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Is this Out of Favor Cell Phone Maker a Buy?

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

My father and I "talk stocks" quite frequently. We trade thoughts on investment ideas and we take turns talking each other down from overly aggressive investments or help each other flesh out the pros and cons of an idea that seems to make sense. However, every so often, one of us comes up with an idea that's a stumper. The other day my dad brought out Nokia (NYSE: NOK).

Not What it Used to Be

Nokia was once the dominant cell phone handset manufacturer. It had massive market share and a powerful brand image. Moreover, it held a leading position in emerging markets, where growth was, and is, expected to be material over the coming years.

However, it pretty much missed the smart phone boat. This has turned Nokia from a leader to an also ran in developed markets, lagging far behind Apple's (NASDAQ: AAPL) iPhone and the many handsets supporting Google's (NASDAQ: GOOG) Android platform. Indeed, while Apple was cementing its position as the dominant smart phone maker, and Google was trying its best to copy Apple's best features, Nokia was working on a smart phone operating system that it eventually threw away.

Nokia still has impressive market share in emerging markets, but its stronghold is among price sensitive consumers. While this is likely to keep the company relevant for many years, it isn't going to lead to growth. Nokia has a real problem. It began working with Microsoft (NASDAQ: MSFT) in an attempt to turn the tide. The thing is, Nokia has much more at stake with this partnership than Microsoft, and the outcome is no slam dunk.

With that as a backdrop, I created a strengths, weaknesses, opportunities, and threats (SWOT) analysis. This is a great tool for quickly, and thoughtfully, examining the internal factors (strengths and weaknesses) and external factors (opportunities and threats) driving a company. Here's what I came up with: 

Strengths (Internal)

  • Well known brand.
  • Strong position in emerging markets.
  • Efficient and low cost manufacturer.
  • Historically strong in research and development, leading to a sizable patent portfolio.
  • Solid financial position.
  • Management well aware of the stakes in its transition efforts.

Weaknesses (Internal)

  • Playing catch up in the smart phone market.
  • Spending heavily in its catch up efforts.
  • Although still well known, the company has little relevance in developed markets.
  • Betting heavily on a partnership with Microsoft.

Opportunities (External)

  • Microsoft has the financial strength to support a product offering until it gains market acceptance (though it doesn't always do so).
  • Building phones using the Android operating system.
  • It could be a potential acquisition target with such a low trading price.

Threats (External)

  • Fierce competition in developed markets and in the smart phone arena.
  • Emerging markets could step to higher-end phones as the countries mature, potentially sidestepping Nokia in the process.

Powerful Friends

Nokia essentially thew its own operating system away in order to focus on Microsoft's. Microsoft pays Nokia for its efforts, which is important since the cost of developing new phones can be expensive. Indeed, one metric that investors should watch carefully is Nokia's cash burn rate, or how much money it is spending each quarter to support its transition. If that spending doesn't translate to money coming in the doors, the company will be in big trouble.

Of course, having Microsoft in your corner is a good thing, but it is also a massive risk for Nokia. If it can't create smart phones that customers want to buy out of this partnership, it could be doomed to obscurity and a slow death. If Nokia fails, Microsoft, for its part, won't really be all that impacted, since others are working with its phone operating system, too. Of course, Microsoft also has a few other businesses to fall back on, like software and video games.

Conversely, if the partnership succeeds, it could be the building block for a Nokia resurgence. It would also lend support to the company for work with other smart phone operating systems, particularly Android. Indeed, while Apple has center stage, Google's Android is quietly amassing a large following by teaming up with manufacturers to take on the Apple juggernaut. If Nokia can make phones people want with Microsoft, it could try to do the same thing with Google.

Still in Good Shape

While Nokia has material issues to deal with, its financial position isn't particularly bad at the present time. True, it is bleeding cash and posting relatively bad earnings results, but it has the financial resources to live through an extended period of transition. So, it can afford to keep going down its current path with Microsoft.

The one thing for income-oriented investors to keep an eye on is the company's dedication to its dividend. If the cash burn doesn't turn, one of the first things to be trimmed will likely be the dividend. In fact, the dividend has already been trimmed a couple of times, so the dividend isn't sacred by any stretch of the imagination. (One thing to note, the dividend U.S. investors receive is variable based on exchange rates because Nokia is not a U.S. company).

What IF?

The problem is, what happens if the Microsoft phones don't gain traction? Nokia can still fall back on Google's Android, but it will be a sign of weakness and not the big splash it is hoping to make with Microsoft. So far, its Microsoft based phones have received good reviews. But good reviews don't always lead to big sales numbers. Ultimately, if this effort fails, Nokia will be in triage mode and that will be bad for investors. 

If Nokia does find itself with a hit, its market presence in emerging markets will suddenly become much more valuable. Nokia knows how to make cheap phones and it has lots of customers in developing nations that know it very well. If it brings out a desirable phone using Microsoft's operating system in those markets, it could wind up with a better market position than competitors and potential competitors in those markets while at the same time growing its presence in developed markets. That would be a material win for investors.

At this point, it is hard to tell which way this unfolding story will go. Intrepid investors willing to take on this risk might consider this high risk/high return opportunity. Others, however, should probably stay away for now.

Hidden Assets

One asset that could provide a floor under the stock, however, is its large patent portfolio. The value of such patents is a bit nebulous, but it gives Nokia value to a potential acquirer and might provide support to the shares. Though at $2 to $3 a share, it's hard to believe that this support is worth a whole lot.

Yours,

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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, 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.If you have questions about this post or the Fool’s blog network, click here for information.

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