Nokia’s Stock Nosedives On Lower Networks Profits In Q1
Nokia (NYSE:NOK) announced a mixed set of Q1 2015 results on Thursday, April 30, as the company beat consensus revenue estimates but fell short in terms of profits. Networks sales increased by 5% year-over-year (y-o-y) on a constant currency basis to EUR 2.67 billion ($3 billion), driven by solid growth in Global Services and a moderate increase in Mobile Broadband sales. In other businesses, the global mapping division HERE saw operational net sales grow 17% y-o-y to EUR 261 million ($294 million). Meanwhile the Intellectual Property (IP) licensing division Nokia Technologies reported a massive 96% y-o-y increase in sales to EUR 266 million ($300 million) on account of certain one-time adjustments to accrued net sales from existing agreements and from higher income from certain licensees including Microsoft (NASDAQ:MSFT). Driven by growth across divisions, Nokia’s overall operational sales grew 11% y-o-y to EUR 3.2 billion ($3.6 billion) in the quarter.
Interestingly, even after the overall strong sales, the company’s stock was down over 12% through Thursday, likely driven by a significant drop in profitability in its core business Nokia Networks and lower management expectations with respect to its Networks operating margin for full year 2015. ((Q1 2015 Press Release, Nokia, April 30 2015)) [1] [2] Nokia’s company wide adjusted operating margin (non-IFRS) fell by 310 basis points over the prior year quarter and 550 basis points sequentially to 8.3%. This was due to a 61% y-o-y drop in Networks’ operating profits partially offset by a robust 124% increase in Nokia Technologies’ profits.
Looking at the changing industry dynamics and its recent performance, Nokia slightly lowered its operating margin estimate for Networks to be around the mid-point of its long-term range of 8-11% for 2015. This was in contrast to market expectations that it would trend towards the higher end of this range in the near term. For its HERE division, Nokia again raised its operating margin estimate from 7-12% to 9-12% for full year 2015 on the back of “positive industry trends” and its own focus on improving cost efficiency. Another important revision pertained to the company’s expected capital expenditures (Capex) in 2015. Nokia raised its Capex guidance from $200 million to $250 million for the full year primarily on account of challenging market conditions in the Networks business.
On its recent proposition to buy Alcatel-Lucent in a 15.6 billion Euro ($16.6 billion) all-stock deal, management stated that it is getting good support from customers in favor of the deal. It also sought to allay concerns and fears over execution risks related to the acquisition considering the company’s checkered history with similar transactions. Nokia CEO Rajeev Suri reiterated that the clarity with respect to structure and governance of the combined company should help “avoid politics” and enable a smooth transaction.
Our $8 price estimate for Nokia is significantly ahead of the current market price.
See our complete analysis for Nokia stock here
Networks Sales Rise Across Geographies
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. Last year, the Networks division reported a marginal 1% y-o-y decline in sales on the back of a more than 11% sales decline in Global Services offset by a 13% rise in Mobile Broadband sales. It got off to a sluggish start in the first quarter, but banking on new contract wins amid rising global LTE spending, Nokia changed gears in the third quarter with robust 15% y-o-y top line gains in the Networks division, driven by 33% y-o-y sales growth in Mobile Broadband. Nokia repeated its strong Networks performance in Q4 2014 with 13% y-o-y growth in Mobile Broadband and a return to positive sales growth in Global Services.
In the first quarter this year, Networks reported a sales increase of 15% y-o-y on solid growth in Global Services (21%) as well as Mobile Broadband (10%). This was aided by a favorable comparable period because Networks sales had declined by 17% y-o-y in the first quarter last year. In terms of geographies, the Asia-Pacific region, contributing 33% of sales, reported a growth of 14% y-o-y in sales driven by robust business activity in India, partially offset by lower Mobile Broadband sales in Japan. North America reported the fastest sales growth of 47% in the quarter driven by solid Global Services sales, including benefit from the acquisition of SAC Wireless last year. Only Europe and Latin America reported declining sales which were driven by lower sales in Germany and Brazil, partially offset by improving sales in Argentina, Italy and Russia.
Networks Operating Margin Turns Negative
The Networks division’s adjusted operating margin (non-IFRS) declined drastically from 9.3% in Q1 2014 to 3.2% in Q1 2015, primarily on account of lower operating margins in Mobile Broadband. The Mobile Broadband adjusted operating margin declined 8.4 percentage points from 8.2% in Q1 2014 to negative 0.2% in the first quarter this year. This was largely because of higher research and development expenses, higher sales, general and administrative expenses (SG&A) and a lower proportion of high-margin software sales in the overall sales mix. The proportion of software sales was about 5 percentage points lower compared to the prior year quarter on account of lower software sales in North America and Japan.
It is still too early to say if this product mix and decline in Networks profitability is a one-time blip or a trend going forward. Nokia’s management stated on its earnings call that the profitability situation should improve by the second half of this year. However, they also said that certain strategic deals, such as those in China, could significantly impact company profitability in the short term.
HERE Sales Continue Solid Growth
HERE, Nokia’s mapping and location intelligence business, saw operational sales grow by 17% y-o-y on the back of rising sales to automobile customers and higher revenue realization from services offered to Microsoft. Sales to automobile customers represents over 50% of total HERE sales and its growth in the quarter was aided by a 29% rise in sale of map data licenses for the HERE embedded navigation systems.
According to our estimates, HERE currently contributes less than 3% 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. [3] 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.
In the latest earnings call, Nokia’s CEO Rajeev Suri confirmed that they were indeed looking to sell the HERE business. However, he also said that they were under no pressure or rush to sell it and they would consider a deal only if a good offer came their way.
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- Q1 2015 Presentation, Nokia, April 30 2015 [↩]
- Nokia Q1 2015 Earnings Transcript, Seeking Alpha, April 30 2015 [↩]
- Nokia to Buy Medio for Analytics Data in Map Push Against Google, Bloomberg, June 12 2014 [↩]