Date: 2017-04-13
Positive view on Nokia
• Investors are not yet in love with the beneficiaries of 5G network upgrades.
The concept of 5G is still perceived as an esoteric and far distanced one, and solid technological explanation around 5G is not yet available. However, Huawei, Nokia, Ericsson, Cisco, and NTT Docomo have been working together to promote an upgrade to 5G, and I believe it is fair to assess that the conceptualization is complete. In this segment, the communication between public and private sectors seems smooth too, given the organizations they form and work with.
Among all, most clearly defined character of 5G is the improvements in the network speed. 5G aims to enable instantaneous actions and reactions among different parties and devices, and this is especially important for some functions driverless cars may need, remote surgery, and many more services Internet of Things (IoT) – and IoT is already here in the mass market; I can turn on and off my Xiaomi air purifier remotely - and Smart City aspire to include in their framework.
• Nokia is the purest play on the network infrastructure upgrades in coming decade.
Excluding Huawei, which is too difficult on the execution front, Nokia seems like the best bet within network infra, to me. News flows around Nokia is still misleadingly skewed towards its handsets, which are only remotely related to Nokia, since Nokia acquired Siemens’ shares in Nokia-Siemens Network (NSN) and later bought even Alcatel-Lucent, it should be clear by now that Nokia is very much focused on the network business.
Commercially, nobody is confident enough to claim that it has mastered what it takes to implement 5G in a stable manner. However, Nokia has been pushing for 4.9G and multiple in, multiple out (MIMO), which clearly is a stepping stone for 5G and is much faster than the current network speed. Nokia’s push for the services for the carriers and corporates in the transition period also seems very marketable, going forward.
• Nokia’s management has been executing well with long term view on its businesses.
Nokia’s transformation in my view was a very reasonable choice for the firms’ management to make, as NSN was a growing business with a healthy margin even from the time Nokia and Siemens jointly owned the company. Nokia’s management has been executing deals smoothly and with good degree of discipline and transparency, in my view. At the same time, the management team has shown its willingness to return cash whenever appropriate, and because I view dividends as one of the proof of properly functioning business models, I am more relieved than otherwise.
• Organic demand for data remains strong and it is most likely to grow substantially.
I am of the view that the capacity of hardware and software network infrastructure has been falling behind the quality of contents and mobile devices. For example, based on my personal observations, people end up watching worse quality videos on Youtube mostly due to the connectivity issue, even when the devices are completely capable of playing the best quality (and practically speaking free) contents. Because humans are impatient and are growingly even more so due to the devices and services immediately available thanks to the technological advancement and reduced latency, any reversal in the (long term) latency reduction trend in online connectivity is most likely to incentivize the consumers to be willing to pay much more for a faster network services, making the carriers more cash rich and then the competition among the carriers is likely to make the network infrastructure services providers like Nokia the ultimate winner. Once the users get used to a faster network, there is no going back to a slower one.
Even if data usage on mobile devices peaks out like some argues, there are IoT devices to count on, and the rates charged for the IoT devices are expected to be relatively high especially at the initial stage. On top of that, there are corporate network upgrades to count on, and so on.
• Fiscal stimulus is supportive of Nokia.
In terms of global macro and policy dynamics, I am of the view that network infrastructure companies are at a sweet spot.
Most convincing and realistically well-binding argument I have so far read about sovereign debt issues and fiscal stimulus matters is Richard Koo’s: sovereigns tend to be better off caring more about sustaining the top-line growth (GDP) – or preventing the top-line from falling too much, rather – while seeking to navigate any debt obligation related issues via any feasible and creative measures. I am of the view that the developed countries around the world are most likely to ignore their respective fiscal deficit issues and seek to stimulate their way out. While it is uncertain what the outcome of stimulus will be, I am of the view that the upgrade in network infrastructure will be a key component of the fiscal stimulus. Because it is only natural for the governments to look for the stimulus projects which are: (1) large scale and (2) ideally with positive long term implication on the economy, I do not see why network infrastructure upgrade project will be neglected.
• Nokia can and is most likely to sustain its dividends for the investors.
Even amid its acquisition of Alcatel-Lucent and restructuring process, Nokia has been making it a point to set some cash aside for dividend. The current yield of ~3.x% is attractive, and I see a good chance of long term growth in its dividend payment, mostly due to the favorable market environment in the long run and positioning, which is quite essential. This is probably true, because the current amount for dividend is paid amid: (1) negative expected top-line growth with pretty stable margin, and (2) large scale acquisition and cost cutting.
• I do not expect network infrastructure hardware and software service providers’ functional area to be internalized by the mobile carriers.
Because 5G is a daunting concept to learn, I am still in the process of understanding the technology and the ecosystem. This is not because I lack conviction in this sector; I am in the process of further assessing the risk, investment time frame, and upside. (If I chose to invest only in those sectors that I know fully, I won’t be able to invest anywhere; if anyone claimed that he or she understood a sector fully, I would view it as a sign of hubris rather than their perfect understanding.)
As I continue to expand my knowledge on 5G, one thing I am sure of is that it is an extremely challenging and complex concept to develop and maintain. Both hardware and software capacity is necessary, and the service provider cannot afford to make mistakes in the clients’ network because it will make the public angry. Given the oligopolistic market structure in the network service provider space, quality is likely to be rewarded handsomely, and the margin is likely to be sustainable and is more likely to grow than to shrink.
• There is absolutely no hype around Nokia, for now. But I foresee this changing over time.
I view the gap between the hype around many tech companies and neglected network infrastructure companies as an arbitrage opportunity, as they must eventually go hand in hand. Because network infrastructure sector is very much consolidated around the globe, it is very unlikely that Nokia will be left out of positive developments that will occur in the network infrastructure space. While the concerns over delayed upgrade coming from the major carriers are understandable, I still find Nokia attractive.
Especially given that the valuation of the equity markets is at an elevated level, Nokia’s humble valuation is extremely telling that this still is an excellent contrarian play which eventually will be crowded by investors who later will realize both the growth potential and the stability, accompanied by healthy yield.
It is not easy to estimate the time needed for the upside to play out, but I expect its relatively high yield to be sustainable, and a wise investor should be willing to wait.