Is Nokia Out of the Woods?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Is Nokia Corporation (NYSE: NOK) starting to pull out of its hole? Shares of the company have spiked in the past couple of months by nearly 48%. In comparison, the S&P500 index has increased by only 1.2% during November and December. Is this recent rally sustainable? Will it continue?

Nokia hasn't done well during the year as its revenues plunged and losses spiked. Nonetheless, the recent launch of the company's Smart-phone - Lumia 920 is getting good reviews and might have contributed to the recent positive sentiment toward the company. Let's further examine this change in market sentiment.    

Nokia and CDS

Nokia's credit default swap (five years, in $) has declined in recent months: it has decreased from nearly $1,204 back in July to $933 as of November. This represents a 22% decrease. The current CDS price means the annual premium is $1.204 million in case of a default of $10 million of debt within the next five years. The chart below shows the developments of the five year CDS in past several years (weekly prices). Despite the recent fall in the CDS price, it is still very high compared to its rate at the beginning of the year.

<img src="/media/images/user_12845/nokia-cds-2010-2012_large.jpg" />

The recent fall in the company’s CDS suggests the market estimates a lower probability of default than earlier projected. The probability is still very high, so the market is still pessimistic regarding the future progress and financial stability of Nokia but not as pessimistic as it was a few months back.

Nokia Financial Reports

The third quarter financial reports of the company weren’t too positive: Nokia's revenues fell by nearly 4% compared to the second quarter of 2012 and by 19.4% compared to parallel quarter in 2011. Moreover, the company’s operating earnings also fell from 71 million euros in the Q3 2011 to 576 million euros in the third quarter. Will the company turn it around in the fourth quarter? Some expect the company's revenues will rise mainly because of the company's growth in sales of its new Lumia 920 Smart-phone.

Even if Nokia won't expand its sales it still has one of its main lucrative assets – patents; the company has nearly 10 thousand registered patents and they product an estimated $650 million per year. This figure might go further up in the near future due to the recent patent war rulings. If this will be the case, then Nokia's patents may appreciate and thus will reflect in the company's stock price. Nonetheless, I suspect most of the recent rally in the company's stock, is because of an expected growth in revenues.  

Nokia Patent Valuation  

The recent spike in the Nokia's stock might be driven by expectations the company will be able to concur a substantial market share in the Smart-phone industry. But if the company will continue to lose money from its operations, its only profitable asset will remain its patents. In such a case, the company's value, based solely on its patents, brings the stock price to roughly $2.

Here is a very crude valuation based on two entirely different methods:

  1. Based on similar companies: Google acquired Motorola Mobility for $12.5 billion mainly for its 17 thousand patents. This comes to an average of $735 thousand per patent. Based on this figure and based on Nokia's 10 thousand patents, Nokia's value will be $7.3 billion or $1.97 per share.
  2. Based on Multipliers: Nokia's revenues from its patents royalties is currently around $650 billion (assuming negligible operating cost and a growth of 15%) the expected earnings are $747 billion. Based on a multiplier of 10 the company's value is $7.47 billion or around $2 per share.

Again, I should emphasis this is only a back of the envelope calculation and should be taken with a grain of salt. This calculation, however, shows the company's value before the recent rally had started coincided with the above valuation. Therefore the recent rise in the company's stock might be mostly due to the expectations the company will reach growth mainly due to its new products. Thus, if the company's revenues won't grow in the near upcoming financial reports (last quarter of 2012 and first quarter of 2012), the company's stock might resume its downward trend.

Let's examine Nokia compare to another struggling cell phone manufacturer –RIMM. 

The chart below shows the operating profitability of Nokia and Research In Motion Limited (NASDAQ: BBRY) during recent quarters. As seen, both companies haven't performed well during the year in general and in the third quarter in particular. Nonetheless, RIMM is presenting a higher (in absolute terms) negative margin than Nokia's as of the recent quarter.


<img src="/media/images/user_12845/nokia-rimm-profit-margin-2011-2012_large.jpg" />

Despite Nokia's losses in the third quarter, the company is still paying a quarterly dividend: as of the last quarter the company paid a $0.25 per share, which sums up to an annual rate of 6%, in comparison, Research In Motion Limited isn't paying dividends as the company isn't showing profits; Ericsson (NASDAQ: ERIC) paid a quarterly dividend of $0.35 per share, which comes to an annual yield of 3.46%. But Ericsson, unlike RIMM or Nokia, is still profitable while sales remained stable: As of the third quarter, the company's operating profitability reached 5.7%; Ericsson's revenues slightly declined by 1.7% compared to the same quarter in 2011.

The Foolish Bottom Line

The rally of the company's stock in the past couple of months seems to be related to the recent developments in the company including the launch of Nokia's new Smart-phone. This could mean the next couple of quarterly reports will provide substantial data for investors regarding the company's growth in sales and whether the recent rally in the stock was justified. If the company won't be able to produce significant growth in sales, Nokia's stock might fall back to the $2 mark.  

For further Reading: Is Exxon Due for a Rally?


Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.

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