Stop Laughing And See How Nokia Stock Hits $9

Nokia stock has declined from a high of $11.70 in February before sliding to below $6 today. Our price estimate for Nokia of about $9 implies a premium of about 70% over the market price. Over the last few years Nokia has struggled to gain ground in the mobile phone business largely due to intense competitive pressure from Apple, Research in Motion, Motorola Mobility and Samsung.

Nokia has lost market share, suffered from declining profit margins and scrapped its smartphone operating system for future models, creating significant uncertainty for the firm’s future. Below we look at some of the factors that explain the discrepancy between our estimates and the market, and we explore what scenarios could cause us to lower our estimates.

Why is the Market Throwing in the Towel?

We believe the following reasons contributed to a slide in Nokia’s shares:

1) Operating system transition uncertainty: Nokia announced a strategic partnership with Microsoft in February wherein Nokia would adopt Windows Phone 7 as the main operating system for its smartphones (see Nokia's Pact with Microsoft: The Long and Short of It). This transition from Symbian to Windows Phone 7 has brought about uncertainty in the minds of investors with regards to its execution and seen as a sign of capitulation over Symbian’s failure.

2) No subsidized smartphones in the U.S.: Nokia continues to sell most of its smartphones as unsubsidized in the U.S. market, which in part explains its small presence in the country. There will be very few takers for Nokia’s phones if they keep selling their phones for in excess of $500 in the U.S.

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3) Prices cuts in Europe show weakness: Increasing competitive pressures have forced Nokia to cut down on its pricing — the latest one in Europe. According to reports, these cuts have happened for some of the company's flagship products including the N8, C7 and E6 and although these are not very big cuts per model, the breadth of products receiving price cuts has not been seen for some time. ^[1]

4) Low-cost Asian mobile vendors: The proliferation of low-cost Asian vendors like ZTE, Micromax, etc, is hurting Nokia in emerging markets. In addition to increasing competitive pressures, Nokia has not been able to bring out customized features for emerging markets in a timely manner. For example, the delay in bringing out dual-sim card phones – which are popular in emerging markets – led to a decline in its market share.

5) What could a cheaper iPhone do to Nokia?: The rumors that Apple could bring out a cheaper iPhone specifically for emerging markets have gained strength. A cheaper iPhone would give Apple an opportunity to penetrate the large emerging markets in which it has little presence currently. However, this move from Apple could further hurt Nokia’s presence in emerging markets (see A Cheaper iPhone Could Spell Disaster for Nokia).

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How We Justify Our Sanguine View

Although we believe that the above-mentioned issues will cause Nokia’s stock price to remain depressed for the foreseeable future, the market seems to have taken a short-term view of Nokia’s problems. We are less bearish on Nokia than the market, as we believe Nokia will be able to resolve some of these headwinds in the medium to longer term.

1) Microsoft partnership to bring about cost savings: Management has mentioned that the partnership with Microsoft is intended to reduce Nokia's devices and services expenses by 1 billion Euros by 2013 from 5.65 billion Euros in 2010. ^[2] This will keep a lid on operating costs as it transitions to its new smartphone platform.

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2) Continued support for Symbian: During the Q1 2011 earnings call, management indicated that Nokia will continue to support Symbian for the foreseeable future. It mentioned that the consumer interest in Symbian has not dropped and that it will continue to bring out software updates to Symbian. ^[3] This illustrates that Nokia is serious about supporting Symbian despite basing future smartphones on Microsoft's Windows platform.

We highlighted recently that Nokia plans for operating margins to recover to 10% or more once the conversion to Windows is complete. Operating margins of 10% on its mobile business would have a significant impact on Nokia's valuation even if average selling prices on mobile phones and mobile market share continue to decline as we predict.

3) Success with smartphones will improve margins: Nokia will continue to bring new smartphones to the market despite a loss in market share and margins. We believe bringing new products in the market is important for Nokia in the fast changing smartphone market. For example, the recent release of N9 have had good reviews and looks promising.

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You can modify our forecast for Nokia's EBIT (equivalent to operating) margin for emerging markets shown above and see that there is about 60% upside to Nokia's market price if EBIT margins reach 10% by the end of our forecast period. (We currently forecast it staying around 6% for this segment). In addition, there is another 10% of upside if similar margin improvements occur in Nokia's EBIT margin for developed markets.

This turn-around will take time and will boil down to execution. Nonetheless it’s clearly a margin story and given how market has punished Nokia’s stock, value players that can stomach some volatility could take another look.

See our complete analysis for Nokia stock here

Notes:

1. Nokia cuts smartphone prices, Reuters, July 5th, 2011 [↩]
2. ref:2 [↩]
3. Nokia Q1 2011 earnings conference call transcript, April 21st 2011 [↩]

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