Nokia’s (NYSE:NOK) debt received a yet another downgrade Thursday as Moody’s joined S&P in pushing its credit rating further into the junk category due to cash flow challenges. The concerns seem to be centered mostly on Nokia’s ability to turn around its devices business in the face of a slow pick-up in demand for the Lumia smartphones amid slumping sales of basic feature phones.  The rating downgrade will increase Nokia’s cost of funds should it choose to raise debt from the public going forward.
However, it is surprising that the ratings downgrade followed Nokia’s acquisition of the remaining 50% stake in the erstwhile Nokia Siemens Networks (NSN) from Siemens earlier this month. NSN is in the midst of an ongoing turnaround that has seen it return to profit and generate cash flows on a consistent basis. Having full control of this entity should therefore give Nokia full access to its cash to not only meet the needs of its devices business but also to pay off debtors.
At the end of the June quarter, the Nokia Group had about Euro 4 billion of net cash on its books. NSN’s acquisition at Euro 1.7 billion implies that Nokia’s net cash position will reduce by an equivalent amount, but will also give it the rest 50% of a business that, by our estimates, is a lot more valuable. We estimate that the networks business accounted for more than 35% of our $4.85 price estimate for Nokia before the acquisition. A bulk of NSN’s value is due to the company’s ongoing restructuring that has strengthened its focus on wireless as well as improved margins and cash flows significantly. The restructuring is in fact going so well for NSN that it now expects Euro 1.5 billion in cash savings by the end of the year as compared to 2011-end – almost 50% higher than anticipated earlier. (see Nokia’s Acquisition Of NSN At A Throwaway Price Steadies The Ship)
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60% upside due to NSN acquisition
Since the acquisition was completed only recently and Nokia has not yet released the consolidated results, we haven’t been able to account for the impact on the company’s fair value. Still, taking the results at the end of last quarter as a starting point, we can make reasonable assumptions to arrive at a fair price estimate for the company’s stock. Assuming that Nokia neither generates nor loses cash during this quarter, the only impact on its net cash balance is the debt that it takes on to pay Siemens. A decline of Euro 1.7 billion in net cash balance will have a negative impact of about $0.60 per share on Nokia’s value.
Most of this is however offset by Nokia’s higher ownership stake in NSN, which is now double the earlier 50%. We estimate that this increases the near-term cash flow attributable to Nokia’s shareholders by about Euro 600-700 million and that towards the end of our forecast period (2020) by about Euro 500 million, adding about $1.75 per share worth of value to the stock. For reference, NSN generated about Euro 1.4 billion in free cash flow last year. The long-term decrease in cash generation is mostly driven by a reduction in NSN’s ability to manage its working capital for cash going forward as the restructuring comes to an end, offset to an extent by margins stabilizing towards the high-end. Feeding these estimates into our model, we arrive at a net upside of $1.15 per share ($1.75-$0.6). This translates into a fair price estimate of $6 for Nokia, about 60% higher than the current market price.
As for the additional interest cost, Nokia has historically paid an interest rate of about 5% on its outstanding debt. NSN has debt of Eur 1.1 billion, which means that Nokia is in line for an additional interest payment of about Euro 30 million (50% of total interest cost). The additional debt of Euro 1.7 billion that Nokia has raised to fund its NSN acquisition will cost Nokia about Euro 100 million in annual interest payments. This compares to the Euro 500 – Euro 700 million of additional cash flows that Nokia will be able to tap due to the NSN acquisition, which will help fund a turnaround in the device business and be highly value-accretive to Nokia’s shareholders.Notes:
- Nokia Cut Further Into Junk by Moody’s on Cash-Flow Concern, Bloomberg, August 22nd, 2013 [↩]