Valuation, synergies and capital return attractive; onto CL-Buy
Nokia has underperformed our EU tech coverage by 18% ytd. In our view this reflects an overly bearish outlook for the wireless market, caution on the proposed ALU deal, and fears of large patent delays. By contrast, we see scope for margin improvement given industry consolidation, while Nokia should have a competitive advantage vs. Ericsson given its converged portfolio. Moreover, Nokia’s management has a strong track record in cost control, underpinning our confidence in its synergy target. Finally, we see scope for sizeable capital returns following the deal. In this context, we view the current PF 9x 2018E EPS (6x ex-cash) as attractive; remain Buy, onto CL.
We expect the proposed offer period with Alcatel to open in late 2015 (pending Chinese approval), and close in early 2016, allowing Nokia to bring forward its capital return plan. Moreover, we continue to expect Nokia to reach a 9.7% EBIT margin in Networks in 2015, and see longer-term improvement potential given industry consolidation, more rational pricing, and continued effective cost control. Finally, we expect one of Nokia’s patent arbitrations to be resolved in the coming months (as per company), and continue to see longer-term upside from improved patent monetization.
Our 12-month PT falls to €8.7 from €9.0 (ADR $9.5, from $9.8) based on a core value/sh of €8.4, reflecting a lower patents DCF value (we cut Patents revenues by 5%-10% in 2015-19 given lower handset estimates), but a higher Networks multiple of 8x (from 7x) given our view that industry profitability is improving. Our M&A value/sh of €9.1 is based on a pro-forma SOTP, valuing Nokia/Alcatel Networks at 8x pro-forma 2016E EBITDA (in line with Ericsson’s historical median multiple). Pending regulatory approval in China, we continue to give the M&A scenario a 50% weighting.