Tech Investments Collision Course Part III: Nokia the Underdog
For some reason, many writers instinctively try to make trilogies out of every idea they translate to paper. Having written quite a lot on potential investments in the Tech Sector, I was planning to deliver a three-part, 30 pages long, sequence of articles called "Tech Investments Collision Course," dedicated to bringing fresh takes on tech stocks to the investment table. The original idea was great, and the first two articles turned out to be quite popular pieces amongst the readers of the Into the Future blog. But, as the author and the sole analyst on these written pieces, I realized that in order to stay true to the original purpose the series of articles must be continued indefinitely. So, I would like to present to you - my dear readers, a new category of articles that will become regular occurrence on this blog under the abbreviated header "TICC."
As always, we will continue to look for maximum value in the markets, and will continue discussing what makes certain companies tick the way they do. Nothing is certain, and I do not claim to hold all the answers. I believe in one thing though - I believe that we can identify the lucrative investment opportunities out there, minimize risks by conducting in-depth analyzes and careful due diligence, and maximize returns by suggesting smart timing and investment management techniques. I hope that you will enjoy this written piece, and as always, I am looking forward to getting feedback from you (either through the comments section on this blog or through Google+, Linked-In and Twitter). I am a regular on Seeking Alpha as well, and can be reached through the "SA" community.
Nokia - the Underdog
Ten years ago, if someone would have called Nokia Corporation "an underdog," I would have laughed in his face. I would have laughed in his face five years ago. Yet, the beauty of the markets, the beauty of the technology sector and the beauty of evolution is that nothing ever remains still on one spot. Everything changes, everything moves forward. Evolution is inbuilt into every notion, into every concept, into every technology. Humans have always co-existed with change - sometime being active agents of change themselves, sometimes being products of change, and sometimes being victims of change. Through creativity and improvement, we have come up with ways to do things better, faster and smoother, often decreasing the cost, the size and the environmental footprint of the product. So, when the original iPhone came out - some consumers embraced it as the much needed agent of change in the mobile telephone market. Of course, Apple was the active agent of change, the disruptor of the existing technological base, while companies like Nokia and Motorola were the complacent rivals who failed to accept the reality of the changes happening in the sector. At the same time, Microsoft was plain late to the party, and even Google, the current Android OS giant, did not bring an answer to the iPhone in time. It was the story of the Apple iPod crushing Sony and the competition all over again.
According to BBC News, Nokia was the biggest vendor of mobile phones in the world in the period of 1998-2012. Yet, its dominant status began to wither away five years ago, when it was way too slow in accepting change and adapting to it. And so began the long fall of the once-deemed-invincible mobile phone and tech giant. Eventually, the Enterprise Value would be at $8.89 billion (as of May 24, 2013) being at a lower point than the company's Cash and ST Investments position.
Before going into the analysis of why Nokia Corporation still has much potential ahead, I would like to draw the readers' attention to three important facts: (1) Nokia Corporation's Enterprise Value is currently at $8.89 billion according to Ycharts; (2) Nokia's Cash and ST Investment position is at $13.37 billion as of March 31, 2013; (3) Nokia's Patents Portfolio can potentially generate around $1 billion per year.
Considering that Nokia spent $65 billion on R&D over the last twenty years, the company has a grip on some of the most important technological "know how" in the sector, holding the rights and patents to essential building blocks of the industry. And so, let us look at how a company with an EV of $8.89B and market capitalization of $13.37B, actually holds a small treasure chest of Cash, potential earnings and valuable intellectual property far exceeding the actual valuation by all logical approaches.
In relation to the question of patents and R&D, here are some extracts from the Form 20-F that was filed with the SEC on March 7, 2013 by Nokia Corporation for the Fiscal Year Ended December 31, 2012:
"Consequently, we have made substantial research and development ("R&D") investments in each of the last three years. Our consolidated R&D expenses for 2012 were EUR 4 782million, a decrease of 14% from EUR 5 584 million in 2011. The decrease in R&D expenses was due to decreased R&D expenses in all businesses. R&D expenses in 2010 were EUR 5 844 million. These expenses represented 15.8%, 14.4% and 13.8% of Nokia net sales in 2012, 2011 and 2010, respectively. In 2012, Devices & Services R&D expenses included EUR 3 million of purchase price accounting related items compared to EUR 8 million in 2011. In 2010, Devices & Services R&D expenses included EUR 10 million of purchase price accounting related items. In 2012, Nokia Siemens Networks R&D expenses included EUR 20 million of purchase price accounting related items compared to EUR 61 million in 2011, respectively. In 2010, Nokia Siemens Networks R&D expenses included EUR 180 million of purchase price accounting related items. In 2012, Location & Commerce (renamed HERE) R&D expenses included EUR 355 million of purchase price accounting related items compared to EUR 343 million in 2011. In 2010, R&D expenses in Location & Commerce included EUR 366 million of purchase price accounting related items."
"At December 31, 2012, we employed 27 551 people in R&D, representing approximately 28% of our total workforce, and had a strong research and development presence in 17 countries, including China, Finland, Germany, India and the United States. R&D expenses of Devices & Services as a percentage 132 of its net sales were 11.8% in 2012 compared with 10.2% in 2011 and 9.2% in 2010. Location & Commerce R&D expenses represented 80.1% of its net sales in 2012, compared with 87.8% of its net sales in 2011 and 116.3% in 2010. In the case of Nokia Siemens Networks, R&D expenses represented 14.8%, 15.6% and 16.9% of its net sales in 2012, 2011 and 2010, respectively. We will continue to invest in research and development in an appropriate manner to support our strategic objectives."
In relation to the IPR (Intellectual Property Rights) attributed to the Devices and Services Business of Nokia, the report holds the following:
"We have built our IPR portfolio since the early 1990s. During the last two decades, we have invested approximately EUR 50 billion in research and development and have approximately 10 000 patent families. As a leading innovator in wireless technologies, we have built one of the mobile products market's strongest and broadest IPR portfolios, extending across all major cellular and mobile communications standards, software and services as well as hardware and user interface features and functionalities. We receive IPR income from certain handset and other vendors. IPR income is reported under Devices & Services Other."
Data extracted from the 2012 Annual Report suggests that Nokia Corporation made somewhere around $1 billion from IPR license sales / fees in FY2012 (EUR805 million) a decrease from the staggering EUR1193 million in FY2011:
On December 31, 2012, the average USD-EUR exchange rate was 1.3119. So, that leaves a number of [805*1.3119=$1056.0795]. At the same time, a recent article on Seeking Alpha by Jacob Steinberg (published on SA on May 20, 2013) suggested that Nokia's Devices & Services division generated 1.28 billion US Dollars from licensing fees and royalty payments last year alone. Here is the link to his article:
At the same time, Nokia Siemens Networks (with a FY2012 Net Sales of EUR13.8 billion and Total Assets of EUR10.2 billion) has the following description of its IPR:
"With a portfolio of around 3 800 patent families, Nokia Siemens Networks is a significant holder of intellectual property rights."
Net Sales for Nokia Siemens Networks increased over the last three years (from EUR12 661 million in FY2010 to EUR13 779 million in FY2012). And although it would be difficult to mine the exact data on the IPR gains of the division, with 3 800 patent families, we can assume that Nokia has made a substantial gains from the development of the global mobile communication infrastructure.
Considering the recent developments in the smartphone market and the constantly evolving mobile infrastructure in the world we can assume a number of things for the short-term and mid-term future: (1) Nokia is a very well positioned company in terms of IPR and holds the rights to quite a lot of technological "know how" that will be required in the near future by a number of key sector players across the globe; (2) Nokia Siemens Networks is a vital business for the Finnish corporation due to the massive net sales that it generates, Nokia will refrain from spinning it off; (3) we can assume that development of so-called "5G" technologies will require Nokia's wealth of IPRs; (4) Nokia is ultimately better positioned in the emerging markets than many competitors; (5) specifically against Apple, Nokia offers cheaper smartphone alternatives; (6) Nokia is still the "go to" regular mobile phone brand in most markets.
Now, let us highlight some key opportunities for growth:
(1) Nokia's partnership with Microsoft Corporation - considering Microsoft's staggering pile of Cash on Hand (74.48 billion US Dollars as of March 31, 2013) and its large marketing budget, Nokia is well set to benefit from Microsoft's communication and distribution maneuvers. In relation to Microsoft, Nokia has found a strong ally because it can offer something that the competition is still troubled with - an effective office package. This is a domain where Nokia can truly shine - it can fully leverage Microsoft's cloud technologies like Microsoft Exchange Server and Outlook, as well as online capabilities of MS Office to bring in large quantities of corporate clients (thus annihilating Blackberry) and those regular Joes who choose Outlook over Gmail. Let's admit one thing - Microsoft's cloud infrastructure has been delivering solid results. At the same time, Nokia can benefit from the launch of the Xbox One by providing exclusive Apps and remote controls / remote functions for games and the console itself (something that Sony should seriously be involved in as well).
(2) Emerging markets - Nokia is a household name in most emerging markets. The phones are sturdy, reliable and of an optimal quality for their price tag. Nokia needs to capitalize on this issue. Apple is already late to the party, and a potential launch of a lower-tier lineup of phones can severely backfire. Nokia has made some very strong moves in China, India and Russia. Personally, I would say that Nokia should aim at becoming the "BRIC phone."
(3) Other mobile sub-segments - Nokia is very well positioned to take on both the "phablet" segment and the tablet segment. This conclusion is derived from the potential long-term success of siding exclusively with Microsoft. Many consumers (especially corporate ones and those with business interests) are looking for devices that can serve them in providing top quality corporate email services and Office processing software solutions.
Nokia Corporation is very far away from being a dead horse. What many analysts need to realize is that the company has undertaken some very effective cost-cutting strategies and has been to the edge already. By selling off Vertu and other assets (like corporate premises and buildings), Nokia showed that it's willing to bite the bullet and restructure problematic areas. By releasing the Lumia 920, Nokia showed that it can deliver a strong flagship device - with more innovation than some key competing products. Of course, more improvements need to be made, but there is a positive road ahead and a possibly-bright future.
I would say that Nokia is a /BUY at the moment. Considering its Cash and ST Investments position, its mammoth Nokia Siemens Networks division, its wealth of IPRs, and the exclusive partnership with Microsoft, Nokia stock has a very strong return potential for investors.
Originally, I was planning to write another mammoth article with two independent sections - one on Nokia, one on Google. Yet, while writing editing this written piece and doing all the final touches, I realized that it would be better to present the two sections as two separate articles. I believe that all information and conclusions should be presented in the most effective manner possible. The reader should not suffer "data-overload" and should be able to walk away from reading an investment article with a number of concise ideas about what value a given investment can generate, the reasons behind the suggestions made and arguments on why a certain position is better than the other. I will be publishing my Google analysis this week, focusing on potential future growth and cross-segments expansions. The next article will surely be "Android-driven."
Stay hungry for knowledge.
Disclosure: I am long NOK.