This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines are all telecom, all the time, as analysts are lining up to up their opinions of Verizon (NYSE:VZ) and Apple (NASDAQ:AAPL), among others.
Declaring victory on Nokia, and going home
Monday's announcement that Microsoft (NASDAQ:MSFT) will buy Nokia (NYSE:NOK) sent Microsoft shares tumbling, as investors worried that Microsoft will be unable to parlay Nokia's Lumia line into a bona fide rival to the iPhone and Android empires. On the other hand, Nokia shares veritably flew off the shelves (in any event, they were selling better than its Lumias), gaining 31% on the day, and rising a further 2% today.
But not so fast, says one analyst. Now that Nokia is transferring its cell phone business to Mr. Softy, Nokia's also giving up the potential to turn around that business, and profit from the turnaround. Plus, a 30%-plus, two-day profit from the shares is not something to be ignored. Consequently, Argus Research is telling investors today that Nokia -- which it had recently recommended buying -- is now no longer the buy that it once was.
Is Argus right? Well, let's see here. With $7 billion, $12.6 billion in cash already, and $7.2 billion soon to arrive from Microsoft, Nokia post-sale will have about $12.8 billion in the bank. Subtract that from the company's $19.4 billion market cap, and you're left with an enterprise value of $6.6 billion for Nokia.
Now what do you get for that? Without its cell phone division to drag it down anymore, rump-Nokia will consist primarily of Nokia HERE and Nokia Siemens Networks. NSN is a profitable division, earning operating profit before tax of $579 million over the past 12 months. HERE, on the other hand, recorded pre-tax operating losses of $386 million over the past year. Subtract the latter from the former, and what you're left with is a rump-Nokia earning about $193 million annually -- before taxes.
So the question here, really, is whether you think that post-sale, Nokia is worth paying 34-times pre-tax earnings for, without the potential for supersized growth from a cell phone division turnaround. Personally, I doubt that it is -- and I think Argus is right to downgrade.
Apple gets a rare endorsement
So if we're not to buy Nokia, then who should we buy? An analyst at Cantor Fitzgerald believes that a better place to put your cell phone-investing dollars today is Apple. On StreetInsider.com, Cantor is quoted pointing out that "Apple's stock has been challenged this year and down 8% YTD vs. a 15% increase for the S&P 500 Index; however, we believe the stock is in the midst of a recovery. In our view, Apple is on the verge of an extended product cycle that we believe will include a refresh of existing products, increased penetration within existing device categories and entirely new market opportunities," potentially including an "iTV" or "iWatch." Between the depressed share price and the sizable growth opportunities, Cantor now says it sees Apple shares hitting $777 apiece within a year.
Nor is Canaccord the only analyst voicing optimistic predictions for Apple. Wall Street analysts on average see Apple growing its profits in excess of 18% annually over the next five years -- a rate that pretty much assumes the introduction of new, yet-undreamed of, products to sustain it.
With a P/E ratio of only 12.4, and more than $25 billion in net cash, this makes for a most attractive relationship between earnings and growth rate. Add in the fact that Apple continues generate superior free cash flow -- $43.2 billion over the past year, versus only $37.7 billion in reported GAAP earnings -- and this "cheap" stock may be even cheaper than it looks -- assuming the analysts are right about the growth rate.
Speaking of growth, one thing we can say about Verizon for sure: it's growing... something.
Analysts only see earnings at the telecom giant growing at about 10% annually over the next five years. However, the company's plan to spend $130 billion buying out Vodafone's interest in Verizon Wireless guarantees that Verizon's debt load will be growing. Even if, as expected, Verizon only pays for about $60 billion of its purchase price in cash, it's likely that Verizon's debt load will soon approach $110 billion, putting the company within a whisker of a quarter-trillion-dollar enterprise value -- $241 billion.
Is the company worth it? R.W. Baird thinks so, and the analyst upgraded Verizon to "outperform" today. But why?
Verizon itself earned about $1.56 billion over the past year. Verizon Wireless, however, earned $16.7 billion, according to S&P Capital IQ. Even without profits from the parent company's legacy landline business (which appear to have been negligible last year), this suggests a modest-seeming 14.6-times-earnings valuation on an integrated Verizon stock.
Assuming Verizon achieves its projected 10% earnings growth rate, and assuming the company can afford to maintain its 4.3% dividend yield, on balance, the stock looks fairly priced to meet today -- and Baird looks right to recommend it.
Motley Fool contributor Rich Smith owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft.