Why I'd Never Pay More Than Book Value for Nokia (NOK)

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Apr 12, 2012
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Someone who reads my articles sent me this question:

Hi Geoff,

This isn't your kind of company, but what are your thoughts on Nokia (NOK, Financial)? I have been tracking it for a while and wonder if you had ever thought about it?



Sivaram is a contrarian investor. He writes a great blog called Can Turtles Fly?

He’s also right about Nokia not being my kind of company. It’s not a stock I’d consider.

I have thought about Nokia. But not for long. I think about anything that drops a lot. I think about Bank of America (BAC, Financial), and AIG (AIG, Financial), and Hewlett-Packard (HPQ, Financial) – and honestly I’d probably pick any of those over Nokia. Because there are a couple questions I ask myself before really digging into a stock. The first three are closely related – some might say essentially identical:

1. What’s my risk of catastrophic loss?

2. What’s the chance this company doesn’t exist in 10 years?

3. What’s the chance I’ll misunderstand this business?

If the answers are: high, high, high – I’m out.

My answers for Nokia to those three questions are: high, high, high.

So I’m out. Now, I’m not saying there’s a better than 50/50 chance Nokia doesn’t exist in ten years. I don’t know that. When I say the risk of catastrophic loss is high, the chance the company won’t exist in ten years is high, and the chance I misunderstand the business is high – I simply mean each of these risks are too high for an investment.

A 25% risk of losing everything in a stock is low in the sense that the event is unlikely to happen. But it’s very high in the sense that you would need a super bargain price to compensate you for a one-in-four chance of losing every dime you put into a stock.

Honestly, I don’t even do a risk/return calculation like that. If the risk of total loss is too high I end the analysis there – before my research even begins.

So why is the risk of loss in Nokia too high for me?

It’s in the cell phone business. And I have no interest in owning a cell phone manufacturer. It’s not a good business to be in. Sure. It looks like a good business for the leader. Until 2009, Nokia usually had returns on investment of 20% to 25% a year.

But, remember, Nokia is the global market-share leader in mobile phones:

Market Share
Nokia 24%
Samsung 18%
LG 5%
Apple 4%
ZTE 3%
RIM 3%
HTC 3%
Motorola 3%
Huawei 2%
Sony Ericsson 2%
Also Rans33%

There are some serious problems with that market share picture. First of all, one-third (33%) of all mobile phones are made by someone other than Nokia, Samsung, LG, Apple, ZTE, RIM, HTC, Motorola, Huawei and Sony Ericsson.

How many other cell phone manufacturers can you even name besides those ten? And – be honest – didn’t you forget one or two of those top-ten companies still even made cell phones?

Second, companies other than the top two manufacturers – Nokia and Samsung – account for 58% of the mobile phones sold in the world. Now, controlling 42% of the world’s market share for a product between two companies doesn’t sound too bad.

But let’s think about this. Are Nokia and Samsung strongly differentiated from the other companies on that list?

Or are they just lucky? Are they just flavors of the decade?

I vote for flavor of the decade. I’m not sure what makes Nokia or Samsung different from RCA or Zenith. And if you check a list of today’s biggest TV manufacturers you’ll notice Zenith and RCA aren’t on the list. In 20 years, will Nokia and Samsung make a list of the world’s biggest mobile phone makers?

It’s a little disconcerting to see 42% of an industry in the hands of two companies that don’t strike me as very different from the other names on that list. That’s really troubling. The fact, that they are headquartered in two completely different parts of the world is also troubling.

Having world leaders located in different places is normally fine. If there’s a reason. But it’s important that there be legitimate geographical reasons why you should have a market leader in Finland and a market leader in Korea.

In general, you don’t want to see market leaders founded in totally disparate times and places. The best industries usually involve several leaders who were founded under similar circumstances. For example, Company A can trace its origins to Company B. You want them to be founded in the same town, region, country, by the same person, etc.

Obviously, having market leaders who entered the business around the same time is a very good sign. It’s one of the best signs of a self-sealing market-entry industry. An industry where the door shuts behind you.

You hate to see a group of the top five companies in your industry where No. 1 entered the business in 1920, No. 2 entered the business in 1990, No. 3 entered the business in 1970, etc. That’s a terrible sign. It means companies are coming and going as they please.

I like an industry with a common origin. I’ve talked about DreamWorks (DWA) in the past. Think about the three brands in the animation you know best – Pixar, DreamWorks and Disney (DIS) – they can all trace their roots to a single company and a single relationship. Pixar and DreamWorks were both founded by ex-Disney people.

We want to see something like the cruise business. Whatever the problems with profitability in that industry – returns on investment are not impressive – we know companies will definitely not be coming and going as they please:

Market Share

Carnival (CCL): 52%

Royal Caribbean (RCL): 26%

Norwegian: 8%

MSC: 5%

Disney: 2%

Also Rans: 8%

Let’s look at the top three cruise companies:

· Carnival (founded 1972 by Ted Arison)

· Royal Caribbean (founded 1968 by several companies)

· Norwegian (founded 1966 by Knut Kloster and Ted Arison)

None of those companies was founded more recently than 40 years ago. They were all founded within about half a decade of each other. Two of them share a founder (Arison). Together, these three companies control over 85% of the global cruise business. The largest (Carnival) has about half the market to itself. And the two largest (Carnival and Royal Caribbean) together have three-quarters of the market.

That’s what I like to see.

So what do I look for when I see market share statistics for an industry?

First, you’d like the company you are looking at to have a high relative market share. So, the company’s market share – if it is the leader in its industry – divided by the next closest competitor is high. Often, 1.5 is considered high. But a relative market share of 2 or more is always nice to see.

A company like McCormick (MKC) has a high relative market share in addition to a high absolute market share. They have anywhere from 40% to 60% of the consumer spice business in the U.S. This is more than double the market share of their nearest competitor.

You want to look at this from a customer perspective – not a corporate perspective. We want to compare actual alternatives. Although different spices are used for different things – and some are sold in grinders and some in pouches and some in flip tops, etc. – they are all just alternatives for the same thing. They are things you buy in a grocery store and add to a dish. Group them together. Likewise, every cruise is an alternative to cruising with another company. They are actual alternatives as well.

For some products, the market we are measuring their share of is very, very small. It’s very specific. Go to a drugstore. Look for wart remover. It’s not a big industry. But the only products that are alternatives to each other are the ones that actually remove warts.

Competitively, it’s more important to know a company owns the No. 1 wart remover in America than that it has 7% of all drug store aisle sales spread across a lot of different products. You can have less than 1% and have a good business if that 1% is being the leader in wart remover, ear wax softener, etc. There’s actually a company like this. It’s called Prestige Brands (PBH, Financial). And, yes, it reports market share for all its major brands – even though these are products like Compound W and Murine.

There are advantages to huge scale. Of course, most of these advantages disappear if your competitors also have huge scale. And there are some very frightening competitive tendencies that appear in industries with a lot of scale and very little differentiation.

In businesses like the one Nokia is in – you don’t control your own destiny. In the long-run you are at the mercy of your competition. Not just one competitor. But the collective stupidity of the group. That’s what determines your long-term returns on investment.

The first line of defense in any industry is not selling the most products to customers. The first line of defense is having the most customers relative to alternatives. It’s being the preferred product.

Nokia has market share. But it’s not a big market share in absolute terms. And it’s definitely not a stable market share. What’s worse is that a couple rungs down from Nokia we see companies with laughably small market share. The cell phone industry has a lot of scale and very little preference.

Complete dominance by a single company is fine. This would mean the company is either a Hidden Champion serving a tiny niche or a multinational monopoly like Microsoft (MSFT, Financial).

But an oligopoly-type business is also fine. Look at the four leading advertising companies:

· Omnicom (OMC, Financial)

· Interpublic (IPG, Financial)

· Publicis


And now look at the four leading mobile phone companies:

· Nokia

· Samsung

· LG

· Apple (AAPL, Financial)

Which group has the more stable position? Which group is more likely to earn consistent profits – as a group? And which list of names is less likely to change in the next ten years?

Likewise, let’s look at the flavors and fragrances industry:

· International Flavors and Fragrances (IFF)

· Firmenrich

· Givaudan

· Symrise

· Takasago

Like the advertising business these world leaders are spread around a bit – one is in the U.S., one is in Japan, one is in Germany and two are in Switzerland.

Again, we have a lack of change in this business like we do in the advertising business. IFF was created out of a merger in the 1950s. It has been public for almost 50 years.

Even in industries where competition is hard to measure, I like to see a company with a strong position that isn’t new. I like to see a lack of change.

I’ve talked about FICO (FICO) before. The company was founded in 1956.

I’ve talked about Dun & Bradstreet (DNB, Financial) too. Their history goes back to the 1800s. They were formed through a merger in the 1930s. And their key product – DUNS – was created almost 50 years ago.

Obviously, there is nothing wrong with a new world leader in some business. Facebook may turn out to be a splendid investment. If you understand their moat and you are absolutely sure it’s durable – you have my blessing to buy that company’s shares when you can. The same is true of Google (GOOG, Financial).

As long as you believe their competitive positions are lasting, you can buy those stocks on a P/E ratio basis.

That’s not true of a company like Nokia. I wouldn’t buy a cell phone company because it had a low P/E.

To me, the cell phone business looks exactly like the TV business. And I expect it will end just as badly for the companies involved.

There have been something like 220 U.S. TV manufacturers over the years. Ninety percent of them have either abandoned the business or gone belly up themselves.

Some of the old American TV brands have been preserved or dug up from the dead and are now used by foreign companies.

The world leaders in the TV business have not been constant. They’ve changed a lot over time. And they have changed a lot in geography. Countries that had a lot of leading TV companies in the early years now have almost none.

Is this just a manufacturing issue? When television was first successfully commercialized (we’ll call that 1948 when the percentage of Americans with TVs was around 1%) the U.S. did a lot more manufacturing than it does today.

Of course, that’s no excuse for why U.S. companies don’t still produce a lot of TVs. Obviously, they could make the sets in other countries if they wanted to. There have to be other reasons why U.S. TV manufacturers aren’t still among the world leaders.

Why are so many foreign companies now selling TVs in the U.S. while foreign companies are not selling a lot of underwear, soda, spices, etc. in this country?

The TV business is not a business you stay in. It’s a business you enter and exit and hope to make some profits by riding a societal wave for a while and getting out before your margins hit zero.

I don’t see any reason why the cell phone business will be different.

They seem remarkably similar to me.

In both cases, the technology was developed long before it became an important feature of our day-to-day lives. The TV was invented sometime in the 1928 to 1934 time period – depending on what exactly you call a TV. It couldn’t really be commercialized until 1938. And it wasn’t really successfully commercialized until almost 1948. The cell phone was invented in – let’s call it – 1978.

So, we’re about as far into the cell phone era – 44 years – as we were into the TV era back in 1972.

In the U.S., it took about 34 years (if we say the TV was invented in 1928) for the TV to reach what we’ll call virtually complete penetration (90% of all American households). That happened in 1962. Depending on which sources you look at, we are either at that level now or a little bit lower than that level with cell phones. And we are also exactly 34 years from the product’s launch. Cell phones aren’t directly comparable to TVs because the percentage of American adults with cell phones will probably never reach 90% - it’s maybe 80% right now. But the number of households with cell phones is higher than 80%. It’s probably about 90%. And, like TVs, the number of devices divided by the number of households in the U.S. is actually greater than 100% because households average more than one device.

The key point here is scale. And that’s the problem. These are widespread devices used as part of our daily lives. But they are the hardware part.

The TV broadcasting business was a very good business for a very long time. The TV set manufacturing business was not.

There may very well be carriers who make a lot of money on cell phones for a very long time. But I doubt cell phone manufacturers will consistently earn economic profits making cell phones.

We are talking about a global business of enormous scale. Yes, when something like smart phones come around – everyone gets excited, and some folks (like Apple) even make some great returns on capital – for a while..

But how is this different from high definition TVs? Companies wanted to leave the TV manufacturing business in the 1970s – companies like Zenith branched out into any related products (like cable) to try to stay on the edge of a societal wave.

But the TV business was bad in the 1970s and 1980s. That’s why companies abandoned the industry.

The TV industry changed again. It’ll always change. They’ll be glimmers of hope.

Flat panels were a lot more exciting. But it’s not like anyone is going to make lasting money in flat panels. It’s a terrible business.

Ultimately, a cell phone is nothing that a TV or a toaster isn’t. And the history of the industry is going to play out like TVs and toasters. This isn’t a business companies stay in. And if they do stay in the business, investors should get out.

There are going to be bursts of innovation and change in the business. And someone like Apple will capitalize on that for a few years. And then everyone will make a phone just like that. And no one will make any money.

In his book, “Security Analysis”, Ben Graham opened with a quote from the Roman poet Horace:

“Many shall be restored that are now fallen and many shall fall that are now in honor.”

That’s the cell phone business. That’s the TV business.

I would never buy a cell phone stock for its earning power. I would never buy a cell phone stock for its market share.

Why would I think that what a company earned last year in an industry like this has anything to do with what it will earn over the next decade or two?

Would I buy a cell phone company on a Ben Graham basis?

As a net-net?


But last I checked, Nokia had tangible shareholder’s equity of 7.67 billion euros. The company’s market cap is 11.37 billion euros. So we aren’t even talking about a company that’s trading below tangible book value.

If Nokia falls another 35% from here – without losing any money in the meantime – I’d take a look at the stock. I could make a case for investing in a cell phone company when it trades below tangible book, as a net-net, etc.

But, no, I would never consider buying a cell phone stock above tangible book value.

I just won’t even look at a company in this industry unless it trades below tangible book.

I have no way of valuing a cell phone stock on its earning power. So, I really don’t care what it once earned.

That sounds harsh. But it only sounds harsh because some people believe the cell phone is a tech business. And tech is sometimes worth a lot more than book.

Yes, the right kind of tech stock is worth many, many times its book value.

But, honestly, there’s no reason a cell phone company should sell for a higher ratio to its tangible book value than a company that slaughters pigs – like Smithfield Foods (SFD) or Seaboard (SEB) – or a company that produces eggs – like Cal-Maine (CALM) – or a company that grows fruit – like Chiquita (CQB), Dole (DOLE), and Fresh Del Monte (FDP).

At a deep enough discount to book value I’d consider any of those companies. And I’d consider Nokia. But – as an investor – Nokia really does look a lot like those companies to me. Cell phones may be more exciting than pigs and pineapples. But I don’t see why the economics are different.

Nokia had its moment in the sun. It was in honor. It fell. And now it’s a global commodity company in an industry with ungodly scale and lots of hungry, desperate competitors.

It doesn’t really matter to me that they’re selling phones instead of pork or bananas. I think the long-term realities of the industry are the same.

Now, you can do things in the cell phone business that maybe would get me interested in your competitive position. But you can do that in pork and fruit too. It’s very tough. But with the right management team and the right decisions in terms of how to control the product and get the very best price for it – gain some degree of pricing power – I could be interested in any of these companies.

But not above tangible book value. I would never pay more than tangible book value for Nokia or any other cell phone company.

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