Nokia’s (NYSE:NOK) is set to announce its Q3 results on October 29th. The company recently entered into an agreement to sell its handset business for $5 billion to Microsoft (NASDAQ:MSFT) and license all its patents to Microsoft for ten years for another $2.2 billion in cash. While Microsoft’s investors will be interested in knowing how Lumia sales held up in the face of increasing competition from Samsung (PINK:SSNLF) and Apple (NASDAQ:AAPL), Nokia can rest assured knowing that a significant risk associated with this business will very likely be soon offloaded from its books. Instead, Nokia’s network business will take center stage in the new company, especially after management’s decision to buy out Siemens’ stake in the erstwhile Nokia Siemens Networks (NSN) joint venture. We will be looking for management insights into how the company plans to deploy the extra cash to increase NSN’s value as well as better monetize its huge patent portfolio going forward.
The Finnish company has seen its stock shoot up by almost 80% since the Microsoft deal was announced last month. The sharp increase shows how much of an overhang the risky handset business had on the rest of the company’s businesses. 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 a bulk of the value in the devices business driven by steady cash flows generated by its IP licenses, the market seemed to have been assigning a negative value to the handset-only business. If shareholders approve the Microsoft deal, we expect the post-deal Nokia to be worth about $7.75 per share, an upside of about 8% over the current market price.
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NSN ‘s LTE Focus
The new Nokia will have NSN (Nokia Solutions and Networks), 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 1.7 billion Euros. The transaction reduces Nokia’s net cash by about $0.60 per share.
Most of the cash outflow is offset, however, by Nokia’s higher ownership stake in NSN, which is now double the earlier 50%. We estimate that this will increase 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. We will be keeping a close watch on the division’s cash flows and the additional cost savings that it is generating from the ongoing restructuring plan.
NSN’s LTE focus could help it win contracts in hitherto under-penetrated countries such as the U.S., where Chinese manufacturers such as Huawei and ZTE have been blacklisted amid security concerns. Nokia has done well to secure recent LTE wins at T-Mobile and US Cellular, and will be looking to take advantage of the ongoing consolidation in the U.S. wireless market to do well in a region where it has historically been a laggard. NSN has a strong relationship with Softbank in Japan that it can leverage to win more contracts at Sprint, which is now 78% owned by Softbank. Even T-Mobile’s recent merger with MetroPCS is likely to work in NSN’s favor. T-Mobile currently sources its equipment from Ericsson and NSN, while MetroPCS does the same from Ericsson and Samsung. As the carriers look to consolidate suppliers, NSN has an opportunity to displace Samsung owing to its relationship with the bigger T-Mobile.
As a result of the high R&D spend incurred over the past decade, Nokia 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) with a majority of them in Europe.  Even in terms of quality, Nokia’s patents stand out. In a 2011 review of the 3000+ patents considered essential to 4G LTE technology, 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 the most essential.
What makes Nokia’s patent strength even more more intimidating is that Nokia and Qualcomm 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 translated to an unrivaled access to more than 30% of the essential LTE patents. Another demonstration of the strength of Nokia’s patent portfolio came in mid-2011, when Apple agreed to pay Nokia an undisclosed one-time sum and recurring royalties for violating 46 of its patents.
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 13.8 years, discounted cash flows (12% discount rate) show that the patents would be worth at least $4 billion in value, or $1 per share. We estimate that this is a floor on the value that Nokia’s shareholders should be attaching to its patent portfolio. Considering that Nokia will now have no phones to sell and therefore faces less danger of being countersued, it would have greater bargaining power in setting patent licensing terms going forward. Additionally, its 4G LTE patents are likely to become even more valuable with time as carriers around the world transition to the new wireless standard and a greater number of handsets support 4G. This could actually bring further upside to our IP valuation.Notes:
- Nokia Has a Valuable and Relatively Young US Patent Portfolio, EnvisionIP, July 19th, 2012 [↩]
- LTE Standard Essential Patents Now and in the Future [↩]