Yup, everyone is running away. We're buying. Sometime over the next five days, the Rule Maker Portfolio will buy approximately $1,500 worth of worldwide wireless giant Nokia (NYSE: NOK). We would have liked to have done this prior to Tuesday's guidance from the company, but what are you going to do? Where Nokia had been the darling child of the industry, suddenly the mangy mutt known as Motorola (NYSE: MOT) was supposedly making inroads, stealing market share, and hurting Nokia.
Maybe. Let's face it -- those new Motorola designs are pretty cool and highly user-friendly. But let's also face the fact that Motorola has shown over the last few years an inability to generate even gross profits in their handset division, so their short-term improvements are really nothing more than that -- yet.
But then the widely rumored, heavily touted market share losses by Nokia in handsets turned out to be a complete crock, and so here we are. Nokia is king of a hurting, hurting industry. It is increasing marketshare in handsets, up to 38% worldwide, and even more quickly in Asian markets, particularly in China. Its new low-end phones can still garner a price premium over the competitions' offerings, including Motorola and Ericsson (Nasdaq: ERICY), while those companies focus on the premium phone offerings. And Nokia has gone to great lengths to wring price efficiencies from its manufacturing, relocating some of it from higher-cost markets such as Finland and the U.S. to lower-cost ones like South Korea, Brazil, and China.
And, as Nokia's press release from Tuesday stated, the company, even in the face of reduced sales, has maintained profit margins. And, as a read-through of the company's most recent financial statements will show, Nokia's producing some really good cash returns, a measure that we put much more emphasis on than straight earnings, which are fraught with goofy adjustments -- and Nokia seems to have billions of 'em.
I find the recent one-upmanship by analysts and pundits to see who can be the most negative about Nokia to be kind of funny. Yes, the market is horrible for networks, which is why Nokia's had to revise its networking sales down to 20%-25% less than last year. Pointing out that the company was losing market share in handsets (it wasn't), that its earnings are going to collapse (they won't, probably), and that its recent slight decline in gross margins was a sign of the Nokia apocalypse (it isn't) isn't showing much in the way of original thought. Has anyone else noticed that analysts are suddenly awfully negative all the time? If that's not a case of closing the barn door after the cow's been carved up into steaks....
The important thing to consider about Nokia? The above noted increase in market share in handsets, which was prior to the release of its newest offerings -- the 5210 and the 3410 have shown quick ramp-ups in sales through March and April, while the new 3510 with polyphonic ring tones is to be released in Europe next week. Also upcoming is the 7650, which will be the first phone based on Nokia's Series 60 platform. Nokia also began shipping its CDMA2000 1X0-based 6370 phone for use on the Leap Wireless (Nasdaq: LWIN) network last week.
None of this is to say that the wireless market is absolutely due for improvement over the short term. From a network perspective, I'd say that all evidence points to the fact that there will NOT be any quick improvement. But Nokia's experience of late in this miserable environment has been leaps and bounds better than nearly any other competing company, and its competitive position certainly has shown no evidence of a weakening.
This too shall pass
One of the things we are trying to achieve here with Rule Maker is to show some patience in places where we have made mistakes in the past. I don't particularly think that I've got a brainpower advantage over the collective of analysts and big investors, but I do have the added advantage of not having to care too much about the performance of Nokia over the next six months if I don't want to. And I don't. I know full well that the overall wireless market is bad. I also know that no company has ever cost-cut itself into prosperity, as Nokia has been doing over the last year. But the Rule Maker in any industry has a decided advantage when times are bad. Applied Materials (Nasdaq: AMAT) has it, so does Nokia. They have the ability to put distance between themselves and their competition when times are bad. Well, times are pretty bad now, aren't they?
Through this, though, Nokia's financial performance has been great. For the full year 2001, Nokia generated US$6.1 billion in operating cash flow. I'd make a few adjustments for this, including an item that skyrocketed last year: long-term loans made to customers of $1.06 billion minus $980 million in capital expenditures still yields free cash flow for the year of $4.06 billion. Take the market capitalization at the close of the day Tuesday, and that is a price-to-free cash flow multiple of 14.6. Even if we take the last quarter for Nokia and annualize it, the price to free cash flow for Nokia comes in at under 31. This would assume that the current environment goes on in perpetuity.
As Oliver Thylmann described in his excellent article for Rule Maker last week, it won't. I'm not so sure of the timing, but I am quite sure of the fact of the wireless web's acceptance. Nokia's recent weakness in sales can also be blamed on simple product cycle gaps -- the company cut down its price on its older existing model handsets just in time to get ready for the new models coming out now. This promises for a significant gross margin expansion as the company's newest models sell at a production premium to the older models.
At any rate, we don't know what the near future has in store for Nokia, but we certainly think that this price point offers us a chance to gain a larger position in a true Rule Maker that has suffered significant recent pain. As such, we're going to put some of our money where our mouths are and make a modest investment of the Rule Maker cash war chest, which stands at more than $6,800. We've still got plenty more for additional companies, and we're not done weeding out old holdings yet.
Bill Mann, TMFOtter on the Fool Discussion Boards
At present the Rule Maker Portfolio is valued at $28,908.14. This brings the total Compound Annual Growth Rate to -4.9%. For the year, the Rule Maker's return has been -8.8%, compared to -21.5% for the Nasdaq and -10.2% for the S&P 500. We will update the Rule Maker Portfolio manually until our automated calculations return to being something close to reality.
At time of publishing, Bill Mann owned shares of Nokia. He also owns a Nokia phone. The Motley Fool is investors writing for other investors.