Regulatory Approval In China Lifts Uncertainty Around Nokia’s Emerging Market Licensing Potential

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Chinese regulators recently approved Nokia’s (NYSE:NOK) sale of its handset business to Microsoft (NASDAQ:MSFT), ending speculation that the Lumia maker may face tougher regulations while enforcing its patents in the country. The 5.4 billion Euro transaction was earlier expected to close by the end of March but delays in securing regulatory approvals led the companies to push it to April. Nokia has already secured the approval of antitrust officials in the U.S. and Europe, and will now be waiting on the outcome of the legal proceedings of its pending tax case in India although that is likely to have little material impact on the transaction value for the company. Moreover, the fact that none of the regulators have so far asked Nokia to make changes to its patent licensing terms lifts the uncertainty around its IP business, which could be a significant value contributor to the company.

The stock is trading close to our $7.50 price estimate for Nokia, which we believe is fair value given its current royalty run rate of Euro 600 million and 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.

See our complete analysis for Nokia here

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Nokia’s IP Clout

As a result of the high R&D spend incurred over the past decade, Nokia has built 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] Nokia’s patents stand out not just in their sheer numbers but also quality. In a 2011 review of the 3,000+ 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.

Currently, Nokia generates almost all its licensing fees from standard-essential patents, which account for only about 10% of its patent portfolio and are required to be licensed to others at fair and reasonable rates under FRAND terms. 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. [3]

All Eyes On Samsung Deal

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 with handset makers. Given that future smartphone sales will be largely driven by these markets, any move by regulators to cap Nokia’s future royalty rates could have limited the upside potential in its licensing business.

With Chinese regulatory concerns out of the way, Nokia will be well served in its 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.

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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 []
  3. Ailing Nokia falls back on patents legacy, Guardian, May 2012 []