By Ritsuko Ando
HELSINKI (Reuters) - Nokia predicted a more profitable future for its NSN networks equipment business on Tuesday, raising hopes for growth in what will be the Finnish firm's main business after its former flagship phones division is sold to Microsoft for $5.2 billion in the new year.
The third-quarter results also showed growth in Lumia smartphone sales, although analysts said Microsoft will still face a tough time in pushing its way into the competitive consumer devices market with the Nokia deal, which is due to close some time in the first quarter.
Sales of Lumia smartphones rose 19 percent quarter-on-quarter to 8.8 million units, thanks to the launch of more models and what the company said was strong demand particularly for the Lumia 520.
It was still a distant third in the smartphone race, however, since Apple sold over 33.8 iPhones in the same quarter while market leader Samsung Electronics shipped 88.4 million smartphones in the period, according to research firm Strategy Analytics.
"We continue to see competitive challenge at the higher-end of the market, both in terms of pricing and required marketing support," Nokia's finance chief Timo Ihamuotila told investors on a conference call, saying such concerns were what drove it to sell the handset business to Microsoft.
Greger Johansson, analyst at research firm Redeye, said Microsoft will be taking over a business that is still struggling to increase sales volumes and profitability. The phone division's operating margin was a negative 1.6 percent in the last quarter.
"I still think it is not obvious they are going to turn that side around," he said.
Stripping out the business being sold to Microsoft, Nokia said its underlying group operating margin in the third quarter would have been 11.5 percent, 7.7 percentage points higher than the actual underlying margin.
The phone division's operating margin was running at a loss of 1.6 percent.
Shares in Nokia rose over 7 percent to mark the year's high of 5.42 euros, a rise of 85 percent so far this year.
Inge Heydorn, fund manager at Sentat Asset Management, said investors were impressed by Nokia's forecast for NSN's profit margin to improve in the fourth quarter to around 12 percent, plus or minus 4 percentage points, from 8.4 percent in the third quarter.
"The share reaction is justified with the superb margin forecast," he said.
The unit's core operating profit fell 33 percent in the third quarter from a year ago to 218 million euros ($301 million), on sales down 24 percent at 5.2 billion euros. This was below the average profit forecast of 228 million given in a Reuters poll, as the impact of earlier cost cuts waned and major contracts were completed.
But Nokia said it expects NSN's sales to show "solid" growth in the final three months of the year, helped by stronger spending by European telecoms carriers on high-speed LTE wireless broadband networks.
"We think LTE will accelerate in Europe starting from Q4 this year," Rajeev Suri, the head of NSN, told investors on a conference call.
Investors said the outlook vindicated Nokia for its decision in early September to sell the handsets business.
"They are beginning to have a direction, and the Microsoft deal looks like a smart move from a shareholder's point of view," said Mika Heikkila, fund manager at asset management company Taaleritehdas.
He also said the outlook soothed fears of an industry-wide slowdown. Swedish network equipment rival Ericsson reported weaker than expected results last week.
"I think this report will calm things down. It gives more information on how they will be going forward, it shows Nokia is coming back," he said.
NSN, which will account for around 90 percent of the group's sales after Microsoft completes its acquisition of the handset business, sells a range of mobile broadband equipment to network operators and has transformed itself over the past year from an unprofitable venture into a source of cash.
It has been cutting costs and turning down low-margin contracts to focus instead on more profitable deals to help build high-speed wireless broadband networks.
Had the Microsoft deal already been completed Nokia said it would have ended the third quarter with net cash of 7.5 billion euros, instead of an actual 2.4 billion euros, with NSN contributing 1.5 billion.
Nokia said it was still considering how to use the cash it will receive from Microsoft. Billionaire investor Daniel Loeb recently took a position in Nokia, saying he expected a "meaningful portion of the excess" be returned to shareholders.
Sources familiar with the matter have said Nokia's board is also considering a possible acquisition of ailing rival Alcatel-Lucent's wireless business. Nokia declined to comment on a possible deal.
While analysts said the latest results showed Nokia might be capable of a deal at least some investors remain wary.
"I'm always scared if somebody goes to buy a French company," said Heikkila. "They still have protectionism, and companies are not allowed to dismantle structures the way they should be."
(Additional reporting by Jussi Rosendahl, Simon Johnson and Olof Swahnberg; Editing by Greg Mahlich)