A Closer Look At Nokia's Comeback Story

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Back in late November I wrote an article entitled Nokia: A Speculative Play on the Safer Side. In this article I argued that Nokia (NYSE: NOK) sported a solid balance sheet, detailed positive aspects of the company's other non-handset businesses, and claimed that the company had bright prospects if smartphone sales started picking up. Sales of the company's Lumia smartphones have apparently picked up, and the stock popped because of it. Let's take a look at the Nokia story a little closer after their recent run-up.

The company should still show a relatively solid-balance sheet at the end of this quarter, when Nokia reports on the 24 of this month. Especially since the company's CEO, Stephen Elop, came out and said that a surprise profit of up to 2% may be in store when earnings are reported- as opposed to an expected loss as large as 10%. Nokia is emerging as a leaner and meaner company as well, after implementing cost-cutting measures such as selling off their main headquarters in Finland- opting to lease it back instead. According to Nokia spokeswoman Susan Sheehan:

“The company is a lot smaller now but people are working better together... Everyone has been pitching in.” 

Nokia also has a strong advantage over competitors in China, after signing a lucrative deal with the world's largest carrier by subscribers, China Mobile (NYSE: CHL). Nokia has strong brand recognition in emerging countries such as China and India, and sells its Asha feature phones in these countries successfully. According to sources, they sold 9.3 million Asha units in India alone, on top of the 4.4 million estimated overall Lumia sales. Emerging market sales should continue to be a strength for the company.

Although becoming a leaner and meaner company, one that is more informed as to what it needs to do to accomplish a successful turnaround, Nokia's "cutting of the fat" may have also created some future weaknesses for itself. It is estimated that the company cut 50 million euros in patent royalties to help itself achieve profitability. This may come back to bite them later on, especially since their industry-leading patent portfolio is currently (and has been) one of their strengths. They have settled patent issues with Apple (NASDAQ: AAPL) for an undisclosed amount, and have recently settled with Blackberry maker Research in Motion (NASDAQ: BBRY). RIM was ordered to pay $65 million to Nokia, as well as royalties for each new Blackberry sold. Nokia's patent portfolio has netted them an annual 500 million euros in the past, and cutting patent royalties bites into this income. 

Still, Nokia has to do what it has to do, and the company has some great upcoming opportunities even without patent income. The company has had issues with supply constraints on its Lumia phones, so this may explain why the phones were selling out so fast initially. This impacts sales as well, and not positively. Assuming supply issues are addressed, sales will increase once demand can be adequately met. The company also has huge opportunities in emerging markets, as they have barely tapped the surface with smartphone sales, relying more on feature phones. The company will be releasing the Windows 8 powered Lumia 620 in India in February, which should help generate and meet smartphone demand in the growing country and boost sales for Nokia. As Windows 8 picks up, there should be more sales of Lumias worldwide, as well. 

Nokia still faces the threat of burning through its cash horde, but since they are finally successfully selling smartphones, it is less of a concern. They still face competition from low-end Android models in emerging markets, however, and if rumors are true they may face competition from Apple as well. The rumor says that Apple will produce low-end, cheap iPhones, which would most likely hurt Nokia significantly. Will Apple do this? I don't know, but it would hurt them too, because it would shrink their margins and damage their "premium" image. It would also potentially wipe out weaker competitors like Nokia, too- so it's all speculation at this point.

One more concerning Apple move for Nokia is Tim Cook's meeting with China Mobile, to discuss "matters of cooperation." If China Mobile does work something out with Apple and provides a subsidized iPhone alongside the Nokia Lumia 920T, it would instantly take away one of Nokia's main advantages and limit one of their strengths. Apple taking away Nokia's smartphone monopoly with China Mobile is definitely a big, big threat.

The Bottom Line:

Nokia is beating expectations and appears to be successfully turning itself around, but it still faces many threats. Competition from iOS and Droid will remain cutthroat. Profitability is great, especially when unexpected- but if key patents are being liquidated it could also lead to less income in the future. This shouldn't be as much of a concern, however, if the Lumias keep selling well. One of the key concerns that needs to be addressed is supply issues. Investors should also keep in mind that Nokia's potentially profitable upcoming earnings may have been boosted by cost cutting and the selling of patents- not solely due to the selling of smartphones. This quarter was a seasonably good one as well. All of the company's segments should beat expectations, however, and if the company can stabilize and remain profitable going forward, relying more on its businesses and less on cost cutting- the comeback will be real. Until then, Nokia still needs to be watched closely; but it appears that the worst may finally be behind them.

Jharry1 owns shares of Nokia. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and China Mobile. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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