News that Microsoft (MSFT) will buy Nokia’s (NOK) phone handset business (and non-exclusive, 10-year licenses to Nokia’s patents) for $7.2 billion sent shares of Nokia soaring—up 31.28% as of the New York close today—and shares of Microsoft tumbling—down 4.55%.
I think two things are behind the size and direction of these moves.
First, by selling its money-losing phone device business Nokia has removed the biggest worry about its continued existence—that it would run out of cash before it managed to turn around its phone business (if it could.) In 2011 Nokia showed a $1.07 billion EBIT cash flow loss. In 2012 that rose to $2.3 billion. With the removal of that worry, Wall Street has been busy changing its ratings for Nokia from “underperform” to “market perform.” Target prices have climbed to $5 or even $6 a share.
Microsoft, on the other hand, has lots of cash so running out of the green stuff isn’t a worry for that company. But still investors aren’t thrilled with the idea that Microsoft’s best idea for what to do with its mountain of cash is to pour it into the smart phone business and to assume the sole burden of building the market share of the Windows Phone operating system to a significant No. 3 behind Android and Apple (AAPL.)
Second, the market wasn’t convinced that Nokia could pull off a turnaround in its phone business and it’s no more convinced that Microsoft is up to the task. (Maybe the most intriguing aspect of the deal is that Microsoft Nokia CEO Stephen Elop who left Microsoft to run Nokia three years ago will return to Microsoft. With current Microsoft CEO Steve Ballmer announcing in August that he’d retire in 12 months, Wall Street is awash in speculation that Elop now has the inside track to be the next CEO at Microsoft. Given the task facing the next CEO at Microsoft and Elop’s less than awe-inspiring performance at Nokia, that seems unlikely to me.)
Yes, the deal will immediately give Microsoft an increased margin on each Windows Phone device sold—the company gets just $10 a share in gross profit now for every Windows device Nokia sold and after the deal that will go to $40 a unit, Microsoft told Bloomberg. But Microsoft will still face the huge task of clawing market share from Android and Apple phones. That would be a tough job even for a company with a reputation for nimble innovation—and Microsoft doesn’t have that reputation or track record.
If you own Nokia shares—as I do in my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ –the big question is what is Nokia worth after the deal?
The company will have three major businesses:
- The wireless network equipment business. Nokia bought out its partner Siemens (SI) in this joint venture last month and the business has recently broken into the black. On estimated sales of 11.8 billion euros in 2013 (and a 9% operating margin), this business is worth about 1.60 euros a share.
- The HERE mapping and location services business. Sales for this unit, Credit Suisse estimates, will hit 950 million euros in 2013 with a very modest 2% operating margin. That values this business, Credit Suisse calculates, at 0.13 euros a share.
- Licensing of patents to Microsoft and other companies. Nokia currently makes 500 million euros a year in licensing revenue with an operating margin of near 100%. Say the licensing business is worth 1 euro a share.
Add that valuation of 2.73 euros a share to the 2.1 euros a share in cash that the company will receive from the sale to Microsoft and you’ve got a sum of the parts valuation of 4.83 euros a share. At today’s exchange rate that works out to a valuation of $6.35. That’s 23.5% above Nokia’s share price today.
Whether you decide to hold in hopes of that potential gain or sell today depends mostly on your view of the market over the next few months and your sense of your available opportunities for investing the cash from selling Nokia shares.
As I’ve noted, I think September and October are likely to bring significant market volatility and I’d like to have more cash rather than less to invest in any bargains that volatility might create. If the market is volatile over the next two months it’s unlikely that shares of Nokia will escape the turmoil. And with the deal not expected to close until 2014, I think you could be looking at more time rather than less before the stock worked its way toward that theoretical $6.35 target
My choice is to sell the shares out of my Jubak Picks portfolio and to hold the cash in hand. At today’s price, I’m looking at a 6.4% loss on the shares I bought for Jubak’s Picks at $5.49 on March 30, 2012.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of Apple as of the end of June. For a complete list of the fund’s holdings as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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