After losing 50% of their business and seeing their stock increase 35%, is Nokia Corporation (ADR) (NYSE:NOK) still a buy? Also, how is this deal fundamentally impactful, and are there any investment lessons that we should take away?
There’s still a lot of questions
Criticism of Microsoft Corporation (NASDAQ:MSFT) is nothing new, and ever since Steve Ballmer announced his upcoming resignation, investors have wondered what’s next for the company. Well, they gave us a big hint at the future direction with a $7.3 billion purchase of Nokia Corporation (ADR) (NYSE:NOK)’s mobile device business, and to license Nokia’s patents and mapping services.
In a company presentation and an email to employees, Microsoft Corporation (NASDAQ:MSFT) CEO Steve Ballmer explains the rationale behind the deal. Ballmer explains that Stephen Elop, largely considered a frontrunner as Microsoft’s next CEO, will lead the larger Devices team, and Microsoft will now try to grow the Lumia-line and their operating system more aggressively.
Most notably, Microsoft Corporation (NASDAQ:MSFT) disclosed receiving just $10 on every Lumia phone sold. This acquisition will increase that share four fold with an integrated team and more focused marketing, thus enabling cost synergies of $600 million within 18 months .
Therefore, the deal looks to be good for Microsoft Corporation (NASDAQ:MSFT) from a cost-saving perspective, but only if it grows in size. Nokia Corporation (ADR) (NYSE:NOK) shipped 7.1 million Windows smartphones in the second quarter, but Microsoft disclosed the need for 50 million units annually in order to breakeven . Hence, the Windows phone line needs to double in size. If so, the acquisition becomes very beneficial to Microsoft Corporation (NASDAQ:MSFT), both in cost savings and in producing a profit.
Making a major one-move change
Following the acquisition, Nokia Corporation (ADR) (NYSE:NOK)’s most recognized segment is now lost, and the company now becomes a telecom company with a massive patent portfolio. However, I see this deal as more beneficial to Nokia Corporation (ADR) (NYSE:NOK), versus Microsoft Corporation (NASDAQ:MSFT), and for three reasons.
1. Improved profitability
2. Improved balance sheet
3. Improved Shareholder Value
First, is the obvious, Nokia Corporation (ADR) (NYSE:NOK)’s cash position increasing to $20 billion or having the luxury to use the proceeds to eliminate all of its debt. Also, Nokia will be losing a segment of its business that had an operating loss of about a billion dollars last year. With its other segments producing an operating profit, Nokia instantly becomes profitable, thus changing the outlook of the company.
The third point is regarding the company’s sum of parts prior to the acquisition. Last year, Nokia had revenue of almost $40 billion, and about half of that revenue came from the segment that was purchased by Microsoft.
Therefore, common sense suggests that after losing half of its business, and increasing in value by 35%, Nokia is now overvalued? However, this is incorrect, as Nokia traded with a market cap of just $14.5 billon prior to the acquisition. Hence, Nokia traded at just 0.4 times sales in a market that trades at 1.5 times sales.
The reason for Nokia’s discount is because of its operational flaws, lack of profit prior to the acquisition. Now, using its current valuation and the near $20 billion that the company’s networking and mapping segments created last year , Nokia is trading at one times future sales.