Up until recently, it appeared that Nokia (NYSE:NOK) was caught in a downward spiral, losing 30% of its value after last October’s earnings report; it seemed like the company’s business model had broken down. As a result, traders dumped NOK stock. Shares hit their lowest point since 2012.
But two pieces of good news have Nokia’s stock on the mend over the past week. The first is that Nokia reported better-than-expected earnings last Thursday. Even more surprisingly, the United States’ Attorney General William Barr said that the U.S. government, perhaps in combination with its allies, should acquire a majority stake in either Nokia or Ericsson (NASDAQ:ERIC).
Surely, if you had told Nokia investors of 10 or 15 years ago about this they’d be shocked. Why would a leader European cellular company end up as an arm of the U.S. government? Yet, the proposal actually does make some strategic sense. Here’s why the bottom may finally be in for Nokia stock.
Nokia: Strategically Vital Asset?
Over the past year, it’s become increasingly clear that the United States will need to make back-up plans for many of its technological networks. While the trade war with China has simmered down for the time being, there’s still a clear lack of faith between the two parties.
As such, it’s vital to have alternatives within the supply chain. The U.S. government – and military in particular – is unlikely to accept a world where China is the only manufacturer of key components.
This brings us to Huawei and 5G. Huawei had built a solid lead in 5G technology and deployments. Even key U.S. allies like the United Kingdom have given Huawei 5G business rather than listening to U.S. requests to avoid Chinese tech providers.
In response, Attorney General Barr said recently that the U.S. should make a move and take a financial stake in Nokia or Ericsson. Here was his reasoning:
“There are only two companies that can compete with Huawei right now as 5G infrastructure suppliers: Nokia and Ericsson. They have quality, reliable products that can guarantee performance. They have proven successful in managing customers’ migration from 4G to 5G. The main concern about these suppliers is that they have neither Huawei’s scale nor the backing of a powerful country with a large market, like China,”
Barr criticized efforts from others in the administration to try to build a homegrown rival, saying that time was of the essence. In fact, Barr said directly that action was needed to “blunt” Huawei’s momentum as quickly as possible and make sure that either Ericsson or Nokia has the “staying power” to win big contracts and serve as a reliable supplier.
The Profit Motive
It’s important to consider that Huawei is a private company. It offers no stock to public shareholders, and as such, doesn’t have to worry about quarterly earnings, dividends, or other such matters. Seemingly, Huawei has significant ties to the Chinese government and as such, it can balance profitability with other national and strategic concerns.
Ericsson and Nokia, by contrast, have to report to shareholders on a regular basis. And when they come up short, investors take action. So far, Ericsson has managed a successful turnaround while balancing strategic and economic incentives. Nokia, however, has not fared so well.
This helps make the case for a well-connected backer, such as a federal government, to come in and give Nokia a big financial backstop by taking a large stake in the firm. It wouldn’t be all bad for shareholders either.
While the company would likely lose some sales and influence in certain markets, it’d benefit greatly from having the same financial and strategic flexibility that top rival Huawei currently enjoys. And, it’s worth remembering, defense companies tend to make outsized profits, certainly more than commodity tech suppliers on many occasions.
Earnings Weren’t Bad Either
Even if you assume there is no potential for an M&A deal, Nokia seems to have turned the corner. Yes, admittedly, revenues were still down 3.6% year-over-year, and that’s not good. But they beat estimates for both revenues and earnings in the most recent quarter. And that -4% figure isn’t at all bad given the trade war headlines that have rocked sales for many tech outfits such as semiconductor companies throughout 2019.
In Q4 alone, Nokia pulled in $1.5 billion of free cash flow, which is quite solid for a company trading at a market capitalization of less than $25 billion. The company’s financial situation is reasonable, despite all the criticism and weak share price performance throughout 2019.
Most importantly, 5G momentum appears to be building. As of the end of the quarter, Nokia is already up to 66 commercial 5G networking deals. Furthermore, it already has 19 5G networks that have gone live. Nokia has made it through some lean years. As 5G ramps up, shareholders should be rewarded.
NOK Stock Verdict
It’s always dangerous to base your primary thesis for owning a stock on a buyout offer. Particularly when the government is involved as a potential cross-border suitor, there’s a ton that could go wrong.
In this case, though, even if no one bids for Nokia as a strategic asset, there still are some decent fundamentals here. You just had a solid earnings report, for example. And on a technical basis, Nokia looks like it is starting to form a bit of an uptrend.
There are still risks, of course. The coronavirus from China could be a problem, for example. It has disrupted supply chains in China and across Asia, and is likely to put off new equipment orders from some vendors for a quarter or two.
For folks worried about Nokia’s traditionally-bumpy quarter-to-quarter results, this might not be the best time to pick up some Nokia stock. Longer-term, however, Nokia is likely to pick up more business, and perhaps even governmental backing, as a key strategic asset to help support an alternative to Huawei.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he had no positions in any of the aforementioned securities.
