A Leaner Nokia Could Be a Good Long-Term Investment Despite Short-Term Troubles

Nokia is not having a great time this year, but it can improve.

Jul 15, 2014 at 6:00PM

Nokia (NYSE:NOK) did the right thing by selling its devices business to Microsoft due to intense competition from Apple and Google in the smartphone market. However, this seems to have had no effect on its share price so far this year. Nokia shares are down more than 5% in 2014, underperforming the S&P 500 by a wide margin.

A weak performance in the first quarter has not helped Nokia's prospects, as its networking business struggled. The company's network infrastructure business faces competition from peers such as Alcatel-Lucent (NYSE:ALU). In such a scenario, will Nokia succeed?

A turnaround in the cards
Given Nokia's moves, the chances of a turnaround look bright. The company will focus on a few key priorities. First, it is trying to enhance its understanding and knowledge about each of its three businesses. Second, it will now focus more on execution. Third, Nokia is looking to make its operations more efficient. Finally, the company intends to move fast to capitalize on newer opportunities, particularly in IP licensing. 

Nokia is investing selectively in strategic deals that will improve its long-term profitability profile, even though they might hurt its near-term performance. This strategy is already proving to be beneficial for the company. 

The Networks segment's gross margin increased 560 basis points year over year to 39.6% in the first quarter. A higher proportion of software sales, significant improvements in efficiency for global services, and high mobile broadband sales were the prime growth drivers.

Nokia's mobile broadband unit is witnessing substantial growth due to LTE deployments. The company is also seeing a pick up in its core business on the back of demand for mainstream products as well as in its next-generation virtualized products. 

Expanding its base
In global services, Nokia is expanding its portfolio to cover new areas. However, it is treading cautiously in areas where it can add significant value and generate adequate revenue. The company is keeping in mind the importance of system integration when it comes to supporting customers with complex cloud and virtualized solutions and expects to benefit from its product roll-outs in this segment going forward. 

Nokia is also well-positioned in the automotive market. It sees opportunity to grow its business in this segment as the market is evolving toward assisted driving, and eventually to automated driving. Nokia is addressing this market with its "HERE" products.

According to Nokia, HERE is the industry leader in advanced telematics delivered through the cloud, which is a crucial building block for the next generation of location services. HERE also allows Nokia to bring the benefits of location intelligence to customers in multiple industries across different operating systems, platforms, and screens.

This year, Nokia will be investing aggressively to build its strength in technologies for smart connected cars, cloud-based services for a wide range of device types, and location-based analytics for enterprises. The company believes that these moves will allow it to capture growth in the long run.

Licensing and competition
The company is also moving forward with its research and development initiatives to benefit from new licensing opportunities. Nokia entered into a patent and technology collaboration agreement with HTC during the first quarter. This partnership will give Nokia access to HTC's patent portfolio, further strengthening Nokia's licensing offering.

Nokia, however, will not have a free hand in the LTE and IP licensing markets. The company can expect fierce competition from Alcatel-Lucent, which is in the midst of a turnaround, as well. Earlier this year, Alcatel announced that it has shipped more than 125 million voice-over-IP subscriber licenses globally. Alcatel has a dominant position in this market, and expects this segment to grow further due to increasing demand for ultra-broadband access to converged voice, video, data, and new applications. 

Alcatel also expects to tap the network- and cloud-infrastructure markets with its carrier-grade IP routing solutions. The French company's strength in edge routing and mobile backhaul positions it favorably to accelerate its IP routing business on the back of LTE deployments across the globe. 

The takeaway
Alcatel poses a potent threat for Nokia, but the Finnish giant has strong cash position of almost $10 billion that will allow it to invest aggressively in innovation. The company is following a smartly laid out strategy to understand the closer nuances of its core businesses.

From a valuation perspective, the company seems relatively cheap. It trades at a forward P/E ratio of less than 20, mainly because analysts expect its bottom line to improve at a compound annual rate of 164% for the next five years. If Nokia executes its plans correctly, there is a strong chance that it will be able to deliver substantial growth in the long run.

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Mukesh Baghel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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