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Nokia Corporation (NYSE:NOK): Target for a Merger?

Nokia Corporation (NYSE:NOK) stock crossed $2.50 on Tuesday gaining 5% in response to news that the company might soon offer Windows 8 devices on Lumia. While Nokia Corporation (NYSE:NOK) could improve its returns (performance suggests that the company’s operations are eroding markedly relative to peers, see our analysis), tighten its belt to reduce operating costs, and change its capital investment strategy (the company has invested capital relatively poorly and now may be inmaintenance mode) to achieve better performance relative to its peers, we also believe it is a target for a merger. CapitalCube’s Corporate Actions assessment is based on comparisons relative to peers. In the case of Nokia the peers we use are:

Nokia Corporation (ADR) (NYSE:NOK)

Company numbers are TTM (trailing twelve months) or latest available. Share price data is previous day’s close unless otherwise stated.This report does not predict dividend or equity actions but highlights corporate actions that are supported by fundamental company performance and corporate finance principles.

Overview

Nokia Corporation (NYSE:NOK)’s relative size and current valuation make it a possible merger target within this peer group. Its peer group includes companies like Apple Inc. (NASDAQ:AAPL), Alcatel Lucent SA (NYSE:ALU), and Motorola Solutions Inc. (NYSE:MSI)

Nokia could achieve growth through acquisitions as it is big enough (by book value) and has only a modest level of goodwill on its balance sheet, but its valuation is not high enough to make acquisitions within this peer group easy.

Downward pressure on Nokia’s dividends due to relatively weak operating results and low interest coverage is offset by the high dividend quality and a strong cash cushion (for the dividend), which does not indicate the need to change dividend policy in the short-term.

While the company’s share price is sufficiently below its 52-week high (currently about 68% below) its interest coverage is low suggesting that a share buyback may not be prudent at this time.

M&A Action

Why merge or acquire?

Companies typically acquire to realize economies of scale, scope, gain customers, bundle complementary products, or gain vertical integration. From an investor’s perspective, these business reasons fall into natural screening categories that include: (a) buying companies to boost growth expectations; (b) buying to realize cost synergies; and (c) buying earnings through acquisitions that increase EPS.
Potential targets would typically be smaller than their peers though sometimes targets can be marginally larger than the acquirer. As a result, when identifying a company as a target, we check for a book value that is up to 80% more than the peer median. In addition, we also filter for a cheap valuation relative to peers (i.e. price to book is less than the peer median) and a share price that is trading sufficiently (i.e. at least 20%) below its 52-week high.
M&A Target Conditions NOK-US Comparable Pass/Fail
Book value <= 1.8 x Peer median 11,432.9 17,294.4 Pass
% below 52-week high share price >= 20% 67.9 20 Pass
Price to book (P/B) <= 1.2 x Peer median* 0.8 1.7 Pass
* We use a 20% tolerance (0.8-1.2x) around the median.
Typically, acquirers are larger than their peers though, as mentioned above, targets can sometimes be marginally larger than the acquirer. To identify a company as an acquirer, we look for a book value that is around or more than the peer median and for growth expectations (measured by its price to earnings or P/E) that are lower than peer median. In addition, we consider whether the company has the capacity to add intangible assets (like goodwill) and whether its valuation (measured by its price to book or P/B) is attractive relative to its peers.
M&A Acquirer Conditions NOK-US Comparable Pass/Fail
Book value >= 0.8 x Peer median 11,432.9 7,686.4 Pass
Price to earnings (P/E) <= 1.2 x Peer median* N/A 16.4 N/A
Net tangible assets to equity >= 25% 42.0 25 Pass
Price to book (P/B) >= 0.8 x Peer median* 0.8 1.1 Fail
* We use a 20% tolerance (0.8-1.2x) around the median.
Relative size and current market value make NOK-US a possible merger target within this peer group.
With a book value of USD11,433 million, Nokia Corporation (NYSE:NOK) could be acquired by others within this peer group. It may also be a possible target now because its share price is reasonably off its 52-week high and not so high in relation to book (P/B is lower than peers) that it would deter an acquirer.

Nokia Corporation (NYSE:NOK)’s relative valuation (P/B) is not high enough to suggest acquisitions in this peer group.

NOK-US could achieve growth through acquisitions as it is big enough (by book value) and has room for more goodwill on its balance sheet. Acquisitions in this peer group would be more likely if its relative valuation (P/B) was higher.

Dividend Action

Dividend cut, increase or initiate?

In this section, we try to identify whether the company is likely to cut, increase or initiate a common stock dividend. In order to screen for these actions, we apply multiple tests to check whether the combination of operating performance, leverage, liquidity, growth expectations and share price performance is sufficient to permit such an action.
To check for a dividend increase at Nokia Corporation (NYSE:NOK), we look for outperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we also filter for relatively low leverage and good liquidity, which indicates sufficient support for debt servicing. We also look for a price to book value (P/B) that is positive, relatively low growth expectations (based on P/E) and a share price that has underperformed its peers. Overall, these conditions suggest that there is pressure on management to return money to the shareholders in the form of a dividend in order to increase their total returns. Finally, we overlay the dividend quality (medium or high) and ending cash dividend coverage (moderate or strong) to indicate whether the company is likely to increase its dividend.
Dividend Increase/Initiate Conditions NOK-US Comparable Pass/Fail
Dividend payout <= 100% (= 0% for initiate) (33.4) 100 Pass
Pre-tax margin >= 1.2 x Peer median* (9.9) 11.5 Fail
Free cash flow (% revenue) >= 1.2 x Peer median* 1.5 5.3 Fail
Interest coverage >= 2.5x 2.1 2.5 Fail
Debt to market equity <= 1.2 x Peer median* 86.3 19.7 Fail
% below 52-week high share price >= 1.2 x Peer median* 67.9 70.0 Fail
Price to earnings (P/E) <= 1.2 x Peer median* N/A 16.4 N/A
Price to book (P/B) >= 0 0.8 0 Pass
Dividend quality = Medium or High High Medium or High Pass
Ending cash/dividend >= 3 (Strong) or 1 (Moderate) Strong Strong or Moderate Pass
* We use a 20% tolerance (0.8-1.2x) around the median.
To check for a dividend cut at Nokia Corporation (NYSE:NOK), we look for underperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we filter for interest coverage that is somewhat tight, which combined with a low dividend quality and a weak ending cash cushion would suggest that a dividend cut is likely .
Dividend Cut Conditions NOK-US Comparable Pass/Fail
Pre-tax margin <= 0.8 x Peer median* (9.9) 7.7 Pass
Free cash flow (% revenue) <= 0.8 x Peer median* 1.5 3.6 Pass
Interest coverage < 2.5x 2.1 2.5 Pass
Dividend quality = Low High Low Fail
Ending cash/dividend < 1 (Weak) Strong Weak Fail
* We use a 20% tolerance (0.8-1.2x) around the median.
Fundamentals do not support a change in dividend policy in the short-term.
Nokia Corporation (NYSE:NOK)’s relatively weak operating results and a low interest coverage could eventually imply downward pressure on dividends. However, its high quality dividend combined with a strong cash cushion (a healthy 6.9x the cash dividend) does not indicate the need to change dividend policy in the short-term.

Share Buyback

Is the company likely to buy back shares?

In this section, we identify whether Nokia Corporation (NYSE:NOK) is likely to buy back its shares. In order to screen for this event, we look for positive free cash flows and good liquidity in addition to a leverage, an earnings multiple and a current share price that are low enough to suggest that there is some pressure on management to buy back shares. If the company pays a dividend, we also confirm that its ending cash balance is more than the cash dividend in order to highlight the greater priority of paying a dividend versus buying back shares.
Share Buyback Conditions NOK-US Comparable Pass/Fail
% below 52-week high share price >= 20% 67.9 20 Pass
Free cash flow (% revenue) > 0% 1.5 0 Pass
Interest coverage >= 2.5x 2.1 2.5 Fail
Price to earnings (P/E) <= 1.2 x Peer median* N/A 16.4 N/A
Debt to market equity <= 1.2 x Peer median* 86.3 19.7 Fail
Ending cash/dividend >= 3 (Strong) or 1 (Moderate) Strong Strong or Moderate Pass
* We use a 20% tolerance (0.8-1.2x) around the median.
A share buyback at this time by NOK-US may not be prudent.
Even though Nokia Corporation (NYSE:NOK)’s share price is sufficiently below its 52-week high (currently 67.9% lower) and it has positive free cash flow margin, its interest coverage is low. Thus the company’s debt constraints suggest that a share buyback may not be prudent at this time. As a reference, the company’s cash balance is currently 139.2% of its market capitalization.

Company Profile

Nokia Oyj engages in the mobile communications technology industry. It operates through the following segments: Smart Devices, Mobile Phones, Location & Commerce, and Nokia Siemens Networks. The Smart Devices segment focuses on smart phones and smart devices. The Mobile Phones segment offers mass market feature phones and related services and applications. The Location & Commerce segment includes the development of location-based products and services for consumers, as well as platform and local commerce services for feature phones and smart phones, device manufacturers, application developers, internet service providers, merchants, and advertisers. The Nokia Siemens Networks segment provides a portfolio of mobile, fixed and converged network technology, as well as professional services including managed services, consultancy and systems integration, and deployment and maintenance services to operators and services providers. Nokia Corporation (NYSE:NOK) was founded in 1967 and is headquartered in Espoo, Finland.

Disclaimer

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This article is originally published at Capital Cube blog.
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