Two Steps to Viability
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In doing research for this post, I think I literally read everything about Nokia's (NYSE: NOK) current quarter. I'm a contrarian at heart, and honestly I'm looking for some sign that this could be a good investment. Because the company is internationally based, obtaining a standard format earnings report is more difficult than a company based in the U.S. However, looking at multiple articles and reading over the company's commentary, let me give you a breakdown of what Nokia needs to do next.
The First Cut is the Deepest
I know shareholders don't want to hear this, but the dividend has to go away. Since December 2010, revenue has decreased sequentially every quarter including the current one. During the conference call the comment was made, “We are managing the company for cash preservation.” What I hear is the dividend is not safe.
While I'm sure investors look at the dividend yield and see opportunity, I see a drag on the company's finances. In the most recent quarter, the company generated about $125 million in operating cash flow, yet paid the equivalent of $227 million in dividends. While the dividend is paid annually, this $227 million is how much the company would need to cover the dividend on a quarterly basis. This is why I suggest the company announce the elimination of the dividend and accept the consequences of this choice. By comparison, Research in Motion (NASDAQ: BBRY) pays no current dividend, has no long-term debt, and generates more free cash flow than Nokia. With both companies struggling, there is no question that Nokia's dividend is not sustainable.
Earnings? What Earnings?
I read over the Zacks article about Nokia's earnings, which shows the following: net loss of $.10 per share, cash on hand down 8% year-over-year, the two largest divisions' revenues decreasing 26% and 8%, respectively. If you want more proof that the company is struggling, consider their gross margin dropped from 30.8% last year to 23.6% this year. The company's devices and services division showed smartphone and tablet revenue down 34%, and even standard mobile phones showed an 11% drop in revenue. As further proof that this division is having problems, consider that the company had to cut the price of its flagship Lumia 900 Windows Phone to $49.99. While the company did sell 4 million Windows Phones in the current quarter, this barely compares to Apple (NASDAQ: AAPL) and its ability to sell over 35 million iPhones in its last quarter. The fact that Apple was able to sell its new iPhone 4S models starting at $199 shows that the price of the phone is not the determining factor when customers sign up for service. Given all these challenges, what else could Nokia do?
He May as Well have Said, 'Any Bidders?'
I've written in the past that the company's Nokia Siemens Network could have some value to a potential bidder. While this division reported revenue down 8%, it at least did turn in a positive operating profit. Nokia's CEO Stephen Elop seemed to hint at a potential deal for this division by saying, “we're configuring it to be a more independent company”. He further said that this division was being referred to as more independent because, “the full range of options is available to us.” When he was asked by an analyst whether the company could possibly IPO this division or sell it, he somewhat dodged the question and just said, “clearly more independence is in the cards for the organization.”
This could be an important tactic for Nokia to shore up its balance sheet and improve the company's future viability. Removing this distraction from the company's operations would allow Nokia to take better advantage of the upcoming Windows 8 release.
This OS Better Be Worth It
On the conference call, multiple comments were made about the Windows 8 release. The question was asked whether Nokia would produce the first Windows 8 phone. The CEO all but made clear that this would be the case. He didn't come out and say the words, but he said when Windows 8 has been shown on a smartphone it has been a Nokia model. This should be good news for the company, as the expectation is that Microsoft (NASDAQ: MSFT) will launch a heavy advertising campaign for Windows 8. Nokia expects this to have a halo effect on the company's new lineup of Windows 8 hardware. In addition, the point was made that Windows Phone now has over 100,000 apps available, and multiple carriers have expressed interest in developing a third competitive ecosystem. This will be critical to the company's future success as they said, “we are committed to Windows phone as our primary smart phone strategy.”
However, a comment the CEO made about this strategy seemed a little unrealistic. He specifically said the company expects to, “push up the price point (on its next Windows Phones) driven through differentiation.” One of the primary ways he expects to accomplish this is through the company's location and commerce capabilities. By driving navigation capabilities in each successive phone release, he expects that consumers will be willing to pay more for these additional capabilities. In my personal opinion, he is overestimating how much differentiation the company can achieve through navigation. Apple has already announced turn by turn directions, and Google's (NASDAQ: GOOG) Android system already offers these capabilities. So bottom line, what should investors do?
It's All about Patents
At this point, Nokia's value is tied directly to their patent portfolio. The company has more mobile patents in the last multiple years than any other. If they are forced to cut the dividend, which I believe they will, the stock's value would lie with waiting for a suitor to buy the company.
If the company is successful in making a deal for Nokia Siemens Networks division, the remainder of Nokia will be their handset and location properties. If investors are looking for a potential takeover play, Microsoft would seem to be the likely suitor. A deal of this type would allow Microsoft to directly compete with both Apple and Google in both mobile hardware and software. However, even if this occurs there is no assurance that this would be a positive investment. Google is expected to grow at over 17%, is generating billions of dollars in free cash flow, and has the number one mobile operating system already. The number two operating system is owned by Apple, which is expected to grow at nearly 22%, and this company generates even more free cash flow than Google does. With competition like this, even if Microsoft were to take over Nokia tomorrow, the combined entity already faces a huge challenge. For investors looking for a easier play on the mobile market, either Apple or Google appeared to be a better choice.
MHenage owns shares of Apple. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, 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.
