Does Nokia Have a Silver Lining?

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

Note: A previous version of this article erroneously referenced Nokia's dividend, which the company has recently eliminated.

Despite the hype over Nokia (NYSE: NOK) and its Lumia smart-phone, the company wasn't able to impress its investors as shares of the company tumbled down by nearly 4.8% in 2013 (year-to-date). Moreover, Nokia's sales didn't grow in the last quarter of 2012. Will Nokia be able to turn it around in 2013? Does this company have any silver lining?

Lumia 920 – Will it Save Nokia?

The company's flagship smart-phone Lumia, which has the OS of Windows 8 by Microsoft (NASDAQ: MSFT), is getting attention as Nokia was able to sell 4.4 million devices in the fourth quarter of 2012. Despite the launch of Lumia, Nokia's mobile device volume declined by 24% compared to Q4/2011. Moreover, the company's reach in the U.S remains very limited despite its new smart-phone. Nokia still has a strong hold in Asia and Europe as they account for nearly 37% and 29%, respectively, of Nokia's total net sales. North America accounts for only 7% of the company's sales.

With a price tag of $560 to $770 for the Lumia 920 (based on Amazon, without a contract) it will be hard for Nokia to compete with other leading brands of Samsung and LG Nexus. These companies' brands including the Galaxy III and the Nexus 4, respectively, are offered at a lower price (again without a contract). If Nokia won't be able to augment its market share in the U.S, it could be hard to present revenue growth based on the European and Asian markets.

Up to now, the collaboration between Nokia and Microsoft with Lumia and Windows 8 have yet to put a dent in the U.S smartphone market: during December 2012 the Microsoft platform accounted for only 2.9% out of the entire smart-phone market. In September 2012, Microsoft's market share was slightly higher at 3.6%. Nokia's Symbian remained stable at 0.6%.

So the launch of the Lumia 920 wasn't enough to augment Nokia's market share in the U.S. At least Nokia is slowly regaining the confidence of bond holders.

Nokia and CDS

One aspect that shows Nokia is regaining the confidence of the market is the sharp fall in the company's credit default swap (five years, in $) in recent months: it has decreased from nearly $1,204 back in July 2012 to $610 as of February 2013. This represents a 49% plunge. The current CDS price means, the annual premium is $610 thousand in case of Nokia defaulting on a $10 million debt within the next five years. The chart below presents the developments of the five year CDS between the years 2010 and 2013 (weekly prices). Despite the recent tumble in the CDS price, it is still very high compared to its rate from 2011.

<img src="/media/images/user_13287/nokia-chart-no-1_large.jpg" />

So even though the CDC rate sharply declined, it is still high for the company; in other words, the expected probability of the company to default on its debt is lower than it was a few months back but it's still high.

Cash Flow Problems and Financial Risk

The company wasn't able to cover the dividend payment with its free cash flow during 2012. Nokia's FCF was €208 million, which wasn't enough to pay the €755 million of dividend payment. As a result, the company's net cash assets fell from €5.58 billion in 2011 to €4.36 billion in 2012 – an approximate €1.2 billion drop. This means, another three more years like 2012 and the company's entire cash base will be depleted.  Another indicator for the sharp rise in the company's financial risk is the increase in Nokia's debt-to-equity ratio: The company's tumble in its equity from €14.3 billion in December 2010 to €8.06 billion in December 2012 led to a rise in Nokia's debt-to-equity ratio from 0.37 to 0.69, respectively.

In comparison, other cellular phone companies such as Ericsson (NASDAQ: ERIC) and Apple (NASDAQ: AAPL) are in much better positions with debt-to-equity ratios of 0.21 and 0, respectively. Despite the low financial risk that both Ericsson and Apple have, they are still spending much less than Nokia in R&D. This brings to one of the silver linings of Nokia.     

Research and Development  

Nokia's R&D provision as a percent of its net sales increased in 2012, as indicated in the chart below. BlackBerry (NASDAQ: BBRY) also increased the percent of R&D out of its net sales, but the percent is much lower than that of Nokia. Moreover, even in USD Nokia is spending well more than other companies on research and development: In 2012, Nokia spent around $5.7 billion, Ericsson spent $5.1 billion and Apple paid only $3.3 billion for R&D. If Nokia will keep spending a big chunk of its revenue on R&D it might eventually lead to another great product that could also increase the company's sales in the near future.

<img src="/media/images/user_13287/nokia-chart-no-2_large.jpg" />

 

The Foolish Bottom Line

The company still has a long way to go until it will clear out of its uncertain situation. Until then, Nokia investors could find solace in the company's high dividend yield and high expense on Research and Development. This expense might eventually lead to newer products that could revive the company's growth in sales in the near future.

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