Nokia: A Growing Value Play

| About: Nokia Corporation (NOK)
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It was a shocker: Microsoft (NASDAQ:MSFT) offering up $7.2 Billion for Nokia's (NYSE:NOK) hardware segment and patents (a license). In this article, I don't plan on analyzing whether it is a good deal (for either Nokia of Microsoft), but to discuss Nokia after the transaction, and another unexpected move that Nokia might take.

The Unexpected Deal

On September 2, 2013, Microsoft announced a deal to purchase Nokia's Hardware business for $5 Billion, and license their patents in a non-exclusive deal for $2.2 Billion for ten years. For the purpose of this article, I will assume that both Nokia and Microsoft will go through with the deal.

The New Nokia

As of September 8, 2013, the market values Nokia at roughly $20 Billion - is it justified?

Using the data from Nokia's most recent report, they had roughly $3.5 Billion in cash. In addition to the cash from the deal, they will have roughly $10.7 Billion in cash and equivalents, leaving them in a great position for M&A and to pay back liabilities. They have roughly $13 Billion in liabilities ($9 Billion in current liabilities), leaving them with $15.8 Billion in equity (including $7.2 Billion from the deal).

I have broken down the NEW Nokia's revenue by segment, predicting future sales (annualized from Q2 revenue and margins in USD):

HERE (maps) Nokia-Siemens
Revenue $1.235B $14.75B
Gross Margin 76% 38.3%
Net Margin -38.2% .3%

The new Nokia will be primarily comprised of HERE mapping systems, and the Nokia-Siemens Network in which Nokia is buying Siemen's (SI) 50% stake in the coming weeks. The deal, valued at roughly $2.25 Billion (values NSN at $4.5B), will be financed mostly by bonds backed by Microsoft (part of the $7.2B deal), hence not affecting Nokia's cash hoard.

The Nokia-Siemens Network, or NSN, is valued at roughly $4.5B according to Nokia's purchase price from Siemens. NSN now represents roughly 90% of Nokia's sales, and can be considered its core business, but it is lagging in profitability.

"And you pointed out the recent NSN profitability, I want to highlight that we have the long-term profitability target for NSN, which is 5% to 10% and in that sense as I said earlier we feel that now NSN is a very, very efficient enterprise and can invest in a prudent way in the right way to grow..."

-Timo Ihamuotila, EVP and CFO

Nokia plans on growing NSN through investment and attention, instead of shrinking it and managing profitability. They feel as if they have a strong asset, which can capture a large portion of the enterprise market through the backing of Nokia's $10B cash hoard and patent hoard, and there is no need to limit its potential.

HERE is a mapping and location service that incorporates traffic, transit, and even weather into its calculations. HERE is not only for personal use, but also for businesses, enabling them to track and manage employees. Reading through Nokia's conference call discussing the $7.2 billion "deal", I found one of Nokia's brightest gems. As part of the agreement, HERE will gain access to Microsoft's patents (for mapping and location services), and,

"Microsoft will become a strategic licensee of the HERE platform and will separately pay Nokia for a four year license."

-Timo Ihamuotila, EVP and CFO

The new Nokia will have roughly $16B in annual sales, and $425 in losses from their core businesses ($44.25M net profit from NSN and a $470M loss from HERE as of Q2 numbers). The bright spot will be their patents ("Advanced Technologies"), which Microsoft recently licensed for $2.2B. The 11,800 patent portfolio, valued at upwards of $7.5B, already earns Nokia roughly $630M a year in royalties, leaving them with a net profit of $205M.

Dan Levine (Reuters) notes that Nokia most likely held onto their patents for a strategic reason. Nokia spokesman Mark Durrant notes that "once we no longer have our own mobile devices business, following the close of the (Microsoft) transaction, we would be able to explore licensing some of those technologies." The $630M in yearly royalties might just be the beginning, with Nokia pursuing even more strategic options. Once more, HERE and NSN are on track to grow both revenue and profit, increasing value in the near future. As of the current numbers, the "new Nokia" is valued as follows:

P/S (est. $16.5B) 1.2x
P/E (est. $205M) 100x
P/B (est. $15.8B) 1.26x

But, we can reconstruct the model to predict next year. Management predicts 5% - 10% margin on NSN, and growing revenue and margins on HERE - lets assume 5% revenue growth, and net margins of 5% for NSN and -20% for HERE (in the process of restructuring).

HERE (maps) Nokia-Siemens
Revenue $1.3B $15.5B
Net Margin -20% 5%
Profit/Loss -$260M $775M

Using this model, we can predict $515 in net income from its core assets. If we assume that Nokia grows licensing revenue, or its Advanced Technology division, to $750M (a $120M increase), they can earn $1.265B next year, putting them at a forward P/E of 15.8.

A New Deal

Nokia is not only in a strong position to grow NSN and HERE, but can also focus on M&A to extend and capture new business. With more than $10B in cash, and even more financing available, Nokia can perform a large acquisition in the coming weeks; the one that comes to mind first is BlackBerry (BBRY). BlackBerry is currently valued at less than $6B, an easy acquisition for Nokia, even paying $8B (33% premium). The values are taken from my previous article, here:

Cash $2.9B
Patents $2.25B
BBM $1.7B
BES $1.2B
Hardware $2B - $3B
Everything Else $0
Total $10B - $11B

The $8B purchase price is partially covered by BlackBerry's $2.9B in cash, leaving the price at about $5B for Nokia -- what do they have to gain? Nokia is planning to embark on multiple patent litigation suits, and BlackBerry's estimated $2B - $3B in patents can't hurt.

Once more, Nokia's NSN is planning on becoming a major player in the enterprise market, in which BlackBerry has a large stake. The newly revamped BBM and BES can help boost NSN, adding up to $3B in value, which covers Nokia's purchasing cost.

The hardware business and everything else comes free. I believe that Nokia does not want to enter the hardware business again (and the low margins that come with it), and instead can make an offer for part of the company (a $7B offer would be extremely fair, leaving $1B in gains for Nokia), or spin off the hardware segment for around $500M - $1B (they have roughly $750M in inventory).

Nokia might decide not to go for a large acquisition like BlackBerry, and instead could focus on growing their core businesses. The purpose of this article was to show Nokia's position after the transaction, and the possibilities that they have. Nokia is likely to grow both revenue and profitability in the coming quarters, turning themselves into a sturdy, growing company, with billions in potential and billions more in value.

Disclosure: I am long BBRY, 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.