Nokia-Microsoft Deal Receives Overwhelming Shareholder Approval; New $7.80 Price Estimate

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An overwhelming majority of Nokia’s (NYSE:NOK) shareholders approved the sale of its devices business to Microsoft (NASDAQ:MSFT) on Tuesday, marking the official end of an era in mobile phones. As part of the transaction, Nokia will receive about $5 billion in cash for its devices business and an additional $2.2 billion for licensing its patents for ten years. The deal received the support of 99.7% of the voting shareholders, which was not unexpected given the amount of value it has unlocked for them in the last couple of months. Since the Microsoft deal was announced in early September, Nokia’s shares have nearly doubled as the market came to grips with the long-term potential of its patent portfolio and the ongoing turnaround in its networks business. Going ahead, we expect Nokia to return most of the cash it receives to shareholders, or look to make acquisitions in order to bolster its remaining businesses.

With the jettisoning of the handset division, Nokia is left with three primary business segments: Nokia Solutions and Networks (NSN), which it assumed full control of last quarter after buying out Siemens’ 50% stake for Euro 1.7 billion; the licensing of its patents, which was earlier reported as part of its devices business and has a current annual revenue run-rate of Euro 500 million; and the Navteq mapping unit, which it acquired in 2007. We have restructured our model to account for the sale of the handset division as well as the resulting inflow of $7.2 billion in cash. As a result, our valuation for the new Nokia is up by about $6.9 billion, which translates to a price estimate of $7.80 per share – about in line with the current market price.

See our complete analysis for Nokia stock here

NSN’s Strong Turnaround

Most of the new company’s value now lies in the NSN division, which will account for almost 90% of its total revenues and about 40% of our $30 billion valuation for Nokia. Over the past year, NSN has increasingly shown signs of turning the corner as a result of an ongoing restructuring initiative that has not only helped improve its operating margins but also restored focus on its wireless business. As a result, NSN has fast emerged as a leader in the ongoing 4G LTE transition around the world, and is taking share away from competitors.

NSN’s LTE focus should 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 improve its position in a region where it has historically been a laggard. Long-time NSN customer Softbank’s recent acquisition of a 78% stake in Sprint helped NSN displace Ericsson in a recently signed LTE deployment contract with the carrier, which plans to use its recently acquired spectrum from Clearwire to bolster data capacity in densely populated areas. Sprint is building out a faster 4G TD-LTE network covering around 100 million PoPs by the end of next year in a bid to catch up with rivals Verizon and AT&T.

T-Mobile’s recent merger with MetroPCS could also help NSN increase its U.S. market share. 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.

At the same time, NSN has divested some of its non-core operations and has been exiting certain contracts and countries that it believes have little strategic importance in the longer term. This is in keeping with NSN’s strategic focus on mobile broadband and profitability. However, this caused its third quarter revenues to decline almost 26% over the same period last year and margins to take a small hit due to operating leverage. Nokia’s top-line growth may be a concern for a few more quarters, with some of the managed service exits likely to impact revenues next year as well. However, we expect the LTE transition to pick up in pace in the coming years as carriers in China and Europe start upgrading their networks. NSN has already bagged the highest revenue share (>11%) of China Mobile’s initial LTE buildout among all foreign bidders, which is likely to become accretive to the bottom-line in the coming months. Along with the ongoing restructuring, which is expected to be completed by the end of the year, this should help NSN hold on to the impressive margin gains it has made in the last few years.

IP Licensing Potential

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. [1] 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. [2] Qualcomm, the dominant mobile chipset manufacturer, trailed Nokia with a share of about 12.5% of the LTE patents deemed the most essential.

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 should now have greater bargaining power in setting patent licensing terms going forward. Currently, Nokia generates all of its licensing revenues from about 10% of its patent portfolio, which are standard-essential and are required to be licensed to others at fair and reasonable rates. Without the handset division though, Nokia will be free to monetize the rest of its patents, which had been exclusive to its handsets until now. Additionally, its 4G LTE patents are likely to become even more valuable with time as carriers around the world transition to the wireless standard and a greater number of handsets support 4G. This could bring further upside to our IP valuation.

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Notes:
  1. Nokia Has a Valuable and Relatively Young US Patent Portfolio, EnvisionIP, July 19th, 2012 []
  2. LTE Standard Essential Patents Now and in the Future []
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