Over the course of 2011, investors steadily unloaded their holdings in Research in Motion (Nasdaq: RIMM) as it became apparent that the maker of Blackberry phones couldn’t keep up with the tag-team onslaught of Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG), which now collectively control more than 75% of the global smartphone market.

Perhaps an even greater victim of the Apple/Google juggernaut has been Nokia (NYSE: NOK), which should have been an important player in the smartphone market.

About two months ago, I suggested that the Finland-based company was headed for trouble.
 
Shares of Nokia remain stuck below $6 and a very high short-selling interest implies more trouble ahead. The recent short position stood at 148 million shares, equating to six days’ worth of trading volume and the second-largest short position on the New York Stock Exchange (after Bank of America (NYSE: BAC)).

But I’m now seeing this stock in a different light. Though it’s a bit too soon for Nokia to declare victory, the last few months have altered the investment thesis. Shares are likely to hold their own in 2012 — or stage a powerful rebound.

Here’s why…

A desperate gambit pays off
Like Research in Motion and Hewlett-Packard (NYSE: HPQ), Nokia found that its operating system (known as Symbian) simply couldn’t keep up with the outstanding software and marketing muscle that Apple and Google developed. Management realized it was too late in the game to truly resuscitate Symbian, so it decided to cast its lot with Microsoft (Nasdaq: MSFT), which was readying a new mobile software platform, known as Windows 7.

A few months ago, I suggested that Microsoft’s efforts to crack the mobile software market had repeatedly failed, and this time would be no different. Since then, technology reviewers continue to laud Microsoft, predicting that the current Windows 7 efforts were yielding a much more competitive offering. Equally important, Nokia’s hardware strategy is beginning to look like a winner, and the combined efforts of these two firms should attract considerably more buzz in coming quarters.

Nokia has begun to release a range of new smartphones called Lumia, which target the low-, middle- and high-end of the market. That’s a wise move for a company with a longstanding presence in price-sensitive emerging markets and a still-considerable presence in more advanced markets in Europe. (The Wall Street Journal’s Walt Mossberg had generally kind things to say about a new low-end offering.)

This should help retain or build market share in emerging markets and at the low-end of the U.S. and European markets, but profit margins are likely to be thin for such a low-cost device.

Yet it’s the upcoming launch of pricier Lumia phones that may really captivate investor interest. There are several reasons to think Nokia may have a winner on its hands, including:

•    Microsoft is expected to spend millions of dollars in a number of countries to tout the new hardware/software combination, creating a high degree of visibility for consumers. Microsoft’s dominant share of server and business software has created anti-trust headaches, though the company has no such concern in the mobile software market and is expected to tackle that market opportunity in a way we haven’t seen the software giant move recently.

•    Wireless service providers are likely to aggressively support Lumia, as they are increasingly wary of the control that Apple and Google have over them.

•    Nokia’s expertise at low-cost manufacturing should enable the company to slightly undercut Android and Apple-based phones while retaining decent profit margins.

You can see the Lumia roadmap start to unfold in coming weeks and months. Later this quarter, major European wireless carriers such as Orange, Vodafone (Nasdaq: VOD), T-Mobile, Telecom Italia (NYSE: TI) and 02 are all expected to roll out Lumia phones. It is also notable that these carriers also have a significant presence in the Caribbean, Latin America, Africa and Asia. T-Mobile and AT&T (NYSE: T) will be pushing Lumia in the United States, (and Sprint (NYSE: S) and Verizon (NYSE: VZ) will presumably follow suit, though I can’t confirm this).

This isn’t to suggest that Lumia will be a home run and Nokia will steal major market share from Google and Apple. Instead, the odds that Nokia will keep losing market share have changed. It’s best to assume that Lumia gains decent, but not major, traction in the marketplace.

Yet even with such modest assumptions, this stock would still find new appeal. Shares of Nokia appear fairly valued at around 15-20 times projected 2012 profits. Yet with decent traction, Nokia’s profits could spike much higher in 2013. Investment firm FBR sees Nokia’s earnings per share rising from around $0.40 in 2012 to $0.85 in 2013. If their forecast is correct, then shares look quite cheap at just six times forward profits.

Risks to Consider: Nokia’s telecom infrastructure business, which is run in a joint venture with Siemens (NYSE: SI), faces myriad competitive pressures and could create a drag on profits if that unit loses market share. Stay tuned to chatter about this part of the business if you consider buying shares.

Action to Take –> It’s a bit early to declare Nokia’s new strategy a success. But it’s also increasingly clear that this company isn’t headed for failure as I and others concluded last year. At current prices, the risk appears greatly diminished while the upside case is starting to take shape. This means short-sellers are unlikely to profit (perhaps creating a major short squeeze).

For investors looking at Nokia for upside, this is a great time to do your homework. If the Lumia phones continue to receive solid praise and wireless carriers start to speak of solid initial demand later this quarter, then the Wall Street herd is likely to pivot back into bullishness. If this happens, then shares could work their way toward the $10 mark, implying more than 60% upside.

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