Nokia’s (NYSE:NOK) deal with Microsoft (NASDAQ:MSFT) may leave it without its iconic mobile device division, but the move unlocks a lot of value for the shareholders. In return for $5 billion, Nokia will be able to wash its hands off a handset business that was proving hard to turn around in the face of rising competition from Android in the emerging markets. For another $2.2 billion, Nokia will grant Microsoft access to its lucrative patent portfolio for the next 10 years. What sweetens the transaction further is that Nokia gets to keep its patents and add other licensees as part of the deal. It is likely that some shareholders might still prefer Nokia to continue on its turnaround quest which could arguably unlock a lot more value. But considering what the market was valuing Nokia’s stock at just a few weeks ago, they are likely to not be too many.
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 being valued negatively. The deal with Microsoft should therefore be hugely value-accretive to Nokia’s shareholders.
In line with this expectation, Nokia’s shares have risen almost 60% since the deal was announced late last month. However, we see a lot more value in Nokia primarily due to its robust patent portfolio and the ongoing turnaround in its networks business of which it has now assumed 100% control. By our estimates, the post-deal Nokia should be worth about $7.75 per share, an upside of about 20% over the current market price.
Nokia Services & Networks
The new Nokia will have NSN (networks business), IP licensing and Here Maps as the three business heads after the handset division is sold. Most of Nokia’s business value will come from its NSN division, in which it recently bought out Siemens’ 50% stake for a measly 1.7 billion Euros. The transaction reduces Nokia’s net cash by about $0.60 per share.
Most of this is however offset by Nokia’s higher ownership stake in NSN, which is now double the earlier 50%. We estimate that this increases the near-term cash flow attributable to Nokia’s shareholders by about Euro 600-700 million and that towards the end of our forecast period (2020) by about Euro 500 million, adding about $1.70 per share or about $6 billion worth of value to the stock. For reference, NSN generated about Euro 1.4 billion in free cash flow last year, benefiting from the worldwide LTE transition as well as the ongoing restructuring of operations. The long-term decline in cash generation is mostly driven by lowering NSN’s ability to manage its working capital for cash going forward as the restructuring comes to an end, offset to an extent by margins stabilizing towards the high-end.
With these estimates, the NSN transaction adds about $1.10 per share ($1.70-$0.60) to our current price estimate for Nokia. Considering that NSN’s restructuring has gone so well that it now plans to realize an additional 500 million Euros in cash savings by the end of 2013, these estimates are actually a bit on the conservative side. (see Nokia’s Acquisition Of NSN At A Throwaway Price Steadies The Ship)
At the current run rate, Nokia’s IP licensing arm generates about 500 million Euros in steady royalty income every year. If we assume this to hold over the average remaining term of its U.S. patents, which is about 13 years, discounted cash flows (12% discount rate) show that the patents would be worth about $4 billion in value, or $1 per share. Since Microsoft’s addition as a patent licensee is an upfront cash deal and will not generate additional revenues, Nokia’s licensing division will not accrue additional value but net cash should jump by $2.2 billion, or about $0.60 per share.
Nokia has a very strong patent portfolio comprised of close to 16,000 issued patents and 4,500 pending patent applications in the U.S. with a dominant position in the arena of standard-essential LTE patents. Considering that Nokia will now have no phones to sell and therefore faces less danger of being countersued, it will have greater bargaining power in setting patent licensing terms going forward. This could actually bring further upside to our IP valuation.
The sale of the hardware division will however cut our estimates for Nokia’s value by a quarter, or a little over $1.10 per share. However, the cash Nokia gets for the hardware business will boost net cash by $5 billion, or about $1.33 per share. The net positive impact on Nokia’s valuation is therefore about $6.7 billion, or $1.80 per share from the Microsoft deal alone ($1+$0.60-$1.10+$1.33). (see Nokia Unlocks Value And New Growth Potential With Microsoft Deals)
Our fair value for Nokia increases by a sum total of $2.90 per share ($1.80+$1.10) as a result of the two deals (Microsoft and NSN) bringing the new Nokia’s price estimate to $7.75 per share. We will update our estimates and model on our site once the deal closes.