Stuff I thought about last week: Nokia’s valuation and the battle for 5G market share
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The global conflict over networking and cellular equipment for 5G, with Huawei at the center, is an increasing problem. Telecom service providers indicate Huawei is a year of more ahead of Nokia and Ericsson, and may need to delay spending and 5G rollouts until the tech is ready. Meanwhile, the UK and others have come out saying they can use Huawei, but then the US responded by saying they’d stop sharing intelligence data with any country that decided to stick with Huawei. And, Trump wants 6G, whatever that is - what a mess! I did a little more analysis on Nokia this past week and fell into some common investor traps I thought might helpful to point out. One of the bits of analysis I did was to look at the present value of future cash flows from royalties Nokia earns from their vital and large intellectual property base. I think the following statement is a common analysis mistake investors make, but it's worth pointing out: it appears that about 50-60% of the EV of NOK is justified based on their smartphone royalty stream which was EUR 800M in in after tax profit in 2018 if you using a typical multiple for that type of recurring cash flow. With 5G, over the next decade it seems plausible that 800M doubles or triples or more as units explode with IoT (this is speculative because the outcome of royalty negotiations are complex and subject to government regulation - so, it’s just one of the possible outcomes). By no means is the rest of company’s networking business free here to investors, but it's earning effectively very low returns with EUR 400M or after tax margins of 2% (I am throwing all the "other" expenses like interest and mark to market of venture investments against the networking business for simplicity - that’s another assumption that is not necessarily accurate or fair, but illustrative). So, to put the question as plainly as possible: how can a company that now appears to find itself in a potential duopoly for all Western markets for all equipment that will run the entire 5G and IoT future be earning 2% net margins? To some degree it rests on the US strong arming of Europe as mentioned above, but even if Huawei maintains some Western market share, the situation should be more positive than 4G was for Nokia and Ericsson.
You should be skeptical of analysis like this because: 1) there is no such thing as “value tech” investing - value tech stocks are dinosaur carcasses waiting to be eaten by disruption; 2) what I am doing here is effectively “sum of the parts” analysis which never works in tech investing, especially in “value tech”; 3) just because something should be a certain way in no way means it will ever be that way, so it’s best to analyze a company as it appears rather than convincing yourself of alternative ways to value it. To refer back to my multiverse decision making exercise, I would be served here to think about in how many future pathways is Nokia likely to be a large participant in telecom infrastructure build out and earn a higher economic return? (Here is another good article on Nokia from EE Times this past week: “Retracing a Bumpy Road to Redemption”)
Nothing in this newsletter should be construed as investment advice. I may own long or short positions in stocks discussed in this newsletter. This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I may change my opinions without updating them in the newsletter. Lastly, often I try to make jokes, and they aren’t very funny - sorry.
I was the portfolio manager of the Janus Henderson Global Technology products (ticker: JAGTX) from May 2011 to November 2018. Prior to that I held various roles as an analyst and portfolio manager at Janus Henderson Investors for most of the period starting as a summer intern in 1998 up until the end of 2018. I graduated from Williams College in 2000 with BAs in Economics and Astrophysics. A complete resume can be found at www.linkedin.com/in/bradsling
Investment framework co-authored with Brinton Johns “Complexity Investing” can be found here: http://www.evolusophy.com/complexityinvesting/
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