nok doc 2007 pantin

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Louis Wilson Fund - Equity ResearchNovember 9, 2007 Analyst: Michael Pantin

Nokia Corp. (NOK-

NYSE)PRICE: $37.94 52 Week Range: 42.22-18.87 S&P 500:1453.70

LWF Company Rationale:We are not recommending purchase of Nokia Corp at this time. Although we feel that the company would be a goodaddition to the LWF, the current price is too high. Nokias performance bears watching over the next few quarters, as it ispoised to take market share from its closest competitor, Motorola. Interbrand has recognized Nokia as one of the worldsmost recognized and most valuable brands. It also has strong penetration into emerging markets for wireless handset(mobile phone) sales, and is experiencing growth in the larger margin market for smartphones. Nokias scale advantagesgive it considerable bargaining power with its suppliers, and give it advantages in supply chain management (Morningstar,2007). Nokias free cash flow generation, dividend growth, and share buybacks make it an attractive target for investors.Our targeted purchase price is $36.00 with an assumed margin of error of 30%. The security is currently trading at

$37.94/share, above average for its 52 week trading range. Our four year price target is $44.00.

Nokia blends well with the LWFs strategy and goals. The firm is in excellent financial condition, with littledebt and the ability to generate substantial free cash flow (capital spending is only 1.5% of sales).Management is competent and modestly compensated, and has a tight grip on cost control. Large profitmargins have moderated in recent years as the average selling price of handsets have declined, yet earningspower remains strong. Nokias ROE and ROA are larger than all of its largest competitors. Though theaggregate market growth for mobile phones is stabilizing, Nokia remains the sales leader in the industry. Ithas 36% market share of the global wireless handset market, twice that of its closest competitor, Motorola.Nokia is also the dominant provider of mobile phones in emerging markets, where it has 45% market share.Its institutional following is low, with the Fidelity Magellan Fund holding the largest amount (2.26%) ofshares.

Business Summary: Nokia is the worlds largest manufacturer of mobile phones (e.g. Nokia N95), and alsoproduces networking equipment (e.g. switches), multimedia applications (e.g. Ovi portal), and enterprise-levelsolutions for security and mobile connectivity (e.g. wireless e-mail services). It operates four businesssegments. The Mobile Phones segment connects people by providing mobile voice and data capabilitiesacross a range of mobile devices. The Multimedia segment provides mobile multimedia experiences toconsumers in the form of advanced mobile devices and applications with connectivity over multipletechnology standards. The Enterprise Solutions segment offers businesses and institutions a range of productsand solutions, including enterprise-grade mobile devices, underlying security infrastructure, software andservices. The Networks segment provides network infrastructure, communications and networks serviceplatforms, as well as professional services to operators and service providers (Reuters, 2007). Sales forMobile Phones in 2006 were $24,769 mil with a margin of 13.25%, sales for Multimedia were $7,877mil witha margin of 12.5%, sales for Networks were $7,453 mil with a margin of 5.3%, and sales for EnterpriseSolutions were $1,031 mil with a margin of -25%. Nokias growth strategy includes expanding their presencein subscriber services to increase margins, smooth seasonalities, and increase subscriber retention (MerrillLynch, 2007). It also will increase product offerings for smartphones, which have higher margins and havethe capability to use Nokias service offerings. Nokia will also continue to aggressively compete in thehandset market in developing economies.

Growth Strategy: Nokias growth strategy includes expanding its presence in subscriber services to increasemargins, smooth seasonalities, and increase subscriber retention (Merrill Lynch, 2007). This can includenavigation services from its Navteq subsidiary, or multimedia/gaming offerings from its Ovi portal. Nokiaalso will increase product offerings for smartphones, which have higher margins and have the capability toutilize its service offerings. Nokia will also continue to aggressively compete in the handset market in


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developing economies. Through its joint venture with Siemens, Nokia Siemens Networks (NSN) producesnetwork hardware that is steadily rising in sales. Nokia is also prepared to enter the wireless broadbandmarket with its WiMAX infrastructure equipment. Nokia relies on effective marketing and a marketsegmentation strategy to target different phones at different customer niches (Morningstar, 2007).

Nokia has a 5 year revenue growth of 5.86%, which is lower than Qualcomm and Motorola. This can be

explained by Nokias poor sales in 2004 and 2005, when it missed demand shifts towards clamshell-style orflip phones (Morningstar, 2007). This resulted in lower sales and loss of market share. Nokia has sincerebounded, and its sales are projected to grow at a rate of 6.05%. This rate is reasonable, considering thatmost of Nokias future sales will be replacement phones, not new subscribers. The growth in new subscribers,at one time very rapid, has slowed significantly and the cell phone replacement cycle is more consistent withgrowth rates in the single digits. Nokia states that 65% of volume in 2007 will be attributable to replacement.Nokias rate is also achievable assuming it does not miss another important consumer trend, and the demandfor smartphones continues to be high. Future trends include more convergence with mobile phones,computers, and other electronic devices. As smartphones become more complicated, Nokia could find itselfcompeting against large software companies, like Microsoft. As with mobile phones currently, averageselling prices of smartphones will begin to fall and profit margins will begin to shrink as competitionincreases. There will be an increasing demand for mobile data, and Nokia can position itself as both thedevice manufacturer, the content source, and the infrastructure provider. Nokia will need to rely more on itsMultimedia, Networks, and Enterprise Services segments as the mobile phone market matures.

Management: Nokia has benefitted from effective management. Its ROE, ROA, and ROIC are all higherthan all of its major competitors. Nokias ROE is almost 3 times larger than Qualcomms. It also has higherinventory turnover and asset turnover than its closest competitors, indicating that Nokia is more efficient atusing its assets and inventory in generating revenue than Qualcomm, Motorola, and Ericsson. Nokia has notbeen aggressive with acquisitions, having acquired only 10 companies in the past six years. Most of theseacquisitions were wireless Internet services businesses, which augmented Nokias position in offeringsubscriber services. Management has been known to set overly optimistic expectations and fail to meet them,however expectations have been more realistic lately. Management has a reputation for cutting costs. Thefirm does not issue many options, and options represented less that 5% of shares outstanding in 2005. For atechnology firm, Nokias salaries for management are very reasonable. Management also owns less than 1%of total equity, and has been reducing the number of shares outstanding by 5%/year through buybacks.

EPS 2007 $1.81, Forecast EPS 2008 $2.15, Forecast EPS 2009 $2.33.

Industry, Competitive, and Regulatory Factors:Industry and Market

The mobile phone industry has approximately 2 billion wireless subscribers.

Key competitors include Motorola, with an 18% share of the mobile phone market, and RIM which has 10%of the smartphone market.

Rivalry in the mobile phone market is intense and inconsistent. Currently, the competitive landscape is calm.Competition can increase suddenly, and erode profit margins.

Nokia has higher EPS and revenue growth than all of its closest competitors

Nokia has higher profit margins that Motorola, but Qualcomm has higher profit margins than Nokia.

Key customers for Nokia are the end users. The smartphone end-user is of particular interest to Nokia, as is

the end-user in a developing economy. Service providers, or operators, are a secondary customer for Nokia. A pending legal dispute with Qualcomm over CDMA revenues could adversely affect Nokias profitability.

Risk:

Nokia is vulnerable to changes in the business cycle. In the 2001recession, Nokias total return dropped 43%, and net income dropped 46% from 2000.

Maturation of the mobile phone market has caused sales growth to slow,but it has remained sustainable around 5.5% to 6% a year


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Profit margins have declined as competition in the industry has increased,causing average selling prices to drop. However, margins are expected to remain consistent in the high pricepoint smartphone market and low-end market where competition is not as intense (Lehman, 2007).

Competition over scarce components has been high in recent months,causing Nokia to reduce the volume of mobile phones manufactured. Nokias scale advantages give it thecapability of coping with supply shortages better than any of its competitors.

Fast-growing Asian markets are very competitive, and low-costmanufacturers are bringing products to market that have cut the average selling price of handsets in Asianmarkets in half (Morningstar, 2007).

Nokia is an export-driven firm, and a weak dollar threatens its growthpotential (Morningstar, 2007).

Missing important consumer trends can cause loss in market share, as seenin 2004 and 2005.

Nokia Siemens Networks has produced sizeable losses in its first monthsof operations. Management has taken steps to cut expenses (Valueline, 2007).

Nokias sharp run-up in price over a relatively short period of time maymake it less attractive to investors as a long-term holding (Valueline, 2007).

If subscriber growth and upgrade cycles are lower than anticipated,

Nokias revenues will fall (Merrill Lynch, 2007).Valuation: Nokia has a current P/E ratio of 17.7x.

We expect Nokia to sell at a normal P/E of 13.9 times and expect earnings per share to reach $2.74 by 2011.Based on these forecasts we target a mid price of $47 by 2011.

Nokia is trading above its intrinsic value, which we estimate to be $36. We believe it is overvalued at itscurrent price of $37.94.

Multi-stage DDM analysis with a non-constant growth rate of 11% suggests an intrinsic value of $26.23. TheDividend Yield model produces an intrinsic value estimate of $31.90, and the Dividend Payout modelproduces an intrinsic value of $23.87. The growth rate will need to be closer to 15% to match the P/E-basedintrinsic value estimate.

Providing devices and applications for wireless connectivity is Nokias value proposition to its customers.Key drivers for this strategy are the growth of mobile data applications, wireless broadband, and network

services. Currently there are 3.825 billion shares outstanding with small institutional investment. The Fidelity

Magellan Fund has the largest holding at 2.26%.

Some analysts are very optimistic about the sales of smartphones in the next quarter and the next year. If theeconomic outlook continues to worsen in the US, revenues from this line of products are likely to fall.

Nokia should be able to meet estimated EPS figures, given the estimated growth in market share, revenues,and projected profit margins.

Nokias consistent cash flow has allowed it to continue buying back stock, which supports the projectedincreases in EPS.

Current assets exceed current liabilities by 2 to 1, and its debt to equity ratio is nearly 0.

Analyst comments on Nokias US market share problems and opportunities are pending.

Sensitivity analysis of P/E, EPS, and IV is in process.

Indicated Present Value Range (Ouma Model Summary): High Mid Low

P/E @ 8.3% PE range 12.0x to 22.0x $46 $36 $26


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Stock Performance Graph (last 5 years):


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WF Industry Sheet here

Analyst: Michael PantinDATE: 11-9-07

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LWF Proforma Model here

NokiaCOMPANY BASICS

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nok doc 2007 pantin

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