Nokia Corp (ADR) (NYSE:NOK) stock has gained a little over 10% in the last two months after experiencing a bit of a rally. However, looking at the picture for the entire year, Nokia stock is still off 31% year-to-date. The fact is that despite the recent comeback, NOK stock still faces several tough fundamental challenges.
Consider that NOK’s outlook for next year calls for a 2% decline in the networking business. It’s important to note that telecom carriers have been holding off on purchases because they have already spent substantial amounts on upgrading their networks to 4G technologies.
There is also weakness in emerging markets. In fact, with the surge of the dollar, the problems may get even worse. All of this is kind of grim, right? But when it comes to investing, a contrarian approach can certainly lead to nice profits.
So does Nokia stock fit the bill? Perhaps the company is poised for a turnaround? Well, let’s take a look.
Three Pros to Owning Nokia Stock
Innovation: Nokia Technologies is the segment that focuses on consumer and professional technology offerings, such as those for digital health and media. Although, for the most part, much of the growth has been from licensing its extensive patent portfolio.
But NOK is certainly investing aggressively with its own innovations. For example, the company has developed a sophisticated virtual reality system for professionals. One of the marquee clients is Sony Corp (ADR) (NYSE:SNE), which has had lots of success with its PlayStation VR platform.
In addition to this, Nokia is making another play for the smartphone market. The device is called the Nokia P, which is based on Alphabet Inc’s (NASDAQ:GOOG, NASDAQ:GOOGL) Android operating system and will be manufactured by Hon Hai Precision Industry Co. Ltd. (OTCMKTS:HNHPF). Granted, the smartphone market is brutally competitive. But it is encouraging that NOK is taking some risks. Besides, the company has a lot of experience marketing technologies in developing countries.
Nokia stock has also been getting more adventuresome with mergers and acquisitions. Just look at the deal for Withings. The company is a pioneer in the connected health market, such as with digital weighting scales, activity trackers and baby monitors. According to NOK’s own research, the market is expected to grow at a compound annual rate of 37% from 2015 to 2020.
Network: NOK has a high-performance, end-to-end platform, covering mobile networks, fixed networks, IP/optical networks, applications and analytics. Because of this, the company has been able to sell to a wide assortment of customers, such as in verticals like energy, the public sector and transportation. What’s more, the recent acquisition of Gainspeed has been important in attracting cable operator customers too.
But the real play is for 5G mobile networks. According to a report from Telefonaktiebolaget LM Ericsson (NASDAQ:ERIC), the market is expected to hit 550 million users by 2022. A key driver will be the megatrend of the Internet of Things, which involves wireless connections among devices, as well as video and VR.
According to InvestorPlace.com’s Dana Blankenhorn: “If you get into Nokia now, you’re catching the next wave of network spending at its bottom, and can ride that wave to profit. That is the bull case, and while that might take some time to prove out, it’s a good bet carriers will spend again in the next three to five years.”
Dividend and Fiscal Disciplne: With the transformative acquisition of Alcaltel Lucent, NOK is expected to generate savings of €1.2 billion per year. And these may ultimately prove to be fairly conservative. If anything, NOK has shown a great ability to be disciplined with its cost structure.
In other words, margins are likely to expand over time, especially as the network business starts to recover.
In the meantime, investors will likely enjoy a competitive dividend, which is at nearly 6%.
Three Cons to Owning Nokia Stock
History and Brand: NOK has a storied history. Back in the late 1980s, the company realized the potential of the mobile industry and started to develop its own devices. Nokia was also critical in establishing the core standards for wireless systems. So by the end of the 1990s, the company was one of the most valuable tech operators in the world.
But unfortunately, NOK failed to keep up the innovation, which allowed Apple Inc. (NASDAQ:AAPL) and GOOGL to dominate the market. By 2012, Nokia stock sunk below $2 a share and it looked like survival was in doubt.
So yes, it is remarkable that the company has been able to get some stability and invest in growth. But then again, when it comes to turnarounds in the tech industry, the success rate is usually not so good. It is incredibly tough to catch up — and there is always the tarnishing of the brand. After all, how many people want to buy a product from a company that seems like a has-been?
Competition: Even with the consolidation, the networking business remains highly competitive. Granted, some of the rivals are not particularly strong, such as Ericsson. But these kinds of companies can still be very problematic since they are often tempted to engage in price wars.
Although, for NOK stock the biggest threat could be from the operators in China, like Huawei and ZTE. They not only have the benefit of low-cost platforms but also preferential access to their home markets.
Moreover, growth has been strong. For the first half of this year, the revenues of Huawei spiked by 40% to $36.8 billion. Then again, the company has a diversified revenue base, which not only includes the sales of networking equipment but also smartphones (ranked No. 3 in the world).
Currently, NOK has the second highest market share for wireless infrastructure equipment, at about 26%. This compares to Huawei’s 23%. However, given the company’s growth ramp, it probably won’t be long until it becomes the world leader.
Patents: Licensing of intellectual property has been the only growth driver for Nokia stock. In the latest quarter, this business helped ignite a 109% increase in sales for the Nokia Technologies division. The run-rate for the year is expected to hit €950 million.
But there is a big issue: About €150 million of existing licensing revenues will expire this year. This is one of the reasons NOK has been ramping up its legal efforts.
Yet this type of litigation can be time consuming and unpredictable. And even if there is a win, it can still take years of appeals to get any resolution. More importantly, AAPL is known to be a tough fighter when it comes to IP claims.
Bottom Line On Nokia Stock
While the long-term prospects of 5G look promising, it will take time for the market to get going. Customers will certainly try to find ways to delay the heavy investments and try to find ways to keep leveraging the existing networks. There are also the intense competitive forces that will weigh on margins.
In the meantime, NOK stock must deal with other problems, such as the expiration of a bulk of the licensing business. If the company is unable to manage this, the revenue impact will definitely be significant.
So given all this, the cons outweigh the pros — even though Nokia stock does sport a compelling dividend yield.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is a registered investment adviser representative (you can visit his site to learn more about his financial planning services). He is also the author of various books on investing like All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
