Nokia’s Turnaround Won’t Be Pretty

07/09/2012 5:27 pm EST


Jim Jubak

Founder and Editor,

But the growing numbers of analysis projecting the company’s imminent death are likely mistaken, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.

In its last update on Nokia (NOK), Standard & Poor’s put the alternatives in front of the company and investors this way.

  • 30% chance that the company goes broke, and in bankruptcy equity investors recoup nothing.
  • 40% chance that the company is acquired/merges/liquidates for something like the $2.50 an ADR (American Depositary Receipt) that S&P estimates as the value of its intellectual property (patents and the like).
  • 30% chance that the company completes a successful turnaround and is worth $5 a share 12 months from now.

I’d agree with that list of alternatives for Nokia. (The stock is a member of my Jubak’s Picks portfolio.)

But I disagree with the odds that Standard & Poor’s places on the alternatives, and to a lesser degree with the target price they calculate for the second and third alternatives.

If Nokia were to go bankrupt, equity investors would indeed probably recoup nothing. But I’d put the odds of that happening at 10% or less.

For Nokia to liquidate through bankruptcy, management would have to be really, really stupid—and very unlucky. (Not that stupid and unlucky aren’t possible. The 2008 purchase of mapping software company Navteq for $8.1 billion certainly fits “stupid.”)

The company finished the March 2012 quarter with $6 billion in net cash (at $1.23 to the euro). Nokia is burning through cash at a significant rate—operating cash flow was negative to the tune of $590 million in the first quarter of 2012—and severe downgrades to the company’s credit rating make raising cash difficult and expensive.

But Nokia will get an annual $885 million in platform support payments from Microsoft (MSFT). Including restructuring charges, operating losses, the reduced dividend payment, and the cash from Microsoft, Credit Suisse figures that Nokia will end 2012 with $4 billion in net cash, and still have $3 billion at the end of 2013.

For Nokia to go to bankruptcy and wipe out shareholders, it would have to burn through all that net cash and be unable to strike any deals to sell assets. I think this scenario is very unlikely.

A sale of the company well before bankruptcy—or a sale of intellectual property—is much more likely. I’d give the odds at 20% rather than S&P’s 40%. Since the ADR closed on July 6 at $1.92, even S&P’s very meager $2.50 a share for intellectual property results in a 30% gain from the current price. (Wall Street also projects that Nokia would sell Navteq for about $730 million now, so I think Nokia’s intellectual property is worth more than $2.50 an ADR.)

That doesn’t recoup the losses that investors have taken since I recommended it for purchase on March 3 at $5.49 an ADR (that recommendation was showing a 65% loss as of the close on July 6). But if you want to know what to do now, it’s the potential gain and not the past loss that counts.

Which, in my reckoning, leaves me with a 70% chance that the company will complete a successful turnaround.

But let’s be very careful in how we define “successful.” Nokia’s ADRs traded at $13.28 on March 25, 2010 and at $31.66 on November 1, 2007.

I’m not talking about a quick return to either of those levels. That kind of success would require sales to return to something like the 100 million unit annual total of 2010, and for the company to climb back near the top of the market share heap in either high-end or low-end smartphones, and for operating margins to recover to something like the 13.4% of 2006 or the 15.6% of 2007.

Not going to happen. Perhaps ever. Certainly not within the time frame of this recommendation.

But Nokia’s new Microsoft Windows phone line looks like it is capable of generating enough in sales to first stabilize the company, then return it to profitability, and then produce a 7% or so operating margin. (Not the 15.6% of 2007, certainly.)

Right now, based on the very limited results of first-quarter Lumia sales, Nokia looks to be on track to ship 41 million smartphones in 2012, according to Credit Suisse. That total would be made up of 22 million Lumia Windows phones and 19 million older Symbian phones. (On that same path, Credit Suisse estimates that Nokia will sell 55 million smartphones in 2013.)

We’ll know on July 19, when Nokia announces second-quarter numbers, how good those projections are.

On the plus side, Nokia has launched its new low-price Lumia 610 in markets such as India ($24 selling price.) On the minus side, Symbian sales have been falling faster than expected, Lumia had some “issues” at launch, and news that the phone, like all existing Windows phones, won’t support all the features of Microsoft’s new Windows Phone 8 operating system won’t help.

There is, I’m afraid, a decent chance of negative news on sales on July 19. (Analysts were projecting that the company would announce a loss of 9 cents an ADR.)

To go straight to the bottom line, the Credit Suisse numbers would produce a further decline in revenue and break even in 2012. In 2013, Nokia would see growth pick up by 5%, and reach a profit of 16 cents to 21 cents per ADR.

I think validation of that path and greater certainty that the end of 2012 numbers would look something like that—no more horrible surprises—would result in a price of $6 per ADR by July 2013. (But if you’re thinking of doubling down on Nokia or starting a new position, I think you’d be wise to wait until after the July 19 earnings report. Just in case.)

Think that price is unlikely for such a modest “success”? Not when so many on Wall Street—30% chance of bankruptcy at S&P, for example—think the stock is going to $0.

But don’t imagine that, even if I’m right, that the path to $6 is going to be smooth. Nokia will give you plenty of angst along the way, even if the company can produce a “successful” turnaround.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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