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Walk through your house and rummage through your junk drawers. Buried beneath some old string, a 1996 stand up calendar from your insurance agent and a pair of stretched out reading glasses, there’s a good chance you’ll find an old cell phone that’s long since been retired. There’s an even better chance it’s an old Nokia (NYSE: NOK) “brick” phone. This was the popular nickname given to the basic Nokia hand set that was typically thrown in with a two-year wireless plan back in the early part of the century.
Although they had the aesthetic charm of a Czechoslovakian army surplus field radio, they were damn near indestructible. I had two of ‘em. The first one I had became obsolete when AT&T (NYSE: T) upgraded the network. That Nokia brick was replaced by another one that looked exactly like the one before. They were heavy, but the sound quality was always crystal clear. They phones had a long battery life. But above all, they were tough — I know, I dropped mine on the concrete at least a few dozen times — a couple of nicks here and there, but the phone didn’t break. Ever.
The toughness of the product reflects the ethic of the company: determined, stoic, Finnish. Recently, Nokia has given up quite a bit of ground. Sales have slipped. Critics howl about how the company missed the boat on smartphones. They did. But don’t count the company out just yet…
Still the world leader and poised to dominate frontier markets for years to come…
According to market researcher Strategy Analytics, Nokia held 33.3% of global handset market share at the end of 2010. That translates into 453 million units shipped. This makes Apple’s (Nasdaq: AAPL) 47.5 million units for the same year look relatively bush league. [See: "3 Reasons Apple's Incredible Run may be Over"]
There’s no argument that Nokia has given up a lot of share in the higher end of the handset space to the likes of Apple and Research in Motion (Nasdaq: RIMM). But there’s an old saying in the restaurant business: “Feed the rich… eat with the poor. Feed the poor… eat with the rich.” This is where Nokia’s opportunity lies, especially in frontier markets such as sub-Saharan Africa.
Let’s say you’re a young, hard-working Ghanaian. You’ve scraped enough money together to buy a cell phone. You walk down the street to Jimmy Njimbi’s corner store. Chances are you won’t have the $300 to buy an iPhone 4. But there’s a good chance it’ll be a Nokia phone that opens up a world of communication that didn’t exist for you the other day. (It’s estimated that about 12 out of the top 15 handsets sold in continental Africa are Nokia handsets.) In 2010, mobile phones represented 90% of all phone lines in Africa. Wireless penetration in Africa is approaching 50% and growing.
Africa is a classic frontier market. Nokia is the dominant force and holds a leading position in other outlier markets like Tunisia and Egypt. But what about the BRIC (Brazil, Russia, India, China) countries? According to techvibes.com, Nokia is the number one handset in Brazil (47%), Russia (47%), India (71%), and yes, China (59%). If you want to grow, then go where the growth is. Nokia’s been there and done that.
However, structural challenges face the Finnish telecom giant. Core devices and services revenue has pulled back 12% so far this year and the company expects an operating loss in that key segment. Earlier this month, the company issued lower guidance on second quarter 2011 earnings, prompting analysts to take earnings per share (EPS) estimates down from $0.56 to $0.27 for 2011 and from $0.61 to $0.25 cents for 2012. The company has lost a lot of traction in the smartphone business and, naturally, this has the market spooked.
Sometimes it seems everyone on the planet has or wants a smartphone. However, most of the world can’t afford a smartphone and simply just wants a phone. Nokia can fill that need, which grows geometrically on a daily basis — IE Market Research projects global handset sales to reach 1.662 billion units this year. This should only continue to grow as cell phones get cheaper and countries around the world continue to develop and people become wealthier.
Action To Take –> This is a huge company ($23 billion-plus market cap) that sells one third of all cell phones on the planet. They make money. Good things should happen.
Despite the market’s anemic growth outlook for Nokia, the fundamentals are quite strong. The company has the equivalent of $16.9 billion in cash on the balance sheet. Revenue has grown at a 10.1% compound annual rate in the past decade. The stock currently trades around $6, with a trailing price-to-earnings (P/E) ratio of 8.5 times earnings. The dividend yield is currently 6.5% or $0.39 per ADS (American Depository Share) and has been paid since 1995, so there’s decent history there.
The market has mispriced the stock (as markets tend to do) based on the revenue slowdown and loss of market share. However, the five-year average trailing P/E has been 19.8 times earnings. Even at 15, the multiple would still be below its historic average. A 12 to 18-month price target of $10.50 would make sense and would expand the trailing P/E to about 15.
The catalyst for Nokia is stabilization of current market share and growth from outlier markets. The headwinds are obvious. Nokia is losing market share mainly due to a lackluster product line. But you don’t get to control a third of product segment by accident. You have to be good at what you do. The company has brought in fresh leadership with a new CEO: the former head of Microsoft’s Business Division, Stephen Elop. As the turn is crafted, though, investors should take comfort in Nokia’s disciplined fundamentals. The company has a solid track record for generating free cash flow (it threw off 4.7 billion euros in 2010, compared with 3.2 billion on 2009). The 2010 ROE (return on equity) was a respectable 16%, much higher than the industry average. I see at least 74% upside for the stock, not including the dividend.
Adam FischbaumSource: StreetAuthority
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