Poor Nokia

Poor Nokia

Fyodor O. Minakov

“Poor Nokia,” wrote a blogger lamenting the troubles to at the once great, now beleaguered company; the markets punish bad behavior with a vengeance. The Finish cell phone maker used to dominate the international handsets business, holding over 40% market share as recently as 2009. Rapidly declining phone sales over the past year and a half in the key smartphone business, and lackluster earnings have taken their toll on the company’s share price, which has halved in the last six months alone.  Why else would incoming CEO Stephen Elop, not five months before he took the reins at the head of the then world’s largest phone manufacturer, have sent a memo stating that Nokia was a “burning platform.” Perhaps this memo came as no surprise to McKinsey & Co. consultants that use the term as an expletive - “What’s your burning platform?”

Stephen Elop’s memo deserves to enter business history as the single least self-effacing move by an incoming CEO. Stocks tend to move up or down in direct proportion to the quarterly earnings targets set by analysts. Negative news from a company’s CEO, no matter how exaggerated, never plays well with the markets. The market, to quote the author of the Intelligent Investor, Benjamin Graham, is a “voting machine”, capable only of gauging popular sentiment, not an instrument for weighing inherent value, at least in the short term. Analysts make certain assumptions about future earnings based on current trends, and if their projections come true, they are handsomely rewarded by Wall Street, and if they are wrong, no harm, no foul. It is because of the latter behavioral phenomenon that stock prices tend to move in rapid jolts around earnings seasons: analysts seldom forecast correctly, but quarterly earnings always impact markets.

Nokia’s share price had been gently falling since the company’s post-internet bubble peak in October 2007 thanks to the synchronized collapse of almost all stocks during the financial crisis. However, the common stock did not begin its uniquely precipitous fall until April 2010, when its share of global smartphone sales began to wane inauspicious. This information resulted in a tidal wave of such magnitude that it knocked Nokia’s share price from a respectable $15 to a humbled $6, a collapse of about 60%.

The board of directors made a change, and the change was the CEO. The throne was taken away from the acquisitive Olli-Pekka Kallasvuo who served from 2006 until 2010, and given to a Canadian former director at Microsoft, Stephen Elop. Nokia has been in existence since 1865, incorporated since 1967, and with the exception of 2006-2010, the company has been under the leadership of engineers. Current CEO, Stephen Elop, studied computer engineering at McMaster University, while Mr. Kallasvuo, the exception to the latter rule, was a lawyer by training. The ostensible reason for the change in management was a ‘Loss of focus’ that resulted in declining market share in Nokia’s formerly dominant handsets business.

Mr. Kallasvuo’s thinking is a common thread among the CEO’s of highly successful companies – the urge to build a conglomerate. Nokia struck a partnership with Germany’s Siemens A.G in 2006, creating Nokia Siemens Networks, a major supplier of broadband and communications infrastructure. Though NSN has yet to return a profit, sales were aided by the acquisition of Motorola Solutions’ wireless infrastructure assets in April 2011. NSN was expensive to set up, making up approximately 40% of Nokia’s long term debt, but margins have been improving, and the company is unprofitable chiefly due to the research and development and marketing expenses that eat one quarter of NSN’s revenue. Two years later, Nokia further attempted to diversify its holdings by buying Navteq, a global positioning company. This too has yet to return a profit, although its sales did improve in 2011, and three quarters of all revenue cover R&D.

Earlier this year, in an attempt to lower costs, and refocus efforts on phone sales, Mr. Elop signed a deal with Microsoft, granting the company access to the Windows Phone operating system, and terminating the Symbian smartphone OS . Symbian had been powering Nokia phones since 2002 when the 7650 smartphone was first launched.

Once categorized as a technology sector growth company, Nokia has ceased growing, and has begun what to many analysts on Wall Street, seems like a death spiral. Long indomitable, the company is being figuratively eaten up by its smartphone-maker rivals. The main culprits are Apple, which produces the increasingly popular iPhone, and handsets that operate on Google’s Android OS. Mr. Elop hasn’t given Wall Street anything to be excited about, lowering earnings guidance for the rest of 2011, decidedly not what Nokia’s analysts wanted to hear. Several discounted cash flows later, the trend that started in April 2010 continues unabated. Just last week, Nokia’s shares rose suddenly to $6.46 on hopes of a private-equity buy out of NSN, only to slide back down to $5.45. Most recently, Nokia posted a loss for the second quarter of 2011, principally due to a one-time write-down of about €600 M for consideration to Accenture that purchased Symbian’s professional services unit. Shares currently trade at below $6.

When closely examining Nokia’s balance sheet, income statements, and cash flows, the “bottom line”, one does not, at least at the moment, see a dying company, but rather one under stress. Nokia’s debt in the handsets division, the company’s former profit center, is more than manageable, and even after the precipitous slide in company’s shares, the handset unit’s total debts are still well below 50% of the value of the common stock.

The measure of how much debt a company has relative to the price of its shares is an important metric that shows what percentage of the company is speculatively capitalized, or using borrowed money as opposed to owner (common shareholder) capital. The higher the fixed charges, the more difficulty a company, as compared with its peers in the same industry, will have servicing debt. The lower the figure, the greater percentage of corporate profits can in theory be returned to its shareholders.

Last quarter, Nokia sold 88.5 million units, or 20% less than a year ago. Despite slashing phone prices, which erodes operating margins, to stem the tide, the company still sells phones at a profit. Nokia’s cash position is respectable, as the company holds about €7.4 billion in cash, and cash equivalents, amounting to just over $4 per share. At a minimum, there is enough cash to see the company through what could be a harsh winter. If Nokia can boost sales in early 2012 when its new array of Windows Phone products is supposed to reach customers all over the world, then this company may yet turn around.

Nokia is in many ways a gamble on what the new Windows Phones will look like, how well they will function, how competitively they will be priced, and if they will appeal to customers in its key markets. The company’s future is in Mr. Elop’s hands, and while it is possible that the board may choose to decrease or arrest entirely the $.48 per share dividend, a yield, that under current prices is over 8%, in the short run, it is the humble assessment of this author that while the trend-watchers may continue punishing the company for exploring different horizons and ‘losing focus’, at ~$6 per share, there is probably more upside than down. In any event, the percentage of the company that is owned by short sellers is just under 3%, nothing scandalous, nothing spectacular.