Nokia (NYSE:NOK) is scheduled to announce its Q4 2013 results on January 23rd. This will be its first earnings call without the iconic mobile division, the sale of which to Microsoft (NASDAQ:MSFT) was approved in November. With the company pocketing $7.2 billion in return, shareholders will be interested in hearing what management plans to do with the extra cash. While the payout of a one-time special dividend or share repurchases could be in the offing, the management could also look to acquire other companies as a means to bolster its remaining businesses and drive long-term shareholder value.
With the jettisoning of the handset division, Nokia is left with three primary business segments: Nokia Solutions and Networks (NSN), of which it assumed full control last quarter after buying out Siemens’ 50% stake for EUR 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 EUR 500 million; and the Navteq mapping unit, which it acquired in 2007. Of the three, NSN is more central to Nokia’s value and a sustained recovery in this business is key to our $7.80 price estimate for Nokia. We expect another quarter of strong margin expansion for NSN, which has recovered well from years of losses to achieve six straight quarters of underlying profitability due to a restructuring program that has shrunk its top-line but enhanced its focus on margins and cash flows. We will also be looking for management comments on Nokia’s future patent-monetization strategy, given that the company currently derives all its royalties from only 10% of its patents and therefore has huge upside potential. Our price estimate is in line with the current market price.
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 the 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 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 with 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. 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 significant operating leverage. Nokia’s top-line growth may be a concern in the near term, with some of the managed service exits likely to impact revenues this 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.  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.
Nokia’s 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. Additionally, it should be noted that Nokia’s patents are not just limited to LTE but also include Wi-Fi and older 2G/3G technologies such as GSM, GPRS, EDGE and W-CDMA. In fact, Nokia likely has a greater grip on these patents considering the much bigger role it had played in the development of the older mobile technologies in the nineties than the more recent LTE standard. Although LTE holds much promise for the future, we expect handsets to remain compatible with many of these older technologies well into the future. This should give Nokia an opportunity to grow its licensing revenues going forward.
At the current run rate, Nokia’s IP licensing arm generates about 500 million Euros in steady royalty income every year. We currently assume that the company will maintain its royalty run rate in the coming years given the uncertainties associated with the timing and royalty rates of future licensing agreements. However, there could be a significant upside to our price estimate if Nokia manages to monetize a greater proportion of its patent portfolio and is able to renegotiate existing contracts at higher rates when they come up for renewal in the coming years.
Considering that Nokia now has 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. This could bring further upside to our IP valuation. (see Nokia Could Have An Additional $4.5 Billion Opportunity In Patent Licensing)Notes:
- Nokia Has a Valuable and Relatively Young US Patent Portfolio, EnvisionIP, July 19th, 2012 [↩]
- LTE Standard Essential Patents Now and in the Future [↩]