Is Nokia Overvalued?

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Late last year a fellow TMF blogger, Mohsin Saeed, offered his assessment of Nokia’s share valuation.  I liked the article for its solid analytical approach to assessing valuation: Mohsin tabulated the “net worth” of Nokia (NYSE: NOK), which he estimated came to about $5 a share. On the basis of this “salvage value,” he concluded that Nokia was undervalued.  While I don’t disagree with the particulars of his analysis, the same numbers led me to a different conclusion.

Salvage Value

On the surface, Saeed’s approach seems logical.  He added up the cash and other assets of Nokia, and subtracted liabilities such as Nokia’s outstanding debt.  As of the end of Q3 2012, Nokia’s net cash and liquid assets totaled EU 3.56 billion or $4.66 billion at today’s exchange rate. 

Next he provided an estimate of the value of Nokia’s patent portfolio of 9500 patents of $7.125 billion, which is certainly open to dispute, but his approach, based on previous patent portfolio sales such as Nortel’s, is okay for a rough estimate. 

Finally, he provided sales price estimates of the profitable Nokia divisions, Location and Commerce, and Nokia-Siemens at $3 billion and $7 billion respectively.  Together these add up to $21.8 billion, well above the current market cap of $15.5 billion, or on a per share basis, $5.87/share, well above the current market price of about $4.2. 

Excluded Facts

My problem with this is not the math, but the interpretation, especially because his interpretation excludes other relevant facts available in Nokia’s quarterly earnings reports.  Revenues are in free fall, declining by 19% year over year companywide and 34% y/y within the Devices and Services Division (home of Nokia’s various phone models) for Q3 2012.  Revenues for “Smart Devices”, smart phones and tablets, have declined even more precipitously, with a 56% decline y/y and with unit sales declining by 63% in Q3.  Consequently, net cash (the $4.66 billion) has also declined by 30% y/y.

Furthermore, Nokia has posted negative earnings for the past four quarters, through Q3 2012, according to International Financial Reporting Standards (IFRS).   Nokia’s losses now total $6.96 billion on revenues of $51.7 billion cumulatively for the past four quarters.  Nokia also states earnings on a non-IFRS basis, but I tend to be leery of using these numbers, since they are so clearly self-serving, and because they exclude “one time” charges that have a way of being repeated over and over as successive restructuring plans are implemented in the hope of a turnaround. 

Before Capsizing  

I would argue that companies faced with this kind of implosion of sales cannot be valued on the basis of current net assets, since those assets are unlikely to be intact by the time the company goes into receivership.  If corporate managements were so solicitous of their investors that they were careful to liquidate in advance of capsizing in a sea of debt, I might feel differently, but such is not the norm.  Instead, managements of companies in trouble, as Nokia is in trouble, tend to formulate and re-formulate turnaround plans, burning through their available cash reserves on the strength of these plans until there is no more cash left to spend or to borrow.  Nortel is a case in point.  Prior to the patent sale, Nortel had a negative net worth of -$2.866 B as of their last quarterly report of June 30, 2012.

Hopes of a Turnaround

In fact, I doubt many of the current Nokia investors have based their valuations on a “salvage value”, but rather on an expectation of a turnaround in the company’s fortunes and a return to profitability.  Therefore, an assessment of Nokia’s valuation must necessarily tackle the problem of assessing the probability of Nokia’s return to profitability.

For Nokia to return to profitability, the Devices and Services division must return to profitability.  Although Nokia still makes one Symbian smart phone, by and large Nokia has embraced Windows Phone.  In effect, the probability that Nokia will return to profitability is equivalent to the probability that Windows Phone 8 will be successful. 

Here success cannot be measured by absolute numbers of phone sales, but rather by market share gained or lost, since the whole smart phone market is growing so rapidly.  If a company’s smart phone sales growth doesn’t exceed the growth of the industry as a whole, then that company is still falling behind.  Nokia’s “smart device” sales, which include some tablet and Symbian phones as well as Windows Phones, have not merely failed to keep up with industry growth, but have dramatically contracted, as the table below shows.

Nokia Smart Device Sales for the Past Four Quarters:

<table> <tbody> <tr> <td> <p><strong>Quarter</strong></p> </td> <td> <p><strong>Smart   Device Unit Sales (M)</strong></p> </td> <td> <p><strong>Y/Y   Unit Sales Change</strong></p> </td> <td> <p><strong>Smart   Device Revenues (Euros)</strong></p> </td> <td> <p><strong>Y/Y   Revenues Change</strong></p> </td> </tr> <tr> <td> <p>Q4   2011</p> </td> <td> <p>19.6</p> </td> <td> <p>-31%</p> </td> <td> <p>2.75E+09</p> </td> <td> <p>-38%</p> </td> </tr> <tr> <td> <p>Q1   2012</p> </td> <td> <p>11.9</p> </td> <td> <p>-51%</p> </td> <td> <p>1.70E+09</p> </td> <td> <p>-52%</p> </td> </tr> <tr> <td> <p>Q2   2012</p> </td> <td> <p>10.2</p> </td> <td> <p>-39%</p> </td> <td> <p>1.54E+09</p> </td> <td> <p>-34%</p> </td> </tr> <tr> <td> <p>Q3   2012</p> </td> <td> <p>6.3</p> </td> <td> <p>-63%</p> </td> <td> <p>9.76E+08</p> </td> <td> <p>-56%</p> </td> </tr> </tbody> </table>


Windows on ARM Assessment

Nokia may have embraced Windows Phone, but consumers apparently have not.  The track record of Windows Phone 7 doesn’t bode particularly well for Windows Phone 8, and Nokia’s fine Lumia phones may not be enough to overcome consumer disinterest in Microsoft’s mobile OS. 

I gave my assessment of Microsoft’s Windows on ARM initiatives in my recent post Microsoft’s Mobile Crisis, and I haven’t heard or read anything to change that assessment:  I believe Microsoft will make little market share headway either on ARM based phones (including Lumia) or tablets (such as Surface RT), and I believe that Microsoft (NASDAQ: MSFT) will eventually abandon ARM in order to focus on Intel (NASDAQ: INTC) based portable devices running Windows 8 Pro, as I recommend in Can the Wintel Marriage be Saved? 

This leaves Nokia with a very difficult year ahead.  Faced with mounting losses, Nokia may well seek shelter in an acquisition, and Microsoft may well be in the market for a hardware partnership a la Google/Motorola.  With Stephen Elop in charge, such a merger may well become inevitable.  But probably not at $4 per share. 


MarkHibben has no position in any stocks mentioned. The Motley Fool recommends Intel Corp. The Motley Fool owns shares of Intel Corp and Microsoft. 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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