Nokia Unlocks Value And New Growth Potential With Microsoft Deals
Nokia’s (NYSE:NOK) shareholders will be one big happy bunch. Not only has the Finnish handset maker succeeded in offloading its handset business, an asset its shareholders were assigning a negative value until recently, but it also pocketed a hefty windfall in the process.
In an agreement announced Monday, Nokia has agreed to sell its handset business to Microsoft (NASDAQ:MSFT) for a total of $5 billion in cash. To sweeten the deal further, Nokia’s lucrative patent portfolio isn’t part of this transaction. Instead, Nokia will grant Microsoft access to its patents for 10 years for another $2.2 billion in cash. Moreover, since the patent arrangement is non-exclusive, Nokia is free to add other patent licensees in this period as well. While the deal has yet to receive shareholders’ approval, it is hard to imagine an adverse scenario considering the amount of value this unlocks for Nokia’s shareholders.
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 the handset division under-achieving in the face of some tough competition from Android and a slow and painful transition to Windows Phone, the markets were valuing the business at only a little over $1 billion. Considering that the patent business, which is part of the company’s handset division, is healthy and has been consistently generating cash flows of around Euro 500 million annually, the handset business (excluding licensing revenues) was being valued negatively. Both the sale of the handset business and the patent licensing deal together with the recent acquisition of Siemens’ stake in NSN should therefore be hugely value-accretive to Nokia’s shareholders.
See our complete analysis for Nokia stock here
Nokia’s patent muscle
As a result of the high R&D spend Nokia incurred over the last decade, Nokia has a very strong patent portfolio comprised of 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 combined) with a majority of them being in Europe. [1] Even in terms of quality, Nokia’s patents stand out. In a 2011 review of the 3000+ patents considered essential to the LTE technology that has fast emerged as the preferred 4G standard, 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 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 gives Nokia unrivalled access to more than 30% of the essential LTE patents – a position of strength that will not only insulate Microsoft from litigation in the ongoing patent war, but also give Nokia enough ammunition (with its 19% LTE patent share) to go after other hardware makers and generate cash through licensing deals. In fact, now that Nokia will have no phones to sell, it faces less danger of being countersued and will therefore have greater bargaining power in setting patent licensing terms.
How much is New Nokia’s Value?
The new Nokia will have NSN (telecom equipment), Here Maps and IP licensing as the three business heads after the handset business is sold. At the current run rate, Nokia’s IP licensing arm generates about $600 million in steady royalty income every year. If we assume this to hold over the average remaining term of its U.S. patents, which is about 13 years, discounted cash flows (12% discount rate) show that the patents would be worth about $4 billion in value, or $1 per share. Since Microsoft’s addition as a patent licensee is an upfront cash deal and will not generate additional revenues, Nokia’s licensing division will not accrue additional value but net cash should jump by $2.2 billion, or about $0.60 per share. The sale of the hardware division will cut our estimates for Nokia’s value by a quarter, or a little over $1.10 per share. However, the cash Nokia gets for the hardware business will boost net cash by $5 billion, or about $1.33 per share.
The net positive impact on Nokia’s valuation is therefore about $6.7 billion, or $1.80 per share from this deal ($1+$0.60-$1.10+$1.33). The upside to this depends on how effectively Nokia is able to monetize its patent portfolio now that it will not have a handset division to worry about while suing others. It is not therefore very surprising that Nokia has already added almost $6 billion to its market cap since the deal was announced yesterday.
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Notes:- Nokia Has a Valuable and Relatively Young US Patent Portfolio, EnvisionIP, July 19th, 2012 [↩]
- LTE Standard Essential Patents Now and in the Future [↩]