Nokia Corporation (ADR) (NOK)’s Valuation Doesn’t Hold Water

Nokia Corporation (ADR) (NOK)’s Valuation Doesn’t Hold Water
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DNB Markets analyst Fredrik Thoresen rate Nokia Corporation (ADR) (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) as sell upon the major restructuring of the NSN unit and asset sales in the networks operation are likely to lead to margin pressure and earnings volatility.

Major restructuring and asset sales in the networks operation are likely to lead to margin pressure and earnings volatility, as regional mix-shifts and product portfolios limit Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s participation in fast-growing subsegments. While IPR licensing might surprise positively and potential tie-ups could improve the company’s market position, we believe the upside potential is already priced in and we initiate coverage with a SELL.

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Regional mix-shift set to put pressure on gross margins

While the restructuring of the Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s NSN unit (solutions & networks) has shown an impressive return to profitability (2012 EUR-799m, 2013e EUR517m), and Nokia has remained a top-3 player in 4G, highly profitable contracts are tapering off and being replaced by lower-margin contracts mainly in China, leading us to expect gross margin pressure on ~90% of group sales.

Network spending backdrop promising

As with Ericsson (ADR) (NASDAQ:ERIC), we expect Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s NSN to benefit from the shift in operator spending from coverage to capacity given the 66% 2012–2017e mobile data use CAGR, and operator spending appears set to continue with its 10-year average ~15% to sales ratio. However, with a much smaller install base than Ericsson, the effect is likely to be limited gross margin support.

Challenging to monetize non-essential patents

With 90% of sales potentially facing gross margin pressure, it will be up to the Nokia HERE unit (navigation and location services) and the patent licence unit to secure >10% group operating margins. While Nokia HERE has had >20% YOY growth in vehicle licence sales, offsetting the drop in licences to personal navigation devices appears challenging. At face value the remaining IPR business (advanced technologies) appears to have substantial upside potential, but mining nonessential patents is likely to be an uphill battle even with regional court wins.

Nokia’s premium valuation unjustified

Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) offers sub-5% sustainable earnings growth at a significant premium to peers; and while there might be a handful of potential acquirers, we believe that is already reflected in the share price. We initiate coverage with a SELL recommendation and EUR5.2 target price (a 10% discount to our SOTP, and 14x 12-month forward non-IFRS EPS).

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