Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get bull's-eyes on their backs, targeted by other companies looking to disrupt their products by selling cheaper alternatives that still prove "good enough." Even if a company continues to dominate its particular field, other changes in technology can shift spending away from its products. Think about how Microsoft
With that in mind, today we're looking at how Nokia
Over the past five years, Nokia has spent an average of 12% of revenues on R&D. Here's how that figure stacks up next to some of its rivals.
|
Company |
2006 |
2007 |
2008 |
2009 |
2010 |
LTM |
|---|---|---|---|---|---|---|
|
Nokia |
9% |
10% |
12% |
14% |
14% |
14% |
|
Apple |
4% |
3% |
3% |
3% |
3% |
2% |
|
Motorola Mobility |
N/A |
11% |
14% |
14% |
13% |
12% |
Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates represent calendar years; yearly totals are for company fiscal years closing in that period.
Relative to Apple, all mobile-phone companies look wasteful in their R&D spending. Still, the difference between the two illustrates why Nokia's high R&D spending failed to keep the company in the mobile lead.
While Apple focused entirely on iOS, porting the operating system from the iPhone to the iPod Touch and eventually the iPad, Nokia pursued several strategies at once. The company continued relying on its Symbian operating system and also poured vast amounts of resources into an alternative operating system named Meego.
Despite the massive spending on these projects, Asymco estimates that Symbian development alone costs double what Apple spends developing the iPhone, and Nokia was never able to "get it right" in high-end smartphones. As the company heads into a future driven by Microsoft's Windows Phone 7, investors can only hope that the company will be able to get its wasteful R&D expenses under control.
Acquisitions
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses such as hard drives and PCs while it focuses on acquiring additional services and software expertise that have transformed its business model.
However, on the opposite end of the spectrum, Hewlett-Packard is often criticized for underinvesting in research and development to the point that it has to overpay on acquisitions to catch up with its competitors.
Investors should remember, most of all, that companies are valued by the cash flow they can bring in for their shareholders over time. If companies need to continue making purchases in perpetuity to keep growing, that amounts to a reduction in cash flows, and investors should treat acquisition spending as a continuing outflow against cash flow. With that in mind, let's take a look at Nokia's free cash flow over the past five years against cash spent on acquisitions.
Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates represent calendar years; yearly totals are for company fiscal years closing in that period.
In the past, Nokia hasn't shied away from splashy acquisitions. The most notable example was the company's $8.1 billion purchase of Navteq. However, I wouldn't expect acquisitions to be a large part of Nokia's future. The company holds nearly $10 billion in net cash, but it will desperately need that cash in the coming years as it follows through with its plan to adopt Windows Phone 7. Last quarter, Nokia reported negative operating cash flow, and its competitive position continues to worsen.
Long story short, the company will need its cash to fund the business while cash flow moves into the red, so don't expect any buying sprees from Nokia in the coming years.
Final thoughts
Nokia's officially a turnaround story. The once-mighty mobile wrangler has seen its value plummet all the way down to $24 billion. Investors hoping for a turnaround would be wise to see whether the company can change its former wasteful habits. Outsized R&D spending was tolerable when Symbian was still viewed as a success and the company was throwing off massive cash flow, but not being able to sufficiently "cut the fat" in its R&D department after Nokia switches to Microsoft's mobile operating system will just be another roadblock to Nokia's profitability in the coming years.
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