We are downgrading shares of Nokia from Market Perform to Underperform based on valuation. Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) shares appreciated a remarkable 105% in 2013 due to two very successful strategic moves in purchasing the remaining stake in NSN and selling its mobile device business to Microsoft Corporation (NASDAQ:MSFT). However, our sum-of-the-parts analysis continues to point to a reasonable price target of approximately $7/share, leading us to downgrade to Underperform.
NSN unit to stabilize
On an organic basis, we expect NSN to stabilize in 2014 following double-digit declines in 2013 as the impact from exiting unprofitable businesses and contracts is completed. However, new business in China and the U.S. is likely to pressure margins. In addition, significant emerging market and Japanese currency depreciation, which impacts as much as 40% of NSN’s revenue base, likely provide a headwind as well. Ultimately, we believe profit contribution from NSN could decline in 2014 vs. 2013, and thus believe a premium P/E or EV/EBITDA to its two closest peers will be difficult to maintain. Placing the same 6.5x EV/EBITDA multiple on our 2014 NSN EBITDA estimate as Ericsson (ADR) (NASDAQ:ERIC) and Alcatel Lucent SA (ADR) (NYSE:ALU) enjoy, we obtain a fair value of ~$2.50/share.
Here/Advanced Technology have limited near-term upside
Although Advanced Technologies and Here have long-term growth potential, we expect Here to continue to be pressured by PND declines and creeping competition in the auto end-market from Android and iOS. We continue to value Advanced Technologies at 10x EBITDA, and expect growth to be limited excluding the one-time step-up related to the Microsoft transaction. We value Here at 1x revenues, which is essentially breakeven from a profitability standpoint. Using this methodology, these businesses are worth a combined $1.70/share.
Nokia’s balance sheet strong, but valuation weak
Upon the completion of the sale of the devices business, we estimate Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) will have roughly $2.50/share in net cash. Not all of this will be usable obviously, but certainly the board would have the flexibility to execute a meaningful buyback or one-time dividend post-sale. In addition, the company will have another €2.7 billion in deferred tax assets resulting from Finnish tax credits. It will take many years to utilize these tax credits and the company will likely still have to pay taxes at the foreign subsidiary level, but we value the NPV of this asset at ~$0.50/share.
If we take the $2.50/share in value from Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s NSN, the $1.70/share in value from Here/Advanced Technologies and the $3/share in value from cash/tax assets, we get a valuation of just over $7/share; and our experience is that companies with diverse businesses usually trade at a slight discount to a sum-of-the-parts valuation methodology. Our non-IFRS EPS estimates for 2014 and 2015 of $0.28 and $0.30, respectively, equate to ex-cash P/Es of 17-20x for Nokia at current price levels which appears elevated given the single-digit growth outlook and already high operating margins. At $7/share, an ex-cash P/E of Nokia would be 14-16x based on 2014/2015 EPS estimates, about in line with the S&P 500. This appears more reasonable to us given the outlook for Nokia’s businesses. We are therefore downgrading our rating to Underperform.