Breaking down Nokia unlocks hidden value that investors are currently ignoring.
A version of this article originally appeared on our US site, Fool.com.
WASHINGTON, DC -- We all know this tale of woe by now. Nokia (NYSE: NOK.US), the lovable Finnish company that gave us a vast array of cheap black-and-white and flip phones for more than a decade, failed to anticipate the smartphone revolution and has joined Research In Motion (NASDAQ: RIMM.US) in being completely eaten alive by Apple's (NASDAQ: AAPL.US) iPhone.
Nokia's fall from grace hasn't been subtle, either; it's been met with thuds and crashes. Total handset shipments fell 24% in the first quarter, and average selling prices for smartphones dropped as the company continues to play catch-up in a mobile sector that requires constant innovation. To add the icing on the cake, its own Symbian operating system was a complete bust and it wasted precious time and cash switching over to Microsoft's (NASDAQ: MSFT.US) operating system in 2011. Doesn't sound very much like a turnaround candidate, does it?
That's originally what I thought as well. I had expressed my disdain for Nokia's CEO, Stephen Elop, last year and questioned the company's decision to switch operating systems so late in its smartphone development process. Digging deeper, though, has given me a markedly different outlook on Nokia's future and valuation.
On the surface, Nokia is losing money, it's shedding 10,000 jobs to cut costs, and its handset sales are dropping, with only minimal growth from its Lumia smartphone. Now humour me as we ignore these well-known problems and take a look into the engine that is Nokia, rather than just the body of this beast.
- Cash: Nokia has cash -- lots and lots of cash! As of the end of the first-quarter, Nokia had $12.37 billion in cash and investments to go along with $6.05 billion in debt. In total, that's roughly $6.3 billion in net cash.
Discounting the approximately $1.6 billion in cash restructuring charges related to layoffs and business downsizing that Nokia will incur in 2012 and 2013, as well as a projected loss of $0.30 for fiscal 2012 (according to estimates on Yahoo! Finance), which translates to $1.1 billion, Nokia will conservatively have $3.6 billion in net cash by the end of 2013. This assumes the addition of no extra cash, which to me seems highly unlikely. Even given its troubles, Nokia can still claim free cash flow generation of $104 million over the trailing 12 months.
- Patents: This is the biggest wild card to Nokia's valuation. Nokia has approximately 10,000 patents in its portfolio and generates $650 million annually in royalties from those patents. If Nokia were to sell some of these patents, it could generate a significant chunk of change.
Over the past year we've seen the value of patents range wildly. InterDigital (NASDAQ: IDCC.US) recently sold 1,700 3G and 4G patents to Intel for about $221,000 per patent. On the other end of the spectrum, the consortium of Apple, Microsoft and RIM outbid Google (NASDAQ: GOOG.US) to secure Nortel's 6,000 patents for a clean $750,000 per patent. Although Nortel wasn't as willing as Nokia to break down its annual compensation, I'm inclined to believe the value of Nokia's second, third and fourth-generation patents falls right in between these two. That equates to about $5 billion in value.
After looking at just net cash and patent portfolio value, my valuation model places Nokia at an $8.6 billion market capitalisation compared with its closing value of $6.8 billion yesterday. Now what if I told you I wasn't quite done valuing Nokia just yet?
- Plant and equipment: Nokia needs buildings and machinery to make its devices. Based on data from Nokia's first-quarter results, its property, plant, and equipment equaled $2.17 billion. Clearly, these possessions are subject to depreciation and most won't retain anywhere near their current value over time, but I think it'd be fair to say that even five years from now there's still around $800 million to $1 billion worth of value in Nokia's working assets.
- Inventory: I get that Nokia may not have the hottest designs, but its phones still cater to, and largely dominate, the lower-income markets. Nokia declared inventory worth $2.89 billion last quarter. Even assuming its inventory was fire-sold off in a liquidation, it could generate about $1 billion.
The previous two figures are definitely arbitrary and open to interpretation, but using the midpoints of my estimates, I think these assets generate another $1.9 billion in market value for Nokia.
But guess what? I'm still not done!
If Nokia were to consider breaking itself up into three separate divisions, it could unlock even more value for its shareholders. Nokia's three divisions are devices and services, which is its bread and butter handset production; Nokia Siemens Network, which is a hardware and software infrastructure division; and location and commerce, which consists of its Navteq mapping technology.
- Location and commerce: The Navteq purchase for $8.1 billion in 2007 wasn't a smart move -- no sugar-coating there. However, it's the only Nokia segment that's demonstrated year-on-year sales growth. Operating on a smartphone platform, its use should only increase. Even if this were sold for just one and a half times annual sales, I'd say this division commands a $2 billion valuation.
- Nokia Siemens Network: Nokia Siemens is a joint venture between Nokia's legacy network business and Siemens' carrier-related operations for telephony networks. It's currently on pace for about $14.5 billion in worldwide sales based on its extrapolated first-quarter results, which generated just over $3.6 billion in sales. Using Alcatel Lucent (another struggling infrastructure company), which commands a price-to-sale valuation of 0.19, as reference, the Nokia Siemens joint-venture infrastructure division should be worth about $2.8 billion, with half of that value going to Nokia.
- Devices and services: Since I already accounted for property, plant, and equipment values, as well as inventory levels, I think adding value here would create an undue overlap. For the sake of simplicity, let's assume Nokia's handset division is toast. No value will be assigned here.
Now for the fun part: the adding!
Based on my valuation metrics, adding Nokia's cash, patents, tangible assets and inventory, and assuming a break-up of the company into three separate divisions, Nokia is worth $13.9 billion, or $3.75 per share -- just more than double its closing price yesterday of $1.84. If Nokia's patent portfolio sells for as much as Nortel's, you can boost that figure to $4.42.
Nokia is not the company it once was and it will indeed need to drastically alter the way it operates if it wants to survive, but after digging deeper, I'd have to say this lame duck is worth a lot more than Wall Street is giving it credit for.
Agree? Disagree? Think I'm insane? Sound off in the comments section and let your fellow Fools hear your thoughts!
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