Nokia Still Straddling Fault Lines
by Stephen D. Simpson, CFA
Roughly 18 months into his tenure as the CEO of Nokia (NYSE:NOK), Stephen Elop hasn't yet proven much of anything about the future of this former mobile device leader. The company has done a better-than-expected job of cutting costs and its Nokia Siemens Networks joint venture is looking a lot better, but the company continues to lose mobile device share at an alarming rate. While the company's ongoing existence as a going concern is arguably not an issue, there's a great deal more to do before the company can be considered a real turnaround stock.

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A Step Back In The First Quarter
While Nokia's stock is still well above its mid-2012 desperation lows, the first quarter results mark a meaningful step back for the company. That the company continues to cede market share isn't so surprising, but the magnitude of the decline continues to surprise in a bad way.
Revenue fell 20% this quarter and 27% when compared to the fourth quarter, a result that was about 10% below the average sell-side estimate. The decline was led by the company's device business, where revenue fell 32% and 25% respectively. Nokia Siemens (NSN) was also surprisingly weak, though, with revenue down 5% and 30%.
Normally investors might cheer the progress that Nokia has made with its cost-cutting efforts. Adjusted gross margin improved almost four points, with year-on-year improvements in both devices (up 70bp) and NSN (up 740bp). Operating income was likewise better, as the company reversed a year-ago loss and posted an adjusted operating profit of 181 million euros.

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Mobile Is Still In Deep Trouble
Nokia may well still have an impressive-looking share of the global mobile phone market, but that position is eroding at a worrisome rate. Making matters worse, the company's efforts to shore up its smartphone business are still coming in short.
Overall units fell 25% this quarter (down 28% sequentially), with mobile phone units down 21% and 30%. Smartphone units were down 49% and 8%, though the company did see 27% sequential growth in the Lumia platform (which is supported by Microsoft (Nasdaq:MSFT)). Numbers like that are doing nothing to quell worries that Nokia is just hopelessly behind Apple (Nasdaq:AAPL) and Samsung in advanced devices and that the company is living on borrowed time.
I'm not sure I quite agree. While it's true that Lumia has not changed the world, the reality is that Microsoft has only had mixed success with its Surface tablet, and that likely means the company will be reticent to launch an independent phone effort. What's more, Microsoft's current management is showing no signs that it is willing to cede the mobile operating system market to Apple and Google (Nasdaq:GOOG), so I think Microsoft will continue to support Nokia as much as possible.
That said, I do see at least one big problem between these partners. Nokia's past success and current strength in distribution would seem to argue for focuses on the value segment of the smartphone market (particularly in emerging markets), but I suspect that that's pretty much the opposite of what Microsoft wants.

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What Is To Become Of NSN?
There are more than enough uncertainties with the mobile device business, but the NSN joint venture is also a big unknown in its own right. This business has turned itself around pretty effectively and is once again a credible threat to the likes of Ericsson (Nasdaq:ERIC) and Huawei. What's more, with the carrier spending market essentially going to sleep over the last 12-18 months, it's not like they missed out on much.
The question is what happens from here. Siemens (NYSE:SI) wants out, and nobody really knows if the companies will pursue an IPO, if Nokia will try to buy out Siemens, and/or whether another company like Alcatel Lucent (NYSE:ALU) could emerge as a strategic and financial partner. Splitting the two businesses may make some sense, but it's NSN that's largely helping things stay above the waterline for now.
The Bottom Line
I freely admit that long-range discounted cash flow models are an exercise of guesswork to some extent even in the best of cases. In the case of Nokia, though, a DCF analysis just feels like a dressed-up version of peering into a crystal ball given all of the unknowns regarding product launches and the fate of NSN.
All of that said, a scenario analysis suggests a floor value of around $2.50 today, with substantial upside if you believe that Nokia can sort out its mobile business and become a viable next-tier player behind Apple and Samsung. With so many unknowns, though, buying these shares today is pretty much a speculation that Nokia's cash, distribution system, and brand name can ultimately underpin better results over the next year or two.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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