Nokia kits up

First published on Industry Briefing, Economist Intelligence Unit, 25 July

When Nokia Siemens Networks (NSN) published its first annual report in March, it seemed the parent companies of the Finnish-German joint venture were stepping up their efforts for either a private equity sale or a listing. Siemens had made little secret of its desire to exit the loss-making manufacturer of mobile broadband equipment. That Nokia ended up buying out Siemens shows both firms ran out of patience. There’s also an air of desperation about the deal.

In a transaction worth €1.7bn, Nokia takes full control of the 50/50 joint venture. But at fair market value, according to analysts at Bernstein Research, Siemens might reasonably have expected around €3bn. To get NSN quickly off its hands, the German firm seems willing to accept a hefty discount. It’s helping Nokia finance the deal, too. Siemens requires only €1.2bn in cash to be paid first, which Nokia has covered with a bank loan. The outstanding €500,000 balance has been settled by a secured loan from the German firm, due to be paid one year from closing the transaction (expected before the end of September).

Nokia needs all the breathing space it can get. Its market share in the mobile-phone market, where it once dominated, has shrunk alarmingly from over 40% to under 20%. And in an attempt to turn things around, by launching new smartphones on Microsoft’s Windows Phone software (after ditching its own Symbian operating system), the Finnish company has needed to spend oodles of cash. In the second quarter alone, Nokia’s net cash pile shrunk by €800m, going from €4.5bn to €3.7bn. More worryingly, sales of Nokia’s Lumia range of Windows-based smartphones, although picking up, are far from spectacular. Consumers still flock to gadgets manufactured by Apple and Samsung.

By buying NSN, however, Nokia appears to be gaining a foothold in a more solid business than mobile devices. True, NSN has been lossmaking – €741 million down the drain in 2012 – but strip out painful restructuring costs and the picture looks rosier. With an adjusted operating profit of €822m from net sales of €13.7 billion, NSN’s operating margin was a shade over 6 per cent in 2012. More encouragingly, adjusted profits were up 145 per cent compared with 2011. On this basis, NSN is the most profitable part of the Nokia Group.

Pierre Ferragu, an analyst at Bernstein Research, says the NSN purchase buys Nokia a future, no matter what happens to its line of smartphones and more basic feature phones. The network business, he argues, has a stronger outlook than Nokia’s device business.

Nonetheless, these are perilous times for Nokia. While NSN sales of mobile broadband equipment – buoyed by demand for LTE, the latest high-speed technology – appear to be well, Mr Ferragu believes Nokia’s balance sheet (excluding NSN) is weaker than it looks.

Rather than having €3.3bn of net cash, as Nokia reports, Mr Ferragu calculates that the real cash position ranges somewhere between a negative €1.8bn and a positive €0.5bn. The Bernstein analyst points to favourable timing disparities between receiving payment for devices and paying suppliers, which boosts Nokia’s reported figures. Then there are accrued expenses of €3.3bn, says Mr Ferragu, largely because of a very high level of marketing. Included in this sum is €700m cash that Bernstein estimates will have to be repaid to Microsoft as part of Nokia’s strategic partnership with the software giant.

Major rating agencies have long been cold on Nokia debt, ranking it below investment grade. On news of the NSN buyout, however, Standard & Poor’s saw fit to lower Nokia’s debt one more notch into junk territory.

If NSN is a lifeline for Nokia – and there are no unexpected expenses from the Siemens buyout – it could mean that one of the biggest brand names in mobile devices morphs into an equipment supplier with services support. That said, it’s still too early to write off Nokia’s chances of making a comeback in the mobile device business, but the firm’s precarious cash position means any recovery must come quickly.

On 11 July, Nokia launched a new Lumia smartphone that boasts a camera with a resolution higher than any of its competitors. It’s an admirable effort, but its success seems to rely on smartphone users prizing the camera function more than the reams of apps they can access on either Google’s Android or Apple’s iOS. That, like Nokia’s future, is unclear.