Nokia’s (NYSE:NOK) announced a strong set of results Thursday, finishing what has been a very volatile year for the company with a net profit in the final quarter. While Lumia shipment volume of 4.4 million units was more than 4 times the same in the year-ago quarter, the newly launched full-touch Asha phones saw close to 45% growth in unit sales sequentially. The strong Lumia performance, together with a sustained high demand for Asha smartphones in the emerging markets, helped the company maintain underlying profitability for the full year despite reporting losses in the first half of the year. A big reason for Nokia’s relative outperformance in the second half has also been the ongoing turnaround at its infrastructure JV with Siemens, Nokia Siemens Networks, which reported an all-time high operating margin (non-IFRS) of 14.4% last quarter.
However, Nokia gave a lackluster guidance for the current quarter, causing its stock to tank more than 8% in trading Thursday as investors grew concerned that the company may not be able to sustain the initial strong Lumia performance in the coming months. The company projected device margins for the current quarter to be “negative 2 percent, plus or minus four percentage points”. Investors were also disappointed by Nokia’s decision to suspend its dividend payments for the first time in over 20 years but we feel that it was a necessary step taken to conserve cash amid an ongoing painful transition to Windows Phone.
Despite the steep 8% decline Thursday, Nokia’s stock is still up over 140% in the past six months. The fact that smartphone ASPs grew 33% y-o-y and 20% sequentially assuages our concerns that Lumia’s strong performance may have been driven by the deeply discounted older Lumias as opposed to the newer Windows Phone 8 models. We continue to believe that even a small improvement in Nokia’s handset business, together with its patent monetization initiatives and the ongoing turnaround in the wireless infrastructure joint venture with Siemens, should help it sustain the value that the market is assigning to the stock currently despite the huge rally in recent months. Our $5 price estimate for Nokia is about 16% ahead of the current market price.
Windows ecosystem key to sustained Lumia sales growth
While Nokia’s holiday launch of the Lumia phones were followed by numerous reports of retailers and carrier partners in the U.S., Europe and China reporting stock sell-outs throughout Q4, it wasn’t clear if the same was due to a limited supply of the Lumias. The Q4 results lift a fair bit of that uncertainty and with Windows Phones finally outselling Symbian and Meego models (by 2:1), a new era at Nokia seems to have finally begun. As a result of the solid performance, Nokia’s mobile devices division regained underlying profitability in Q4 2012.
However, Windows Phones currently constitute only a minor proportion of the smartphone market dominated hugely by the duopoly of Apple and Samsung. Moreover, competition is increasing with RIM entering the fray with its BB10 launch next week. Still, Windows Phone 8 gives Nokia its best opportunity of creating a new mobile ecosystem for its Lumia devices. While building Windows 8 and WP8, Microsoft ensured that both share the same kernel and therefore inherit the same rich feature set that has made Windows a household name in the PC industry. This will help integrate the two platforms closely, thereby making apps developed for either platform easier to port. Having a huge user base for its Windows PC platform will therefore help Microsoft generate significant support for the new integrated Windows8/WP8 user experience, driving the sales of Windows Phones in general and the Lumia in particular.
NSN turnaround in full swing
While the spotlight has been mainly on Nokia’s smartphone business of late, its oft-ignored telecom joint venture with Siemens seems to be finally turning the corner. On the back of a huge restructuring and the ongoing LTE transition in the telecom world, Nokia Siemens Networks (NSN) reported an y-o-y gain of close to 10 percentage points in underlying operating profitability and generated cash flow for the fifth quarter in a row. Last quarter, the division contributed over 80% of Nokia’s sequential net cash increase of 800 million euros.
With NSN turning the corner, we estimate that the division contributes close to 35% of Nokia’s fair value. With 4G LTE deployments ramping up in many parts of the world, NSN should continue to benefit from the 3G to 4G wireless shift in the coming years. The company has close to 70 LTE contracts globally and is focusing on key regions in the Asian markets of Japan and Korea where LTE is being laid out. Of particular interest to NSN in the coming quarters will be TD-LTE, a variant of 4G technology that is being used in many emerging markets such as China and India. In addition, NSN is ramping up efforts to gain market share in the lucrative North American market where its performance has been dismal of late. It is therefore a good sign that NSN has also won LTE contracts at U.S. Cellular and T-Mobile, which should boost its top-line as well as bottom-line growth in the coming quarters.