Nokia Is Still Extremely Cheap

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

Nokia (NYSE: NOK) has almost doubled in the last six months. The company went from being the biggest manufacturer of cell phones in the world, to junk rating and was not far away from becoming a penny stock. Luckily for Nokia investors, the company's management was not sleeping through this chaos, unlike their seemingly perpetual slumber during the rise of iOS and Android. I believe despite the rally, Nokia is still trading below its salvage value. Therefore, I recommend investors to go long on Nokia due to downside protection coupled with huge upside potential.

Nokia Turnaround Efforts

Nokia has dumped its Symbian operating system but rather than boarding the Android bandwagon, opted to put their money on Microsoft’s Windows Phone. It is still too soon to say that Nokia Windows Phones are a success, but they are definitely in the game. In a rapidly maturing market with competitors such as Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG), Nokia has managed to produce a piece of hardware which is being regarded by many as superior to its competitors. While the superiority of Lumia (WP8) can be debated, its importance to Nokia’s turnaround efforts is unquestionable.

Google's Android is currently the most used smartphone OS in the world and Apple's iOS is in second place. A major advantage to Android is its availability to a large number of different smartphone manufacturers. The recent decline in Apple's price (from $700 plus to $500) is due to various issues with the iPhone 5. A leading complaint about Apple's flagship product was the new Map application. Other issues included purple pictures and scratches on the aluminum body.

While the weaknesses with the iPhone 5 have hurt Apple's stock price, it has improved turnaround prospects of Research in Motion (NASDAQ: BBRY) and Nokia. RIMM is also trying to put a stop to its eroding customer base and will be launching its BB10 operating system at the end of January. This operating system launch will also accompany devices based on this latest operating system from RIMM. 

As the red marks on the table show, the launch (Sept. 5) and market release (Nov. 2) of the Lumia WP8 have impacted the stock price. Since the September launch of Lumia WP8, NOK has delivered a staggering 35% return. Despite investor faith in Lumia and Windows Phone 8, there were reservations if the company could even last long enough to enjoy the fruits of Lumia, especially considering its poor credit ratings. A look at Nokia’s financial strength reveals that these reservations were not totally misplaced. The Debt to Equity ratio is approximately twice the industry and five times the sector average. Combine that with a ‘Junk’ credit rating and Nokia's survival seemed a long shot at best.

The company has since partially offset these fears with excellent cash management, restructuring aimed at reducing costs, and more recently, its better than expected 3rd quarter results. The company achieved operational profitability (1.1% non-IFRS) with better than expected revenues, triggering a 20% increase in stock price. As the table below shows, these factors have enabled Nokia to maintain a healthy interest coverage ratio and quick ratio (nearly equal to the industry average), dispensing any immediate liquidity concerns.

<table> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Industry</strong></p> </td> <td> <p><strong>Sector</strong></p> </td> </tr> <tr> <td> <p>Quick Ratio (MRQ)</p> </td> <td> <p>1.16</p> </td> <td> <p>1.62</p> </td> <td> <p>1.64</p> </td> </tr> <tr> <td> <p>Current Ratio (MRQ)</p> </td> <td> <p>1.28</p> </td> <td> <p>1.96</p> </td> <td> <p>3.01</p> </td> </tr> <tr> <td> <p>LT Debt to Equity (MRQ)</p> </td> <td> <p>48.76</p> </td> <td> <p>22.29</p> </td> <td> <p>10.61</p> </td> </tr> <tr> <td> <p>Total Debt to Equity (MRQ)</p> </td> <td> <p>66.45</p> </td> <td> <p>39.67</p> </td> <td> <p>19.69</p> </td> </tr> <tr> <td> <p>Interest Coverage (TTM)</p> </td> <td> <p>4.9</p> </td> <td> <p>4.91</p> </td> <td> <p>164.78</p> </td> </tr> </tbody> </table>

 Figure 1: Financial Strength/ Reuters

Valuation

Nokia is currently operating at a loss and the sell side expects the company to become profitable, somewhere in 2014. The stock is very volatile, as can be assessed from the 100% run in the last 6 months. I believe Nokia’s share price will continue to fluctuate with short term catalysts and it’s still pointless to value the stock on 2014 earnings given the uncertainty. Instead, investors should value the company on a worst case scenario. I believe at this point, Nokia’s biggest assets are its impressive patent portfolio, Cash, NSN and Navtaq.

I have used three recent patent sales to get an approximate value per share for Nokia’s current patent portfolio.

<table> <tbody> <tr> <td> <p><strong>$ millions</strong></p> </td> <td> <p><strong>AOL (AOL) Patent Sale</strong></p> </td> <td> <p><strong>Vringo (VRNG) Purchase</strong></p> </td> <td> <p><strong>Nortel Networks</strong></p> </td> </tr> <tr> <td> <p><em>No. of Patents Sold</em></p> </td> <td> <p>800</p> </td> <td> <p>500</p> </td> <td> <p>6000</p> </td> </tr> <tr> <td> <p><em>Sales Value</em></p> </td> <td> <p>1100</p> </td> <td> <p>22</p> </td> <td> <p>4500</p> </td> </tr> <tr> <td> <p><em>Price Paid Per Patent</em></p> </td> <td> <p>1.4</p> </td> <td> <p>0.0</p> </td> <td> <p>0.8</p> </td> </tr> <tr> <td> <p><em>No Nokia Patents</em></p> </td> <td> <p>9500</p> </td> <td> <p>9500</p> </td> <td> <p>9500</p> </td> </tr> <tr> <td> <p><em>Patent Portfolio Value</em></p> </td> <td> <p>13063</p> </td> <td> <p>418</p> </td> <td> <p>7125</p> </td> </tr> <tr> <td> <p><em>Shares Outstanding</em></p> </td> <td> <p>3830</p> </td> <td> <p>3830</p> </td> <td> <p>3830</p> </td> </tr> <tr> <td> <p><em>Per Share ($)</em></p> </td> <td> <p>3.4</p> </td> <td> <p>0.1</p> </td> <td> <p>1.9</p> </td> </tr> <tr> <td> <p><em>Average Price Per Patent</em></p> </td> <td colspan="3"> <p><strong>0.79</strong></p> </td> </tr> <tr> <td> <p><em>Average Patent Portfolio Value</em></p> </td> <td colspan="3"> <p><strong>7316</strong></p> </td> </tr> <tr> <td> <p><em>Average Per Share Value ($)</em></p> </td> <td colspan="3"> <p><strong>1.91</strong></p> </td> </tr> </tbody> </table>

 Figure 2: NOK Source: Google Finance

As the calculations show, the patent value per share of Nokia’s patents comes down to $1.91 per share. According to Nokia’s disclosures, the company ended Q3 with gross cash of $11.5 billion (EUR 8.8 billion). The Q3 results also indicated that Nokia had EUR 288 in currently maturing debt and EUR 1.1 billion in short term borrowing.  Deducting other liabilities, we arrive at a net cash position of $4.7 billion (EUR 3.6 billion). This comes down to a per share amount of $1.22, and adding the per share patent value of $1.91, the value of cash and patents together is $3.13.

Bottom Line

I believe Nokia still trades way below its salvage value. The company’s patents and net cash, alone are worth $3.13 per share. This of course does not include Nokia’s Navtaq business and NSN (Nokia Siemens Network). These divisions continue to be profitable, despite problems of Nokia’s smartphone division. In Q3 NSN sales were EUR 3.5 billion and operating profit was EUR 323 million; the operating profit of location and commerce segment was EUR 37 million. The combined value of Navtaq (3x sales for $3 billion) and NSN (0.5x sales for $7 billion) is around $10 billion ($2.6 per share). This gives us an approximate per share value of $5 for NOK. Therefore, I believe Nokia is still trading at a discount to its salvage value and is an excellent value opportunity.   

 

 


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