25 January 2008

NOK: Financial Analysis through December 2007

We have analyzed Nokia's (NOK) financial results for the quarter and year that ended on 31 December 2007.

The creation in April 2007 of Nokia Siemens Networks, a 50/50 partnership with the German powerhouse, has made it difficult to compare Nokia's current and past results. Recent financial statements fully consolidate the operations of the partnership. However, previous results, including the relevant year-earlier periods, do not include data for the businesses Siemens contributed to the partnership. This is a significant difference since the partnership would by itself be considered a large-cap company.

Readers should be aware of some facts about Nokia's financial reporting that distinguish it from companies based in the U.S. First, the financial statements are prepared in accordance with International Accounting Standards (IAS), rather than U.S. Generally Accepted Accounting Principles (GAAP). Second, the Euro is the currency used in Nokia's financial statements. Third, Nokia doesn't required file 10-Q and 10-K reports with the SEC.

Nokia, headquartered in Espoo, Finland, is a global seller of cellular phones and the equipment for mobile phone networks. Cellular phones, especially lower-cost models, have become a commodity. More expensive devices compete both on style and technical features. The rapidity of new model introductions and changing consumer tastes leads to frequent alterations in the relative fortunes of the various manufacturers. Nokia is presently on an up-swing: it now has a 40 percent market share, far surpassing rivals Samsung and Motorola, according to one consultant.

A relatively recent challenge is Apple's (AAPL) iPhone. Nokia has responded by establishing an online music service, now operating in the UK.

When we analyzed Nokia after the September quarter, the Overall score was a disappointing 25 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 14 points. Value was weakest at 0 points.

Now, with the available data from the December 2007 quarter, and subject to the comparability limitations identified above, our gauges display the following scores:

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.


Dec 2007
Dec 2007
Dec 2006
Op expenses

CGS (10017)

R&D (1620)

SG&A (1652)
(1400) (1189)

Other 64

Other income


Interest, etc.
Pretax income

Income tax

Net Income


Revenue was 12.3 percent above our estimate. We expected Revenue to be 19.6 percent greater than in the year-earlier quarter, and the actual increase was 34.3 percent. It is important to recognize that the magnitude of the increase was inflated by the formation of the Nokia Siemens Networks partnership. Since the partnership's Revenue in the quarter was €4.6 billion, an apples-to-apple Revenue growth rate is closer to 15 percent. The rate probably would have been higher if not for dollar weakness relative to the euro.

We thought the Cost of Goods Sold (CGS) would be 67 percent of Revenue, and the actual value was only 63.7 percent. Research and Development (R&D) expenses were 10.3 percent of Revenue, slightly exceeding our 10 percent estimate. Similarly, Sales, General, and Administrative (SG&A) expenses were 10.5 percent of Revenue, compared to our forecast of 10 percent.

The higher Revenue growth and the lower CGS led to Operating Income 38.8 percent above the forecast value.

Non-operating income was also better than expected, but the Income Tax Rate was 29.7 percent, instead of the predicted 26 percent. Net Income still blew away our prediction by 33 percent.

Cash Management. This gauge didn't change from 4 points in September.

The measures that helped the gauge were:
The measures that hurt the gauge were:
Increases in Inventory and DSO (i.e., accounts receivables/sales) can be warning signs that revenue growth will slow in the future.

Growth. This gauge increased from 14 points in September to 15 points now. The score might not be valid since growth rates have been inflated by the accounting of the Nokia Siemens Networks partnership.

The measures that helped the gauge were:
  • CFO growth = 76.0 percent year-over-year, up from 8.1 percent the previous year
  • Net Income growth = 67.3 percent year-over-year, up from 19.1 percent (Net Income benefited from a change in the income tax rate from 24 to 17 percent!)
  • Revenue growth = 24.2 percent year-over-year, up from 20.3 percent in a year
The measures that hurt the gauge were:
  • Revenue/Assets = 136 percent, down from 182 percent in a year; the increase in assets was greater than the increase in revenue.

Profitability. This gauge increased from 13 points in September to 14 points now.

The measures that helped the gauge were:
  • ROIC = 54.7 percent (terrific), up from last year's 47.8 percent
  • FCF/Equity = 48.5 percent (!), up from 32 percent in a year
  • Accrual Ratio = +0.1 percent, down from +2.1 percent in a year (good cash flow)
The measures that hurt the gauge were:
The increase in operating expenses was primarily the result of small increases in R&D and SG&A costs as a percentage of Revenue.

Value. Nokia ADR's edged up from $37.93 to $38.39 over the course of the quarter. Since the ADRs began 2007 at $20.32, the increased during the year was a dramatic 88 percent. Despite good operating results, it's not surprising that the Value gauge dropped to zero under these circumstances.

None of our measures could push the gauge into positive territory.
The average P/E for the Communications Equipment industry is currently 22. The average Price/Revenue for the industry is 4.6.

Now at 26 out of 100 possible points, the Overall gauge is weak despite substantial increases in revenue, cash flow, and earnings. This is because the stock has already surged (in part, because of the weakening dollar), costs went up faster than revenues, and the earnings increase was aided by tax changes.

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