Berstein Research analysts Pierre Ferragu, Jasmeet Chadha and Viral Gandhi rate Nokia Corporation (ADR) (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) as Market Perform.


Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s stock price appears to be overheating and analysts recommend investors avoid the name. It is expensive and will likely disappoint this year: they expect earnings 15% below consensus as NSN takes a toll on profitability in order to restore topline growth. Analysts nevertheless do not recommend Nokia as a short. With unclear catalysts and a strong sentiment component, analysts at the firm do not find the risk reward attractive enough. Below are the 5 convictions to keep in mind:

Nokia HERE’s future uncertain

In the last 3 years, Smartphones have dwarfed the PND and Auto end markets, and mobile ecosystems have captured the aggregation layer of the map & location service value chain. As a result map data provider leaders are not in a position to generate good returns anymore, which is evident in their most recent financial performance. The likely payments from Microsoft Corporation (NASDAQ:MSFT) to Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) for HERE services and what TomTom NV (OTCMKTS:TMOAY) (AMS:TOM2) gets from Apple Inc. (NASDAQ:AAPL) for their service show how limited the earnings power of map providers are in this context, and ongoing efforts by mobile ecosystems to grow more independent of map providers clearly mean this is not set to improve.

In this context, we believe HERE can only be a minor contributor to Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s value, be it as a contributor to earnings or disposed as a strategic asset. As a strategic asset, we don’t believe HERE would attract bids much above the €1bn region. Tele Atlas is a very similar asset and easy to acquire, as part of the listed TomTom NV (OTCMKTS:TMOAY) (AMS:TOM2). Assuming a 30 to 50% premium and the product division valued €500m (10x earnings), a strategic buyer would get away with a fully loaded location services platform for between €1bn to €1.3bn. Even arguing that it is a better service platform, we don’t see Nokia’s HERE business worth an order of magnitude more.

Nokia’s IP Licensing is no treasure in the attic

Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s IP portfolio appears as one of good quality, comparable to those of other industry veterans, although not playing in the same league as Qualcomm’s. Nokia’s portfolio looks very similar to the ones of Ericsson (ADR) (NASDAQ:ERIC), Alcatel Lucent SA (ADR) (NYSE:ALU) and Motorola/Google Inc (NASDAQ:GOOG). This makes sense as these players all have a very similar pedigree, rooted in the telecom and wireless industry since its early days. Qualcomm, Inc. (NASDAQ:QCOM) benefited from a unique set of circumstances, developing CDMA all on its own, securing its unrivalled position in the licensing landscape.

Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) has the potential to increase licensing revenues over time but in a lumpy and humble way. We deep-dived into where Advanced Technologies’ revenues currently come from, potential upsides and downsides we should expect from the profound changes affecting the company and the industry as a whole. We conclude that the segment will likely contribute 9 cents to Nokia’s earnings next year, growing to 13 cents in 2018. Standalone valuation is challenging as uncertainty remains on the portfolio’s terminal value, and we end up with a valuation range of €2.3bn to €4.0bn.

NSN unit gains control of profitability

Wireless equipment is a commoditized business with high R&D intensity, where scale (or a low R&D cost base) is the only profitability driver. In the now consolidated competitive environment, we believe NSN has won some control over its profitability, and can therefore stabilize margins around 6-8% (2-5% in Equipment and 7-10% in Services) while achieving top-line growth of 4-6%.

Such economics, in our view, would justify an enterprise value of €7bn and a contribution to earnings of €0.19 in 2014 and €0.27 in 2018. We see potential upside to NSN’s value if Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) can merge with Alcatel Lucent SA (ADR) (NYSE:ALU) or acquire the company’s Wireless division, but see this as a longer term opportunity. Nearer term, we are more worried that NSN disappoints because of pressure on margins as the company tries to stabilize its top-line.

Nokia’s value in in breakup of its business

On a pure sum-of-the-parts basis Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s equity could be worth between €19bn and €21bn, or €5.2 to €5.6 per share. However, this value would realize only in case of a full company break-up, with HERE sold as a strategic asset, Advanced Technology run as a pure IP play or possibly sold to an industry player, NSN run independently, and, most importantly, all excess cash returned to shareholders. Based on management comments, we believe this scenario is very unlikely.

We believe Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) will keep all three businesses and distribute excess cash to shareholders only partially in order to keep strategic options open. Such a scenario should attract a conglomerate discount of 17% on the company’s valuation, which would correspond to the value of HERE being fully discounted and a 50% discount on Net cash. We base our target price on this scenario, and estimate it at €4.5 per share, corresponding to 11x 2015 earnings after a €2.9bn special dividend. This may sound a low multiple but actually would correspond to 14x earnings with a normalized tax rate of 25%.

Downside risks for 2014

We see downside risks for 2014 and forecast earnings 15% below consensus, which is mostly driven by our conviction that NSN’s operating margins will have to pull back as the company improves its revenue trajectory. Other elements participating to a risk of miss on consensus expectations are the fact that HERE will lose in 2014 internal revenues that will be in our view only partially compensated by Microsoft payments.

On balance, we conclude Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) is likely overpriced today, but also offers a poor risk/reward on the short side: It is difficult to anticipate a change of sentiment on Advanced Technology and we don’t have conviction on timing for a pull back on margins for NSN. We are also unsure how the stock would react to the latter. We reiterate our price target of €4.5, based on the above SOTP and conglomerate discount analysis.

Investment conclusion

We maintain our price target for Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) of €4.5, based on our SOTP and conglomerate discount analysis. After a €2.9bn special dividend, our price target corresponds to 11x 2015 EPS of 34 cents (HERE 2 cents, Advanced Technologies 12 cents, NSN 21 cents, and others -1 cent). This may sound like a low multiple but actually would correspond to 14x earnings with a normalized tax rate of 25%. We see a 15% downside to earnings in 2014, but don’t see it as enough of a catalyst to justify a short position. We believe the good old days of a duopoly in mapping is over and, with the emergence of strong mobile players in the aggregation layer, the future of independent map data providers is uncertain. We believe NSN has now earned more control on its profitability but is on a margin override at the moment and we are worried operating margins will disappoint in

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