For the last couple of years, investors of Nokia Corporation (ADR) (NYSE:NOK) have been on a roller coaster ride. Apple and Samsung have obliterated its market share but Nokia Corporation (ADR) (NYSE:NOK), to some extent, bounced back with its Lumia series. The real issue with Nokia Corporation (ADR) (NYSE:NOK) has always been the enormous downside risk. The recent purchase of NSN gives investors some downside buffer but this comes at the cost of much needed cash.
Nokia Siemens Network
Nokia Siemens Network is a multinational telecommunications vendor with presence in over 150 countries. With headquarters in Finland, it is a joint venture between Nokia Corporation (ADR) (NYSE:NOK) and Siemens AG (ADR) (NYSE:SI). NSN has become the third largest network equipment provider in the world with a market share of 15%. China’s Huawei Technology Co Ltd (SHE:002502) has a market share of 17%, and Ericsson (ADR) (NASDAQ:ERIC) leads the race with 35%.
The telecom industry is nearing maturity in North America and Europe. With network coverage nearing 100%, equipment vendor revenues are also on a decline. NSN has also been struggling due to this industry-wide slowdown. Decline in demand has forced the company to implement a global restructuring plan.
NSN has cut almost 17,000 jobs across the globe to reduce operational expenses. The aim of this cut was to save NSN around 1 billion euros in annual costs. The plan has been successful as NSN was finally able to turn a profit in the second quarter of 2012. The company reported full year earnings of 778 million euros in 2012.
The focus on LTE (Long Term Evolution) has also been a key factor behind the improved margins and profitability. In the absence of growth through network expansion, the upgrading of networks to 4G has become the most sought after contract in the mobile equipment vendor industry. The higher margins of this target market have contributed to improved profitability of the entire division.
The sale
Nokia Corporation (ADR) (NYSE:NOK) and Siemens AG (ADR) (NYSE:SI) have been trying to sell NSN for quite a while now. The companies were engaged in negotiations with private equity firms back in 2011, but talks failed due to lack of consensus on price. According to recent reports, Nokia Corporation (ADR) (NYSE:NOK) has agreed to buy Siemens AG (ADR) (NYSE:SI)’ half of NSN for $2.2 billion. The price was much lower than predictions of analysts. This deal has priced the JV at $4.4 billion, much lower than the $5 billion expected by the market. Shares of both Siemens and Nokia surged on the news.
Everyone has emerged a winner from this transaction. Nokia has found something to fall back on if its phone segment fails. Siemens has been looking to leave this industry for quite a while and would be able to invest more in its energy endeavors. Nokia has announced that it doesn’t plan to change the management of NSN which is a healthy sign for the business.
NSN’s future
The deal has put a lot of strain on the cash reserves of Nokia. The company is already posting negative cash flow due to losses in the device segment. According to management, it has 3.5 billion to 4 billion euros in cash, which will fall below 2.5 billion euros after it pays Siemens. Nokia’s cash position is instrumental in determining the future of NSN. Initially, there were rumors that NSN will be integrated in Nokia, but management has denied any such ambitions.
Nokia has a number of options when it comes to NSN. It can spin-off NSN into a separate publicly listed company. This will generate cash from the IPO and ensure that Nokia has enough dough to finance its phone ambitions. On the other hand, if the company feels that it no longer has a future in the smartphone arena, it can focus its entire energy on developing the NSN business. If nothing else works, it always has the option of selling the entire NSN business to a third party.
However, for the time being, it seems Nokia will focus more on reducing NSN costs and improving operations. It might push NSN to divest its equipment manufacturing and rely more on outsourcing. If such a plan is implemented, it will positively impact margins and enable NSN to compete on price.Chinese players like Huawei Technology Co Ltd (SHE:002502) are able to provide low cost services because of cheap Chinese equipment manufacturing. If NSN is able to lower costs and transfer that benefit to clients, it can threaten the market share of Ericsson (ADR) (NASDAQ:ERIC). Huawei Technology Co Ltd (SHE:002502) is in a much better position to compete on cost.
NSN will continue to focus on LTE, which is the next big thing in the telecom sector. Telecom operators are trying to upgrade to 4G LTE networks, and NSN can profit from this trend. The biggest threat to NSN’s 4G ambitions is the leading industry player Ericsson (ADR) (NASDAQ:ERIC). The company’s LTE system includes LTE Radio Base stations (RBS6000 series), mobile backhaul solutions, and Evolved Packet Core Network. It also holds 25% of all essential patents for LTE.
Conclusion
The purchase of NSN is excellent news for Nokia investors. Even if we ignore the future implications, the low purchase price is a clear win for Nokia’s management. NSN has given Nokia a downside buffer. Even if the company fails in the phone segment, it can still focus on the telecom equipment industry. With control over NSN, a rich patent portfolio, and an emerging Lumia series, Nokia has become an even better investment option.
Mohsin Saeed has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Mohsin is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Another Reason to Buy Nokia originally appeared on Fool.com is written by Mohsin Saeed.
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