Nokia Raises Full Year Guidance As Q2 Profit Beats Estimates

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Nokia (NYSE:NOK) announced a strong set of Q2 2014 results Thursday, as the company easily beat market estimates on the back of robust global LTE spending and continued high level of profitability in its Networks business. Although Nokia continued to see its networking services revenues shrink on the back of divestitures and contract exits in unprofitable regions, this impact was somewhat offset by healthy demand for mobile broadband infrastructure among carriers, especially in regions such as China where the transition to 4G LTE is underway. Although Europe remained challenging during the quarter, the company has built a strong pipeline of orders on a number of recent contract wins, such as Everything Everywhere and Vodafone, which should bolster sales towards the latter half of the year. A second-half revenue boost is expected in the U.S and China as well, with carriers such as Sprint (NYSE:S), China Mobile(NYSE:CHL) and China Telecom (NYSE:CHA) expected to substantially increase their network spending.

Even though overall sales declined in high single-digits on a y-o-y basis, they grew in double-digits over the previous quarter. Moreover, they were far above analyst forecasts compiled by Thomson Reuters. Compared to the Network division’s reported operating profit of $378 million and operating margin of 11% for Q2, analyst estimates for the same metrics were $265 million and 7.7%, respectively. In fact, looking at its progress in maintaining profitability along with top line gains, the company raised its operating margin estimate for Networks to be slightly above the higher end of its long term target of 5-10%.

Our $7.30 price estimate for Nokia is about 10% below the current market price.

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Networks to Drive Sales, Profitability

The sale of the handset business made Networks (formerly NSN) the biggest contributor to Nokia’s value, accounting for almost half of its total value by our estimates. Before being promoted as Nokia’s CEO, Rajeev Suri headed the Networks division for the company. At the helm of NSN, Suri is credited with turning the division around to sustained profitability on the back of a big restructuring program that cut its operating expenses by Euro 1.35 billion and increased its focus on mobile broadband. However, the transition took a toll on Nokia’s top line, which declined by 17% year-over-year in the first quarter this year as the company exited unprofitable service contracts, primarily in EMEA and Latin America.

In the second quarter, the company was able to reverse much of its top line losses by banking on higher LTE spending across geographies, especially Greater China and the Asia-Pacific. Excluding the impact of divestitures, contract exits and currency fluctuations, Nokia’s Q2 Networks revenues actually grew by 1% y-o-y – an improvement over the decline of 6% in the previous quarter and 12% in Q4 2013.

Going forward, rising 4G LTE deployment activity should help improve revenues further. Nokia has done well in winning LTE contracts with China Mobile and China Telecom, and has emerged as one of the leading foreign players in the Chinese LTE buildout. Although European sales have been slow to recover, the deal pipeline looks strong as carrier spending returns amid receding macroeconomic uncertainty. In Europe, Nokia won two large LTE contracts with Everything Everywhere and Vodafone, which should help stabilize revenues in the second half of the year. The company’s contract win at Sprint is also unlikely to prop revenues until the second half, with the carrier unlikely to splurge on its Spark program before the completion of its initial LTE layout by mid-2014.

Nokia Preparing HERE For The Long Run

HERE, Nokia’s mapping and location intelligence business, saw operational sales grow by 2% y-o-y on the back of rising automotive sales as well as embedded navigation system sales. The company also made a couple of interesting deals in the quarter to make its HERE unit more personalized and intuitive and boost the long term potential of its mapping business. The Finnish company acquired artificial intelligence firm Desti towards the end of May and announced its plans to buy predictive analytics company Medio Systems last month. Nokia also launched a $100 million Connected Car Fund recently to identify and invest in companies which can help grow HERE’s location and mapping ecosystem in the automotive space. [1] [2] [3] According to our estimates, HERE currently contributes less than 4% of the company’s valuation but its potential for future growth is immense considering the rising demand and growing penetration of intelligent location and mapping services, especially in autos and smartphones.

Nokia provides its map data to 80% of all car-navigation systems in the world and several major enterprises including Amazon (NASDAQ:AMZN), Yahoo (NASDAQ:YHOO) and Microsoft (NASDAQ:MSFT). [4] In fact, Microsoft is going to be one of Nokia’s biggest customers in the short to medium term with its four-year licensing deal to use HERE on its mobile devices. We expect the recent acquisitions and investments to help the company lay a solid foundation for its long-term growth and attract customers going forward.

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Notes:
  1. Press Release- Desti Acquisition, Nokia, May 30 2014 []
  2. Press Release- $100m fund, Nokia, May 5 2014 []
  3. Press Release- Medio Acquisition, Nokia, June 12 2014 []
  4. Nokia to Buy Medio for Analytics Data in Map Push Against Google, Bloomberg, June 12 2014 []