This segment represented in 2010 around 68% of total revenues, being composed by smart devices and mobile phones, each one representing around 50% of total sector revenues (-8.89% CAGR of revenues 2008-2010). Indeed, smart devices are expected to increase more than mass-market handset devices due to the factors already mentioned.
However, this segment presents an operating margin around 11.32% meaning that is profitable sector with small financial risk. In the smart devices market, the Symbian OS represented 37.60% of the total market (figure 24). Nonetheless, if the takeover approach takes place, the Windows Phone 7 should be the new smartphone OS; while the Symbian OS will be retained for use in the mid-to-low-end devices (mobile phones). In turn, the absence of a reliable and strong device able to contender against Google’s Android and Apple’s iOS will lead to a decrease in revenues in 2011.
In addition, revenues have grown 5% on the first quarter of 2011 compared with the 2010 first quarter, but comparing with the fourth quarter of 2010, they have decreased almost 17%, thereby, one can expect a decrease of 3% in 2011 and 2% in 2012, due to the reasons mentioned before and the changes in the smartphones platform/OS as a consequence of the merger. From 2013 on, it is expected to grow 4% a year after the
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transition process had been achieved - post transition – (2.47% CAGR of revenues 2011-2015).
6.2.1.2. NAVTEQ
This division represented in 2010 only 2.3% of total revenues, a tendency of growth equals to 67% since 2008 (66.6% CAGR of revenues 2008-2010) and a negative operating margin of 22.46%. However, one shall bear in mind that this segment was only integrated into Nokia in 2008 after an acquisition process. NAVTEQ is directly correlated with the Smartphones devices since its main services – Nokia Maps – and applications are only accessed through smartphones. Therefore, despite revenues have increased 23% on the first quarter of 2011, in the year of 2011 it is expected to decrease 2% (correlated with the smartphones revenues decrease) and after that, a growth of 4% year. In fact, Nokia digital maps will be considered the heart of Bing an AdCenter – search engines for all Nokia phones whether the merger takes place (4% CAGR of revenues 2011-2015)
6.2.1.3. Nokia Siemens Networks
This segment is a result of a joint-venture in 2006 with Siemens providing solutions to the operators and service providers representing in 2010, 29.7% of total revenues (- 9.06% CAGR of revenues 2008-2010).
In spite of its growth of 17% on the first quarter of 2011 compared with the first quarter of 2010, this segment is expected to follow the other Nokia’s segments, decreasing in about 2% in 2011 and 2012 due to the transition process; nevertheless, from 2013 on it will tend to increase in about 2% year. However, with the merger this segment might be challenged, due to the new strategy focus and partnership with Microsoft, which is somehow a Microsoft’s competitor (Siemens), in terms of equipment and peripherals (1% CAGR of revenues 2011-2015).
6.2.2. Operating Expenses
Looking at Nokia’s cost of revenues, one can figure that they have been representing more and less 63.5% of total revenues since 2008. In turn, cost of revenues seems to be flat according to the historical trend, thereby as revenues are expected to decrease until 2012, the cost of revenues will also decrease, assuming its weight as a percentage of revenues – 63.5% - will be kept in the following years.
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Regarding to Research & Development expenses, as it was referred before, this item will tend to decrease as a part of the new restructuring plan headed by the new leadership team (Stephen Elop). Indeed, R&D represents 13.3% of total revenues on average. As innovation is one of the main secrets for the Microsoft success, in the future, Nokia’s R&D expenses will follow the historical trend average and in the medium and long term – from 2016 on – this item might be shared with Microsoft. Concerning to Sales & Marketing item, which represented on average in the last three years a tendency of 9% of revenues, it is expected to decrease from 2011 on due to the Nokia’s market-share loss as a consequence of Google and Apple success. Therefore, it is assumed a value equals to 9% on the next years. Furthermore and with the merger in place, Nokia may take advantage of the strong Microsoft’s Marketing support to achieve the network effects – increase the user numbers, attract more customers.
With regard to General and Administrative expenses, its weight as a percentage of total revenues has been kept at 2.6% of revenues, and the same trend is assumed until 2015. Concerning to Employee Severance item, it has been null over the past three years. Nonetheless, from 2011 on Nokia is expected to start cutting off on jobs and its respective personnel expenses in about 1% of total revenues year-over-year, being considered another major strategy shift taken by the new leadership.
Depreciation and Amortization, as it represented 4.5% of total assets based on the historical trends, thus in the following years it is assumed to be in line with the current tendency. The provision for income taxes from 2011 on, it is expected to follow the corporate tax rate of 26%.
In terms of Dividends as it was done with Microsoft, it is expected the same value until 2015 as a way to keep capital structures and cash at constant levels, as well as to build a strong balance sheets. In fact, Nokia should follow its restructuring plan initiated in 2010 by the new Board of Directors as well as, the telecommunications market trend towards a reduction of costs, focus in turn on, the new tablets and smartphone segment as Apple and Google did.
6.2.3. Assets, Liabilities and Equity
Starting by Assets, cash and short-term investments are expected to decrease 10% in 2011 due to the pre-merger agreement and from 2012 on, the total cash and short-term
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investments are expected to increase 5% a year. Concerning to the accounts receivable and inventories, both will follow the historical tendency of growth, representing 29.6% and 5.25% of total revenues respectively. In turn, the accounts payable will follow the cost of revenues’ average tendency of growth – 19.6%. Regarding to the Short-term debt, on the next five years the short-term debt will be considered the same value as 2010 (appendix 18), while the Long-term debt will decrease will decrease 4% until 2012, as the historical trend from 2009 to 2010, and from 2013 to 2015, with the post- transition phase, it is expected to start increasing in about 4%, according to the Goldman Sachs projections. As opposite to Microsoft, Nokia considered minority interests according to the previous annual reports; hence, non-controlling interests for the next 5 years will be 14.5% of total Retained earnings and common stock per year, following the historical tendency (2008-2010).
6.2.4. Net Working Capital
Net Working Capital represents the amount of money that a firm has in order to operate day-by-day. According to the formula already mentioned as well as, the composed items and its respective projections, the Nokia’s NWC over the last three years has been relatively stable, directly correlated with the total revenues. Thereupon, the expected NWC value is expected to be the direct application of the formula.
6.2.5. Capital Expenditures
Nokia’s CAPEX over the last three years has been very unstable, being impossible to come up with a historical trend. Further, Nokia has been cutting in capital expenditures since the beginning of the economic downturn (appendix 19). However and in a near future, more precisely, from 2011 on, Nokia must start investing more and more in the new tablet and smartphones infrastructures due to the two other powerful ecosystems – Google and Apple. Moreover, Nokia’s restructuring plan contains in itself and by nature, an increase in the capital expenses in order to accomplish with its goals and market-leader’ duties. Thereby, on the next three years, CAPEX is assumed to be equal to the average of past year’s values, which is equal to 37.4% and from 2014 on, assuming a more stable stage, CAPEX will be equal to Depreciation and Amortization. In fact, this new investments and corresponding growth in CAPEX should be viewed by Nokia as a way to come up with a sustainable differentiation business model and products in order to compete against Google and Apple.
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6.2.6. Financial Leverage and Cost of Capital
After the calculation of the FCFF, it is now necessary to compute the respective discount rate – WACC - bearing in mind that in order to compute the firm value, it is going to be used the WACC methodology. Additionally, the assumptions taken to calculate the discount rate of Nokia cash-flows will be quite similar to those used in Microsoft’s valuation, as well as the formulas. Firstly, Nokia’s rating – AAA and Aaa - is considered the same as the Finland’s rating according to S&P’s and Moody’s credit rating agencies (appendixes 7 and 8). In turn, the Finnish risk free rate is 2.52% according to the IMF’s website, and the total risk premium in January 2011 is considered 5% according to Damodaran (2008). Concerning to the unlevered beta in the Telecommunications Equipment industry in Europe, it is assumed to be 0.86 (appendix 9).
The cost of capital ( ) will be the sum of the risk-free rate with the default risk according to the Nokia’s probability of default, which is 0.50%, in a word, cost of debt capital will be equal to 3.02%. Concerning to the corporate tax rate applied in the Finnish market, it is 26% (Damodaran’s website) and the Nokia’s capital structure at market values is 11.57%, so the debt’s weight is almost 1/8 of equity. Regarding the diluted number of shares outstanding in 2010, this item was around 3,713 Billion of shares. At the same time, the minority interest was $2.604 Billion USD, thus the enterprise value is the sum of Equity value plus Net Debt and the non-controlling interests. As result, the unlevered cost of equity is expected to be 6.82%, while the levered cost of equity is 7.22%, since instead of using the unlevered beta (0.86), one uses the levered beta (0.94); lastly, the WACC is 6.64%. All this considered, the Nokia’s Enterprise value through the WACC method is $48.620 Billion USD and the price target for Nokia using the same method is $10.98 USD.
6.2.7. Sensitivity Analysis
After the base-case scenario valuation, now it is going to be taken different assumptions in order to analyze the changes in the firm value. Indeed, Telecommunications industry is labeled as competitive, innovative, with constant developments, thus the considerations made before may not concretize in the future. Firstly, it is considered changes in revenues, operating expenses and terminal growth rate. The bear-case
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scenarios assumes revenues and terminal growth rate 1% lower for each of the following years and operating expenses 1% higher (appendix 22); while the bull-case scenario assumes revenues and terminal growth rate 1% higher and operating expenses 1% lower (appendix 23). Thus, for the bear-case situation the price target would be $6.86 and for the bull-case scenario it would be $14.78. In conclusion, this sensitivity analysis allows us to claim that Nokia is overvalued, since the price target under the bear-case scenario is still smaller than the stock price at May, 13.
6.2.8. Multiples Valuation
In this case, the Relative valuation method will compare Nokia with similar companies operating in the Telecommunications Equipment Industry based on similar growth and risk levels. This is an industry that shows a bit more internationalization with several Europeans and Asiatic companies, though 40% of the Peer Group is composed by U.S. headquartered companies. The same source (Reuters) and method was applied in the computation of the financial indicators for 2011 (Figure 30). Looking at the ratios, Nokia is more and less in line with the industry.
Company Country
Stock
Price Target Price Market Capitalization (in million) P/E P/Book P/Sales EV/Sales EV/EBITDA EV/EBIT
Alcatel-Lucent FRA 6,10 7,924 17,07 1,62 0,33 0,32 3,36 7,00
Apple USA 340,50 355,613 15,18 5,13 3,54 3,29 8,00 8,86
Cisco Systems USA 16,88 84,263 13,17 1,78 1,95 1,23 4,20 4,77
Google USA 529,55 170,117 19,00 3,27 5,10 4,87 8,95 10,10 LG Electronics KOR 18,46 8,698 0,66 0,16 0,23 6,32 13,14 Motorola USA 46,65 13,873 21,81 2,06 0,96 1,23 6,73 8,05 Qualcomm USA 57,12 82,206 18,65 3,12 5,96 4,89 11,30 12,70 RIM CAN 43,24 15,306 4,63 1,60 0,74 0,57 2,55 3,30 Samsung KOR 852,89 110,584 7,53 1,08 0,76 0,52 3,14 5,39 Sony JAP 27,58 20,648 0,63 0,23 0,14 1,90 4,70 TomTom NV NED 8,53 656 1,00 0,45 0,66 3,86 6,45 ZTE CHN 3,38 9,933 17,72 2,43 0,90 0,84 10,30 15,70 Average 162,57 127,93 14,97 2,03 1,76 1,57 5,88 8,35 Nokia FIN 8,66 32,11 12,03 1,50 0,55 0,83 7,73 12,46
Figure 30: Nokia Peer Group
Indeed, this multiple valuation only confirms that Nokia stock price is somehow undervalued since the P/Sales ratio in lower than 1. This is also a complement which underlies the WACC methodology results.
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