Nokia's (NYSE:NOK) decision to dispose its handset business to Microsoft (NASDAQ:MSFT) is making sense after a look at its second-quarter results. Nokia is now more focused, and it is working toward attaining profitability in its network business. However, the company will now face stronger competition from the likes of Alcatel-Lucent (ALU) and Ericsson (NASDAQ:ERIC), which are already established in the networking space.
Moreover, net sales in Nokia's networking business declined on a year-over-year basis in the previous quarter. In fact, Nokia saw an 8% decline in the networking business from last year. However, this was a result of currency headwinds, excluding which Nokia's networking segment would have increased 1% year over year.
A closer look at networking
The networking business accounts for 90% of Nokia's overall business. Due to the headwinds stated above, operating profit from this segment declined 14% year-over-year to 281 million euros. But, the important thing was that the operating profit was way ahead of the 197 million euros analysts estimated.
This clearly suggests that Nokia is performing ahead of expectations, and as data spending picks up further, its performance should improve. According to Gartner, global IT spending will improve 2.1% this year and 3.7% next year. In fact, data center spending is forecast to grow at a pace of 2.9% next year, while telecom services will grow at a rate of 2%, well ahead of 2014's expectations of 0.4% and 0.7%, respectively.
Hence, networking spending is expected to grow due to data center deployments and LTE roll-outs, and Nokia is seeing improving sales in China. As a result, Nokia was able to boost its profit forecast for the year. Looking ahead, the prospects remain bright and the company should do well despite recent weakness and intense competition.
LTE and Europe
Nokia has bagged some major contracts, which include a five year deal with Vodafone (NASDAQ:VOD), LTE contracts with Everything Everywhere in the U.K., VimpelCom in Russia etc. These contract wins indicate that Nokia is gaining traction in the European market.
In fact, Everything Everywhere has selected Nokia for the expansion of the U.K.'s biggest LTE network. More such deals can be expected going forward, as LTE is still growing in the region. For example, according to Statista, 4G penetration in Western Europe is expected to jump from just 3% at the end of last year to 50% at the end of 2020. This means that telecom carriers will need to invest in the required infrastructure, and this will open up more opportunities for Nokia.
Mobile broadband and cloud are more drivers
Coming to its mobile broadband unit, Nokia displayed strength in LTE sales, and expects the same trend to continue in the future as well. Its performance was driven by demand for its mainstream products, along with new cutting-edge next generation virtualized products.
Now, Nokia is a supplier to "more than 90 of the world's 100 largest operators worldwide." This gives it a solid opportunity to benefit from growth in mobile broadband usage. As such, it isn't surprising that Nokia is targeting new markets in countries such as the Philippines to improve its networking business. As reported by updatemag.com:
"In the Philippines, Lennox said, the company will focus on LTE by utilizing its 600 to 650 manpower pool and is looking to expand.
A study conducted by ABI Research in March 2014 showed that operators in the Philippines are driving huge mobile data and usage growth through LTE. On average, the compounded growth rate of mobile data usage in Asia Pacific over a period of five year is 32%, but this could grow to more than 80% with LTE."
Clearly, Nokia is operating in the right areas to benefit from growth in networking via the expansion of faster mobile networks. The increasing opportunities in these markets should lead to an improvement in sales, although a definite number cannot be put on how much Nokia will gain because the company doesn't offer a forecast going into the next five years.
Opportunity in maps
Nokia's mapping business, called HERE, has been doing well on the back of strong demand from the European automotive market. In the second quarter, Nokia's HERE "sold map data licenses for the embedded navigation systems of 3.3 million new vehicles." This was better than 2.7 million licenses sold in the year-ago quarter. The HERE business is still small, accounting for 232 million euros in revenue last quarter. Excluding currency headwinds, the segment grew 2% year over year, and the trend is expected to continue in the future due to the following reasons.
According to Nokia:
"HERE is differentiated in two clear ways. First, we are the industry leader in advanced telematics delivered through the cloud.
This is a critical building block for the next generation of location services and thus a strategic focus area for our customers. And second, unlike our main competitor HERE has a very flexible business model which enables it to bring the benefits of location intelligence to multiple customers in multiple industries across different operating systems, platforms and screens."
Nokia will continue to build on its innovative platform, trying to deliver the world's best mapping system.
Strong licensing opportunity
Going forward, as Nokia does not have a mobile business anymore, it will no longer need to obtain licenses for mobile devices. On the other hand, mobile industry participants still require licenses to use its patents. Thus, Nokia has immense opportunities to grow its technology business with its licensing agreements. According to management:
"We see a significant opportunity to grow our technology business as existing license agreements with mobile industry participants are renegotiated and as we seek to enter into new agreements with new licensees."
Now, licensing is Nokia's smallest business, generating 147 million euros in revenue last quarter. More importantly, this is a high-margin segment, clocking gross margin of 98.6% last quarter, up from 94.5% in the year-ago quarter.
Moving ahead, the company plans to expand its licensing efforts into new areas apart from mobile devices. Nokia expects the segment to get better due to new licensing agreements. According to management, "Microsoft is becoming a more significant intellectual property licensee," and this indicates the traction that Nokia is generating in this segment.
Impressive fundamentals and capital program
All in all, Nokia reported a solid quarter, and management is pleased with the financial progress it has made in all its business areas. In addition, its plans for a €5 billion capital structure optimization program will improve its balance sheet significantly. Management is committed to develop the business strongly, and the opportunities that Nokia has will further enhance shareholders' value in the long run.
Moreover, at a forward P/E ratio of just 21 and an expected bottom line growth rate of 164% a year for the next five years, Nokia looks like a good buy. This is a remarkable improvement from the loss of 36% a year that Nokia has seen in the last five years. The company's balance sheet looks impressive as well, with 9 billion Euros in cash, and the company is aggressively cutting its debt. Hence, Nokia should be able to sustain the momentum in the future.
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