, or 16bn mkt cap on 4X.

Leave out the 3.9bn cash on balance sheet, leave out the price they pay for hitachi. Just for simplicity they bought hitachi at 4bn, for about 30-40m HDD's. That was before the pricing uplift...before asp rise to give a 15% net cash margin.
So today you have a company making 90m HDD's per quarter, making a billion a quarter.
Watch the market cap of WDC after Hitachi go to 20bn, or up another 100% in a year.

Disclosure: I am long WDC.