Nokia’s (NYSE:NOK) sale of its devices business to Microsoft has been postponed until April due to delays in securing regulatory authorization in certain countries. The 5.4 billion Euro transaction has already received the approval of antitrust officials in the U.S. and Europe, but is being held up by regulators in Asian countries such as China, according to the New York Times.  The regulatory delays add uncertainty to a deal that was initially expected to close by the end of this month and has helped unlock significant value in Nokia. Nokia’s stock is up almost 80% since the Microsoft deal was announced in September, and is trading close to our post-deal $7.50 price estimate for the company. While it is unlikely that the deal will be called off, any concession that Nokia might have to make to appease Asian regulators is a potential risk to our fair value estimate for the company.
Royalty rates at risk
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One of the possible anti-competitive issues that regulators might have with the deal is that it could lead to higher licensing fees for smartphone makers. Currently, Nokia generates almost all its licensing fees from standard-essential patents, which account for only about 10% of its patent portfolio and are anyway required to be licensed to others at fair and reasonable rates. The rest, which include implementation patents, haven’t been monetized well since Nokia historically preferred to use them to defend its handset business instead.
As a result, Nokia’s handset royalty rate is estimated at less than 0.3% currently, as compared to Qualcomm, which licenses out the breadth of its patent portfolio to handset makers and collects a licensing fee of about 3.2% on the ASP of each device containing its technology. Also, while Qualcomm has over 250 patent licensees paying it recurring annual royalties, Nokia has only about 40. 
There is therefore a big opportunity for Nokia to bring more patent licensees into the fold, and to license a bigger portion of its patent portfolio without having to worry about cross-licensing and protecting its handset business. This might allow the company to negotiate better royalty rates, potentially making it costlier for local Asian players to manufacture handsets and sell in price-sensitive emerging markets such as China and India. Given that future smartphone sales will be largely driven by these markets, any move by regulators to cap Nokia’s future royalty rates could limit the upside potential in its licensing business.
Repercussions on Samsung deal
One of the bigger near-term impacts that this could have is on deciding the future course of Nokia’s royalty renegotiations with Samsung, which is the biggest Android player and accounts for almost 35% of the smartphone market currently. Nokia recently extended its patent licensing contract with Samsung, which would have otherwise expired by the end of 2013, by another five years. The companies haven’t agreed on the royalty rate and other contractual terms yet, but expect to settle through arbitration in 2015.
Given the uncertainty surrounding the timing of future deals and the royalty rates that the company will be able to negotiate in the coming years, we conservatively estimate that the licensing business accounts for about 13% of Nokia’s value. The outcome of the regulatory reviews and Nokia’s negotiations with Samsung will be important for investors in determining the kind of upside potential that is left in the company’s stock, following the 80% rally in recent months.Notes: