Nokia: Value Investment or Value Trap?
Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The market has been punishing Nokia (NYSE: NOK) for years, with the Finnish phonemaker losing 90% of its value since 2007. Nokia is priced for underperformance, selling at a 10% discount to book value and a 70% discount to sales. However, its recent partnership with Microsoft (NASDAQ: MSFT) has gotten value investors interested.
The Lumia, Nokia's flagship device powered by the Windows Phone operating system, has charmed critics. And Nokia isn't alone in backing the Lumia: Microsoft is desperate to break into the mobile market, and telecom carriers like AT&T (NYSE: T) are eager to introduce a third operating system to compete with iOS and Android. All three companies are promoting the Lumia, leading many to conclude that better days are ahead for Nokia.
First quarter earnings put a chill on that enthusiasm like opening a sauna door to a Finnish winter. Net sales dropped 29%, with the critical Devices & Services segment plummeting 40% on lower volumes for smartphones. Gross margins on smartphones also fell, from 28.9% in 2011 to 15.6%. Nokia blames a “competitive environment,” particularly in Asia, for bringing volumes and margins down faster than expected as it transitions from older phones running its Symbian and MeeGo platforms to the Lumia and Windows Phone.
Unfortunately for Nokia, this “competitive environment” isn't going away. With sales of other devices in free fall, Nokia needs the Lumia to be a blockbuster. Nokia has a limited window to generate excitement before other devices steal the Lumia's thunder, and given the recent release of Samsung's Galaxy S III and the impending release of the iPhone 5 from Apple (NASDAQ: AAPL), it's entirely possible that that window has already passed. Even should Nokia and the Lumia's other supporters manage to keep the device in the spotlight, the Lumia faces serious challenges in ramping up volume or in maintaining margins.
Consumers buy a smartphone in part due to its ecosystem of apps, and here Windows Phone suffers. Windows Phone has about 70,000 apps, compared to over half a million for both Android and iOS. In a vicious cycle, as long as Microsoft's market share remains small, fewer developers will build apps for it, and if Windows Phone can't offer the apps consumers want, then volumes will languish.
Finally, even should Windows Phone prove successful, Nokia lacks an exclusivity agreement with Microsoft, leaving rival handset makers able to introduce competing Windows Phone devices. Samsung and HTC, in particular, have expressed interest in creating a device running the Windows Phone platform, and both companies are extremely competent device makers. Nokia has endured vanishing margins when faced with such competition in the past, and the Lumia may be no exception.
Nokia faces immense risks, and even a stunning success for the Lumia could primarily benefit Microsoft and leave Nokia as a low-margin commodity electronics producer. While a comeback is not impossible, value investors should consider that the market may be right about this one: the company's current share price could be an accurate reflection of Nokia's desperate circumstances and bleak future.
Daniel Ferry owns shares of Apple, and has sold short shares of Nokia (extremely profitably, he might add). The Motley Fool owns shares of Apple and Microsoft. Motley Fool newsletter services recommend Apple, Microsoft, and Nokia. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
