3 Reasons Nokia Investors Should Be Nervous

When a company rids itself of a money losing business, investors sometimes get wrapped up in the idea of how the company may do in the future rather than looking at actual results. Clearly Nokia Corporation's (NYSE: NOK  ) decision to sell its handset business to Microsoft made sense. Nokia can now focus on its Network, HERE, and Technologies divisions and Microsoft is folding the handset business into its burgeoning devices business. The bad news is, the new Nokia isn't growing and without significant changes, investors should be nervous.

Is this just an excuse?
Just because Nokia doesn't have to distract itself with the handset division isn't a sure sign of better results in the future. The company's single most important division is Networks which represents about 87% of the company's revenue.

This is a significant difference between Nokia and a few of its competitors like Alcatel-Lucent (NYSE: ALU  ) or Juniper Networks (NYSE: JNPR  ) . Alcatel gets just less than 46% of revenue from Networking where it produced year-over-year revenue growth of nearly 7%. Juniper did even better with more than 88% of the company's divisions reporting year-over-year revenue growth of at least 6%.

The first reason Nokia's investors should be nervous, is the company's heavy reliance on its Networks business. If this unit doesn't return to growth, not much else will matter. Given that this division reported a 17% annual decline in sales and last quarter this decline came in at 22%, Nokia's Networks division is clearly losing business to its peers.

Even more disconcerting for investors is the fact that in successive quarters, Nokia's management said that this sales decline occurred because of the exit of certain projects. The company also noted that there was a cyclical slowdown in LTE roll-outs. Ironically, Alcatel-Lucent specifically said that, "LTE continued to be strong, notably in the U.S."

Nokia investors can have their cake and eat it too. The company is losing sales while its peers are reporting growth in the same areas. If the company is strategically exiting certain businesses, investors have to wonder what will be left once the division is done adjusting its focus for the future.

Regular or special dividends won't matter if they aren't sustainable
The second reason Nokia investors should worry, is the company is proposing both regular and special dividends as a show of good faith from the Handset division's sale. While normally dividends are a positive from any company, paying dividends with questionable staying power seems like desperation.

Compared to its peers, Nokia's proposed regular dividend would have used about 70% of the company's core free cash flow (net income + depreciation – CapEx) in the last quarter. Juniper on the other hand, has a newly minted dividend that would use less than 23% of the company's free cash flow, and Alcatel-Lucent isn't in a position to pay dividends at this time. The point is, Nokia is offering investors a dividend with its primary division awash in a negative sales trend.

Another issue is, Nokia's special dividend and proposed share repurchases will use about $3 billion of the company's cash. For a company with limited free cash flow, this is a significant expense. In addition, Nokia's diluted share count has risen by almost 7% in the last year, so even a significant share repurchase may only allow investors to get back to even.

This is a long-term challenge
The third issue Nokia shareholders should be nervous about is, how long it will take for the company to regain the cash it is about to spend. Based on last quarter's free cash flow, Nokia would have only generated about $60 million in cash beyond capital expenditures and regular dividends.

Just Nokia's special dividend and proposed share repurchases of $3 billion, would take over 5 years to recover even one-third of what the company is about to spend. The point is, it's difficult to see how Nokia's regular dividend would be well covered with nearly 90% of the company's business in decline.

The bottom line is, Nokia is free of its handset division, but the company's troubles are hardly over. Short-term investors may benefit from dividends and share repurchases, but long-term investors have multiple reasons to be nervous about the company's future.

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Read/Post Comments (8) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 22, 2014, at 4:26 PM, lee654 wrote:

    LOL ! Nokia is the winner! L & B !

  • Report this Comment On May 22, 2014, at 5:21 PM, wwu12345 wrote:

    LOL! Nokia stock price has had a period of consolidation between $7 and $8. I have taken a position in this stock and am expecting Nokia to break up to a higher ground, $10 and eventualy higher. Nokia stock has made another attempt yesterday and today. In just a few days, we will see if this attempt is successful.

  • Report this Comment On May 22, 2014, at 6:57 PM, fleaman2014 wrote:

    I believe somebody better do their homework. Nokia owns NSN. And NSN and Juniper are already in a partnership to develop and sell network equipment to carriers.So that means if Juniper is doing good well ! so is Nokia.

  • Report this Comment On May 22, 2014, at 7:01 PM, DamnSkippy wrote:

    Now lets use common sense, Nokia reportedly invested near $60 billion into research and development. Windows phone with less then 5% market share had MS pay up 2.25 Billion USD to use Nokia's IP for 10 years. Arbitration with Samsung will take place in 2015 as well as Apple in 2016. Now look at the 4th quarter 2013 windows phone had 3 percent of the handset sales. Android had 78 percent and IOS 18 percent. I would think Samsung is at least selling 10x windows phone or MS sales, which in that case would be about 22.5 billion USD coming Nokia's way in 2015 while apple in 2016 could write a check for 8-10 billion..

    Think about this Apple sues Samsung 2 billion at a time for 1 or 2 IPs. Its a fact Apple is using over a dozen of nokias

  • Report this Comment On May 22, 2014, at 7:57 PM, ajaykc wrote:

    "In addition, Nokia's diluted share count has risen by almost 7% in the last year, so even a significant share repurchase may only allow investors to get back to even."

    Could you please point me to the reference of that statement? I have been Nokia investor for more than 4 yrs and I don't think share counts have gone up at all, let alone be 7% dilution. I am very curious about this info.

    "The point is, it's difficult to see how Nokia's regular dividend would be well covered with nearly 90% of the company's business in decline."

    I guess, you are saying that Networking business is in decline. Right? As per my knowledge, NSN aka Nokia's Network division has won several contracts in past 12 months and continues to win more. Maybe US is not going to spend money on LTE build out but I know SPRINT is spending several billions to deploy LTE network and T-Mobile is doing the same. I guess, Verizon and AT&T, maybe saturating. Think about 4G LTE deployment in China, India, Africa, Asia, UK, Germany, France, and rest of Europe. Oh, I forgot Vimpel from Russia gave contracts to Nokia to build LTE network. LTE deployment around the world is just beginning not ending. Maybe you are not aware of Nokia's business at all and using headlines to create headlines.

  • Report this Comment On May 23, 2014, at 9:13 AM, loadTheBoat wrote:

    3 Reasons:

    1. "Business is in decline..."

    Nokia's Networks division is no longer pursuing business that doesn't fit with its core methodology of meeting certain criteria - the major criterion being solidly profitable margins; furthermore, the division's operating margin hovers between 7-12% and should continue to do the same for the foreseeable future.

    Remember, there's no point in growing sales if the margin is compromised to a point where money is being lost. Let the ALU's of the world enjoy this kind of (monkey) business.

    2. "Regular dividend being unsustainable..."

    Nokia is proposing a regular dividend of 0.11 Euro and a 0.26 Euro special dividend to shareholders for the upcoming general meeting.

    According to Nokia's latest quarterly results, operating profit from continuing operations was around 260 Euro. Extrapolating this, assuming limited growth, we get around 1B Euro (~0.27/sh Euro) in operating profit for the year. This is more than sufficient to maintain a regular dividend.

    Moreover, once the Samsung settlement is finalized in early 2015 (currently in arbitration), Nokia's Advanced Technologies division should enjoy robust growth in revenues thereby solidifying the floor of the regular dividend, and perhaps signify a dividend increase.

    3. "Long term challenge..."

    As Nokia continues to buy back its shares and pay down its debt, the net effect of profitability is accentuated; not only does the EPS go up (indirectly showing growth), but its credit rating increases become expedited. The fact that they're using some of their windfall to cancel outstanding debt (at higher yields) will result in substantially lesser debt costs. Subsequently, once Nokia becomes investment grade (as per their agenda), the path for revenue growth will become less burdensome.

  • Report this Comment On May 23, 2014, at 10:53 AM, Bull683 wrote:

    Let's just talk "HERE". You know, the little Nokia segment you glossed over. You know, the technology behind Garmin GPS and major automobile manufacturer's navigation systems. Do your research Chad! If you do, you might also realize you failed to mention the vast portfolio of Nokia's mobile patents, that are the most expansive in the business.

  • Report this Comment On May 25, 2014, at 11:24 AM, john4 wrote:

    How's that WWE working out for you?

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