The past week was a very exciting one for the mobile phone sector. Nokia (NYSE:NOK) agreed to sell its handset business to Microsoft (NASDAQ:MSFT) for $5 billion and license its patents for a 10-year period for another $2.2 billion in cash. Apple (NASDAQ:AAPL) sent out media invites to an event scheduled for September 10th, where it is likely to unveil a cheaper iPhone and a potential smartwatch in addition to the regular next-generation iPhone. Samsung Electronics (PINK:SSNLF) introduced its Galaxy Gear smartwatch this week, but limited compatibility with smartphones and a high starting price of $299 means that the demand is likely to be muted initially.
In an agreement announced Monday, Nokia agreed to sell its handset business to Microsoft for a total of $5 billion in cash. What sweetens the deal for Nokia’s shareholders is that fact that the company’s lucrative patent portfolio isn’t part of this transaction. Instead, Nokia will grant Microsoft access to its patents for 10 years for another $2.2 billion in cash. Moreover, since the patent arrangement is non-exclusive, Nokia is free to add other patent licensees in this period as well. While the deal has yet to receive shareholders’ approval, it is hard to imagine an adverse scenario considering the amount of value this unlocks for Nokia’s shareholders.
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Before the deal was announced, Nokia was trading at a market capitalization of about $14.7 billion. By our estimates, Nokia’s non-handset divisions, including cash, accounted for about 75% of its $18 billion fair value before the deal. With the handset division under-achieving in the face of some tough competition from Android and a slow and painful transition to Windows Phone, the markets were valuing the business at only a little over $1 billion. Considering that the patent business, which is part of the company’s handset division, is healthy and has been consistently generating cash flows of around Euro 500 million annually, the handset business (excluding licensing revenues) was basically being valued negatively. Both the sale of the handset business and the patent licensing deal together with the recent acquisition of Siemens’ stake in NSN should therefore be hugely value-accretive to Nokia’s shareholders.
Apple this week sent out invites to a media event scheduled for September 10, where the company is widely expected to launch its next-generation iPhone. What is likely to set apart this year’s event form the previous ones is that Apple faces immense pressure from investors to launch a cheaper iPhone model for the emerging markets. The largest technology company in the world has seen its shares decline by over a quarter in the past year as its smartphone market share declined and profits plateaued amid increasing competition from rivals such as Samsung. Growth in the high-end smartphone market, which Apple has been primarily targeting, is slowing down while the low-end market is burgeoning with a solid rise in demand from emerging markets such as China and India. Penetrating these low-end markets is likely going to be Apple’s strategy going forward, but the interesting question in front of investors will be the margin hit it might have to take in order to do so.
Considering Apple’s brand and high-end forte, we believe that Apple will target the mid-end market first with its first cheaper iPhone release this year. Such a strategy will help Apple minimize its brand dilution while opening up the low-end markets for entry in the coming years as it discounts the older models with each subsequent release. Launching a cheaper iPhone could also help Apple sign on China Mobile as a carrier partner, which could be hugely value-accretive to shareholders.
After dominating the mobile market with smartphones and tablets, Samsung is looking to lead the mobile foray into wearable devices with its smartwatch launch on Wednesday. Christened Galaxy Gear, Samsung’s latest mobile addition is designed to work as a smart companion to its market-leading Galaxy smartphones, allowing users to perform many of the basic functions such as sending messages, receiving calls or clicking photos from their wrist without having to access their smartphones. While there are many smartwatches such as the Pebble currently available in the market, Samsung’s entry could popularize this segment a lot more and open up new opportunities to boost growth.
However, priced at an expensive $299, the Galaxy Gear is not built for the mass-market and seems to be just an experiment by Samsung to see if it can increase the appeal of its Galaxy brand in a high-end market that is nearing saturation. For starters, the Gear will be launched with limited compatibility, working only with the Galaxy Note 3 phablet that was launched alongside the smartwatch the same day. Older smartphones such as the Galaxy S4 which do not support Android 4.3 currently, will be able to synch with the Gear only after they receive the 4.3 update. It is also not clear if Samsung will make the Gear compatible with rival Android smartphones or just look to build its own hardware ecosystem around the wildly popular Galaxy smartphones. The strategy will likely depend on the kind of initial response the smartwatch gets from buyers in the coming months. (see Limited Upside To Samsung From The Smartwatch Experiment)