Many believe that it is too soon to bet on Nokia’s (NYSE:NOK) turnaround solely based on its smartphone business. Even though the Lumia Windows Phone 8 smartphones are seeing sell-outs at many retailers across Europe and the U.S, there may be supply challenges at the moment and we have no way of knowing how long Nokia will be able to sustain the initial demand considering how well-entrenched iOS and Android have become as mobile ecosystems. However, we believe that Nokia’s increasing initiatives to monetize its patent portfolio and the ongoing turnaround in its telecom equipment joint venture with Siemens, Nokia Siemens Networks, add enough value to the company to support our $4.50 price estimate for the stock.
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As a result of the high R&D spend Nokia incurred over the last decade, the company now has a very strong patent portfolio, comprising close to 16,000 issued patents and 4,500 pending patent applications in the U.S. Outside the U.S., the company has over 20,000 patents (both issued and pending combined) with a majority of them in Europe.  Nokia’s patents stand out even in terms of quality. In a 2011 review of the 3,000+ patents considered essential to the LTE technology that is quickly emerging as the preferred 4G standard, Thomson Reuters and Article-one found that Nokia held close to 19% of the standard essential LTE patents and was the LTE leader by a big margin.  Qualcomm, the dominant mobile chipset manufacturer, trailed Nokia with a share of about 12.5% of the LTE patents deemed essential.
What makes Nokia’s patent strength even more more intimidating is that Nokia and Qualcomm had entered into a 15-year patent licensing agreement in 2008, which basically gave Nokia access to all of Qualcomm’s patents for use in its mobile phones. This essentially translates to an unrivaled access to more than 30% of the essential LTE patents – a position of strength that not only insulates Nokia from litigation in the ongoing patent war but also gives it enough ammunition (with its 19% LTE patent share) to go after rivals and generate cash through licensing deals.
Nokia gave an ample demonstration of the power of its patent portfolio when it sued Apple in 2009 for violating 46 of its patents. The suit was settled two years later in mid-2011, with Apple agreeing to pay an undisclosed one-time sum and recurring royalties. With its smartphone business losing money, Nokia has continued its newfound strategy of using patents to generate cash by suing HTC, RIM and ViewSonic this year.
As a result, the company is now earning a steady royalty income from its patents at a current annual run rate of over $600 million. If we assume this to hold over the average remaining term of its U.S. patents, which is 13.8 years, discounted cash flows (12% discount rate) show that the patents would be worth at least $4 billion in value. This alone would comprise about a third of its current market capitalization – not to mention the company’s substantial cash position, which we estimate constitutes nearly 27% of Nokia’s fair value. With Nokia getting aggressive with patent litigations, revenues from royalties would only increase going forward and add even more value to Nokia’s stock.
LTE transition propping up NSN
At a time when Nokia’s problems in the handset business are hogging most of the attention, the markets seem to be discounting the turnaround taking place at NSN. NSN’s in-house operational issues, together with the aggressive pricing strategies of Asian rivals such as Huawei, had caused NSN’s market share to fall behind Ericsson and Huawei in the wireless infrastructure market over the past year. However, with the ongoing restructuring, the company seems to be regaining focus on its core wireless competence and is also looking to upstage Huawei by the end of 2013.
The restructuring initiative, which was announced in late 2011, will help NSN cut a total of 17,000 jobs and achieve savings of 1 billion Euros by the end of 2013. At the same time, NSN is selling off non-core assets and increasing focus on wireless broadband which has strong long-term growth trends as opposed to the relatively stagnant landline market. As a result of the reshuffle, NSN has done much better this year and even returned to operating profitability last quarter – a big positive sign that the company’s cost-cutting initiatives are taking hold. Underlying operating profitability rose to more than 320 million Euros in Q3 2012 from about 6 million Euros during the same period last year. NSN has now generated cash for the last four quarters and last quarter’s strong 9% operating margins coupled with next quarter’s guidance of 8% shows that the division is doing well and truly turning around.
Last quarter saw NSN post strong market share gains in the mobile broadband market, riding on the back of a good number of 4G LTE contract wins. According to market research firm Dell’Oro, NSN had about 20% share of the wireless infrastructure market in Q3 2012, only 2% behind number 2 player Huawei. While the overall mobile broadband market shrunk (11% y-o-y) due to tepid spending in an uncertain macro-economic environment, NSN was helped by carriers choosing to invest an increasing portion of their CapEx dollars in 4G upgrades. As a result, the 4G LTE radio access network (RAN) market almost tripled in size over the past year, and NSN’s aggressive re-posturing as a mobile broadband specialist helped it gain major ground in this transition period.
With 4G LTE deployments ramping up in many parts of the world, NSN will continue to benefit hugely from the 3G to 4G wireless shift in the coming years. The company has close to 70 LTE contracts globally and is focusing on key regions in North America, Japan and Korea where LTE is being laid out. Of particular interest to NSN in the coming quarters will be TD-LTE, a variant of 4G technology that is being used in many emerging markets such as China and India. NSN is the current TD-LTE market leader with five out of a total of 11 commercially deployed TD-LTE networks using NSN’s gear.  Both China’s and India’s biggest wireless operators, China Mobile and Bharti Airtel, have chosen NSN to deploy their respective LTE networks. With NSN’s future prospects looking brighter than ever before, Nokia will be banking on the division to generate cash and help it tide over the tough Windows Phone transition.Notes:
- Nokia Has a Valuable and Relatively Young US Patent Portfolio, EnvisionIP, July 19th, 2012 [↩]
- LTE Standard Essential Patents Now and in the Future [↩]
- Nokia Siemens Networks sets TD-LTE speed record, goes beyond 4G, NSN Press Release, September 18th, 2012 [↩]