After a couple of years in the wilderness, Nokia Oyj (ADR) (NYSE:NOK) stock has made a solid comeback over the past few months. Nokia stock reached a three-year low in late November, falling near $4, but NOK stock has rebounded 57% since then.
There are some reasons for optimism. The comeback of Nokia’s phone business — sold to Microsoft Corporation (NASDAQ:MSFT) earlier this decade — offers potentially high-margin licensing revenue and exposure to growth in Asia.
Internet of Things demand could help the core networking business. Nokia’s balance sheet is strong — the company has about $4.6 billion in net cash — and Nokia stock offers a nearly 3% dividend, based on this year’s annual payout.
But it looks like all the good news is priced into NOK stock at this point. That may not be true for long-term concerns relative to the core networking business, which continues to decline. With revenue growth and margin expansion both likely limited, earnings growth will be tough. And that should keep a lid on Nokia stock.
The Good News for NOK Stock
By no means is Nokia a terrible company. And by no means is the bull case for Nokia stock completely without merit. The merger last year with Alcatel-Lucent created a global networking giant that seems reasonably well-positioned for the eventual rollout of 5G. There’s still another €400 million ($468 million) in cost savings from the merger expected in 2018, according to the Q2 release.
NOK has managed to expand its portfolio from being mostly mobile-focused to providing what it calls “end-to-end” solutions, including an emphasis on higher-margin service offerings. It’s targeting Cisco Systems, Inc. (NASDAQ:CSCO) and Juniper Networks, Inc. (NYSE:JNPR) in the core router space.
Beyond networking, there’s good news as well. Nokia’s phone business won’t ever be what it was at the beginning of the century. But licensed Nokia phones offer high-margin revenue with little capital expense. Meanwhile, intellectual property licensing has the potential to add profits — and it already has.
A settlement with Apple Inc. (NASDAQ:AAPL) is bringing in an €1.7 billion upfront payment — or about $2 billion. As an added bonus, it removes an estimated €100 million in annual litigation expense. Nokia might not be a “patent troll”, per se, but like at fellow former phone star BlackBerry Ltd (NASDAQ:BBRY), IP revenue is material to the bull case here.
NOK: Are IP and Phones Really a Driver?
The problem above $6 is that a lot of the good news here seems priced into Nokia stock.
The Apple payment sounds huge. But NOK stock has a market cap of $37 billion. The Apple agreement is worth in the range of 35 cents per share — pre-tax.
The same is true for the phone business. Licensing handsets in China is a good way to leverage the Nokia name. But some of the profits will go to partners, competition will be intense (Apple and BlackBerry, along with local manufacturers, similarly are targeting the market), and given the size of the networking business, phones just don’t move the needle.
Nokia simply is a vastly different company than it was just a few years ago. It bought out JV partner Siemens AG (ADR) (OTCMKTS:SIEGY) in 2013. It sold the phone business that same year, and its mapping business in 2015. It has transitioned to becoming something close to a networking pure-play. And that’s a double-edged sword.
Too Much Seems Priced Into Nokia Stock
The markets Nokia is focusing on aren’t exactly prized — as seen in both Nokia’s results and the valuations of other networking plays. The networks businesses combined drive over 90% of revenue (though a smaller portion of profit). Revenue in those businesses fell 12% last year, and another 5% in the first half of 2017.
There’s some hope the business can stabilize, but expecting a return to growth still seems optimistic. There’s a reason CSCO and JNPR trade at 12-13x forward earnings. Investors aren’t very hot on the networking business. The same is true in mobile, where Qualcomm, Inc. (NASDAQ:QCOM) was receiving a similar multiple even before its legal tussle with Apple.
To be fair, Nokia stock isn’t that much more expensive, trading at about 15x 2018 EPS estimates plus its net cash. But there’s a case that investors would be better off with the clear leaders in the space … at a cheaper valuation.
It puts a lot of pressure on the IP and phone businesses to support upside to NOK stock. And while both businesses are important to Nokia, they simply don’t look like enough to drive that upside from current levels.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
