Nokia's Shares Are Benefiting From Irrational Exuberance

| About: Nokia Corporation (NOK)

Despite the fact Nokia Corporation (NYSE:NOK) issued a pedestrian performance forecast for its Q4 2012 and Q1 2013 results on January 10th, investors bid its shares up by 19% anyway. Maybe they felt that Nokia's performance couldn't sink any further. While we think that Nokia's fundamental business operating performance probably can't decline any further from its lows achieved in 2012 and while we believe that Nokia's not likely to suffer a near-term bankruptcy, we believe that Nokia's shares are benefiting from irrational exuberance. We were surprised to see Nokia's shares run up by 19% on January 10th because we found that Nokia's preliminary performance for Q4 2012 and Q1 2013 forecasts to be quite underwhelming and these performance forecasts and figures will be the subject of this analysis report. We were also surprised to see that even with this 19% pop on January 10th, it is only 2% above its eight month high of $4.35 achieved on December 19th. We believe that Corporate Financial Results in general and Nokia's Financial Results in particular are like a Rorschach inkblot test because different people have different reactions to what is presented.

Source: Morningstar Direct

Nokia's Devices and Services Division - Smart Devices: Considering all the hype surrounding the Nokia Lumia Windows Phone 8 smartphone devices, we were expecting Nokia to have sold more than 4.4M units during the quarterly period. While this was certainly better than the Q3 2012 period, we would like to point out to the investment community that Nokia sold 4M Lumia Window Phone smartphone devices in Q2 2012, and Q2 2012 did not have the benefit of the year-end holiday shopping season. Furthermore, Nokia's Symbian sales volumes continued its ongoing deterioration, and it is obvious that Lumia Windows Phone sales volume growth is basically offsetting Symbian sales declines. At least Nokia will probably euthanize the Symbian platform sometime next year as its sales volumes have collapsed from the 28.8M sold in Q4 2010 and the 19.6M in Q4 2011. Although Nokia's Q4 2012 Smart Devices revenue of €1.2B (US$1.59B) was about 23% higher than its Q3 revenue of €976M ($US1.3B), it was less than the €1.7B (US$2.25B) achieved in Q1 2012 and the €1.5B (US$1.99B) achieved in Q2 2012.

Sources: Nokia's 2012 Quarterly Earnings Reports and 2013 Preliminary Guidance

Nokia's Devices and Services Division - Mobile Devices: Nokia's lower end mobile phone devices generated €2.5B (US$3.315B) in revenue for Q4 2012, which was a decline of over €500M (US$663M) versus Q4 2011 levels. We were intrigued by Nokia Asha series sales volumes (9.3M in Q4 2012 and 6.5M in Q3 2012), however, this was not even to offset a 15% unit sales volume decline in Q4 2012 (79.6) versus Q4 2011 (93.9M). The good news for Nokia's lower end mobile device business was that its sales volumes increased sequentially for the third straight quarter from its Q1 2012 low of 70.8M, but the bad news is that its full year sales volumes of 310.7M in 2012 declined 8.6% versus 339.8M achieved in 2011.

Sources: Nokia's Q4 2011 Report and Q4 Earnings Pre-Release

Nokia's Devices and Services Division - Other: Nokia's Devices and Services Division generated €0.2B (US$0.265B) in other revenues not directly attributed to the Smart Devices or Mobile Devices division, including €50M (US$66.3M) of non-recurring IPR revenue. We believe that investors bid up Nokia shares because the Nokia Devices and Services Division's non-IFRS operating margin of 0%-2% for the quarter was better than the previous outlook of -6%. This was due to the following four factors:

  1. Better than expected Lumia sales volumes
  2. Narrower sales declines in the Mobile Devices segment than expected
  3. €50M (US$66.3M) of non-recurring IPR revenue
  4. Lower expenses due to Nokia's ongoing restructuring program
  5. We would also like to remind Nokia's investors that Nokia's non-IFRS operating margin is still below the 4.9% achieved in Q4 2011 and the 12.1% in Q4 2010

Sources: Nokia's Q4 Reports from 2010-2012

Nokia's Devices and Services Segment is expected to generate a negative non-IFRS operating margin of approximately -2%, plus or minus 4%. This is based on continued sales penetration expectations of its Lumia smartphone devices and its Asha feature phone series as well as ongoing cost reductions in the division. This operating margin is in line with its -3% operating margin in Q1 2012 but a long way from its 10.3% operating margin in Q1 2011.

Nokia's Location & Commerce Division: Nokia Location & Commerce was estimated to have generated €300M (US$398M) in revenue during the quarter and a non-IFRS operating margin of 13%-15%. We were surprised that it did not generate a larger increase in revenue considering that it signed widely touted deals with BMW, Oracle, Mercedes, Garmin and Amazon. At least it was able to increase its operating margin from 9.5% in Q4 2011 to 13%-15% in Q4 2012. We are also pleased that it did not write-off any goodwill and intangible assets from this division in Q4 2012. We believe that Nokia's write-down of €1.1B (US$1.46B) was more than sufficient and we were pleased that Nokia provided an estimated recoverable value of €4.1B (US$5.44B) for its Location & Commerce Division (formerly NAVTEQ) in its Q4 2011 report.

For Q1 2013, Nokia Location & Commerce is expected to generate a negative non-IFRS operating margin due to lower recognized revenue from internal sales, which carry higher gross margin, and to a lesser extent by a negative mix shift within external sales. We were surprised to see this regression back to Q1 2011 levels for Q1 2013 since Nokia Location & Commerce generated a 12.9% non-IFRS operating margin in Q1 2012 after suffering the indignity of a -6.9% non-IFRS operating margin in Q1 2011.

Sources: Nokia's Q1 2012 Report and Nokia's Management Guidance for Q1 2013

Nokia Siemens Networks: Nokia Siemens Networks' restructuring program is starting to bear fruit for the company because its non-IFRS operating margin increased from 3.7% in Q4 2010 to 4.6% in Q4 2011 to 13%-15% in Q4 2012. Nokia Siemens Networks can attribute its improved operating margin to lower expenses thanks to its restructuring program and a 5% increase in Q4 2012 revenue (€4B (US$5.3B)) versus Q4 2011 levels (€3.815B (US$5.06B)). Nokia Siemens Networks also benefited from non-recurring IPR income of €30M (US$40M).

For Q1 2013, Nokia Siemens Networks is expected to generate a non-IFRS operating margin of 3%, plus or minus 4%. This outlook is based on Nokia Siemens Networks' expectations regarding a number of factors, including the competitive industry environment, product and regional mix, the global macroeconomic environment and NSN's restructuring program. At least Nokia Siemens Networks can take comfort in the fact that its projected operating margin is expected to be much better than the 0.1% achieved in Q1 2011 and the -5% in Q1 2012.

Sources: Nokia's Q1 2012 Report and Nokia's Management Guidance for Q1 2013

We have to agree with former Nokia executive Tomi Ahonen's assessment of Nokia's Devices and Services performance. While we believe that Nokia has made significant progress with Nokia Siemens (SI) and Nokia Location & Commerce (formerly NAVTEQ) has had mixed results, Nokia's bread and butter Devices and Services division has a long way to go in order to restore its relevance in the marketplace. Stephen Elop basically destroyed the market for Symbian with his Burning Platform memo and the Lumia 920 is best suited for bench-pressing than as a communication device. Since Elop arrived at Nokia in September 2010, Nokia's quarterly smartphone market share has collapsed from 29% in Q4 2010 to 3% in Q4 2012.

Sources: Tomi Ahonen Consulting Analysis

Despite the fact that Nokia had the advantage of selling its new flagship Windows Phone 8 Lumia smartphone devices in Q4 2012 whereas Research in Motion (RIMM) won't be selling its flagship BlackBerry 10 smartphone devices until January 30th, Nokia's Q4 2012 smartphone sales volumes were less than RIMM's Q3 2012 sales volumes of 7.4M. We thought that even though Nokia has no chance of catching up to Apple (NASDAQ:AAPL) or Android, at least it would have a 13 week head-start against BlackBerry 10 in order to win the hearts and minds of consumers with its Windows 8 flagship smartphone devices.

In conclusion, we are still unimpressed with the sales results of the Windows Phone 8 devices as well as Nokia Corporation's overall results. We can see encouraging trends from its Nokia Siemens Networks division as well as its Asha feature phone product series. Based on the whopping 4.4M sales of its Lumia Windows Phone devices, we can see that our thesis that Nokia's stock-outs were most likely due to the intentional management of the supply rather than creating a cutting edge device that people want to use. According to customer surveys conducted by Bernstein, only 37% of Windows Phone customers would consider buying another Windows Phone device and that doesn't bode well for the Nokia Lumia Windows Phones, even if Will Arnett says otherwise. If Nokia Location & Commerce sees its FY 2013 operating margins regress from its 2012 levels, we expect Nokia to have to take another impairment on the division, just like in 2011. In short, we believe that the investors who bought into Nokia at around $2 during the June and July 2012 period may want to take some of their profits. To those investors that sold or shorted Apple at around $700/share in September and bought Nokia at less than $3/share in 2012, we would like to remind you that quitting while you are ahead is not the same as quitting.

Disclosure: I am long AAPL. 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.

Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.

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