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By Laura Lallos| 5-1-2012 9:00 AM

Dodge & Cox Makes the Case for Nokia

Nokia's valuation today reflects extreme skepticism that the company will successfully transition to a new operating system using the Windows platform, says Dodge & Cox manager Diana Strandberg.

Laura Lallos: Another company that is under a cloud of uncertainty right now would be Nokia, and I think if there's one thing that might distinguish Dodge & Cox from a number of large-cap funds out there, it's that you own Nokia, not something like Apple, for example. Can you talk about the opportunities there?

Diana Strandberg: Well, what we think about when we look at any investment, Nokia would be no exception, is we want to compare valuation and we want to look at that in the context of fundamentals. And when we think about fundamentals, meaning how the business is operating, the management, the competitive dynamics, the financial situation at the company, we want to think about an array of possible outcomes looking out three to five years, from what can go wrong to what can go right, and then relating that to what are we paying today.

So, when we look at a company like Nokia, we think about ... it's a wide range of outcomes, to be fair. We think about a very low valuation, and we look at a variety of metrics: How much are we paying for their R&D effort? How much are we paying in relation to the cash flow they are generating? Future earnings potential, or lack of, depending on your point of view about the company? And we think about the various parts of the company, the value of the patent portfolio and other assets that the company owns. So, a very low valuation today, reflecting extreme skepticism that the company will successfully transition to a new operating system using the Windows platform, the Microsoft Windows platform.

Some of the things that we look at on the fundamental side are, we ask ourselves, and this is not always the obvious answer when you look at these situations, does management have a sense of urgency? Do they understand the magnitude of the problem and the speed with which they need to fix it? And Nokia management does. Hence the burning platform memo last year, and they are working very, very rapidly to address the issues at the company.

Can the company fix it? Do they have the financial flexibility and ability to change? And Nokia has a strong balance sheet, and can afford to restructure the company.

Do they have other resources that they can draw upon? And we would point to their partnership right now with Microsoft, where they have a deep-pocketed partner that really wants mobile to succeed, and by extension, Nokia to succeed, and they are actually contributing financial resources to the joint venture, to that regard.

Charles Pohl: You also have the operators who have expressed real interest in making a success of the Windows phone product--Verizon and AT&T, I think, both of whom would like to see a third strong competitor in the marketplace for their own reasons. So, they have a real interest in the success of the Microsoft-Nokia venture.

Another thing, I think, that shouldn't be missed is that Nokia, in addition to having very strong technology in the phones, and then this partnership with Microsoft, which brings Microsoft's expertise in software to the table, has tremendous distribution in the emerging markets. So, you've got that as well going for you.

Most key of all is that you pay very, very little. The market cap of Nokia, which ships more phones than Apple does, is a tiny fraction of the size of Apple's market cap. So, it's a very attractive valuation as well.

Strandberg: We would observe in the market today, we certainly saw this in 2011, we saw it again in April so far, is that uncertainty is something that investors are avoiding, to the extent that things that have certainty, in our opinion, are priced quite dearly.

So, in 2011, we saw long-term Treasuries among the best-performing assets on the planet, up over 30%, for example, for the year. So, when we get into these situations where there is a lot of uncertainty, today we're getting a very big valuation opportunity.

What we think we bring to the table is a research team that has tremendous expertise, not only in specific industries, but by working all together in San Francisco and over long periods of time, a collaborative opportunity, where our telecom-services analyst, for example, is working with our telecom equipment analyst, our semiconductor analyst; [they] are working together to really assess what does the ecosystem look like? What do the customers say? What do the suppliers say? Just as one example of the ways in which we would collaborate.

Then the team decision-making, we like to think, brings a lot of experience and perspective to the table, so that we can really debate and have a full view of what can go wrong, and what does that mean to the portfolio? But importantly, what's the opportunity and how big is it in relation to taking on the uncertainty and the amount of effort that we need to put in to keep the position.

What we observe over very long periods of time is that persistence is rewarding, not in every instance, but in general.

Lallos: Terrific. Thank you very much for joining us today. We appreciate it.

Pohl: Thanks for having us.

Strandberg: Thank you.

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