We recently highlighted Nokia (NOK) as a company which could benefit from the Windows 8 launch. But there is more to the Nokia story. Share price was up 12.2% on Wednesday, and 7.5% on Black Friday, before pulling back early this week. Rumors around Wall Street attribute the rally to strong Lumia sales in Germany.
My investment thesis for Nokia is complicated, but can be broken down into four main points. 1) Margin of Safety: Nokia’s impressive patent portfolio serves as a steady revenue source and significantly increases the liquidation value of the company, insuring shareholders against loss of capital due to share price depreciation. 2) Core Competencies: Nokia’s Mapping Technology segment and their Siemen’s Global Network segment show solid growth in profitability. 3)Emerging Markets: Nokia’s presence in emerging markets is growing through their feature phone line, Asha, which is especially popular in India and China. 4)Lumia/Windows Phone 8: Nokia has long been a niche player in the international smart phone market, but early sales seem to indicate aggressive pricing and innovative design of the Lumia 920 coupled with the long-awaited Windows Phone 8 mobile operating system will return Nokia to relevancy and profitability in the mobile phone market. This return to profitability in their Mobile Phone Segment, coupled with the cost reductions in recent years, and the other factors previously mentioned, should return Nokia to profitability and cause the stock to appreciate significantly over the next year.
Nokia stock performance (last 30 days)
Margin of Safety:
Value Investors have always looked to invest in companies which possess a “Margin of Safety”, essentially a margin of safety is when for some reason the market price of a stock, is significantly below the intrinsic value of a company. This term explicitly differentiates between the price and value of a company. The price of a company refers to the current price shares are trading for on the stock market. The value of the company refers to the worth of the company as determined by one or more of various valuation methods. Nokia possesses this coveted margin of safety in the form of their patent portfolio.
Nokia owns approximately 18% of all necessary patents for LTE, which is used in iPhones, Android and BlackBerry. As a result, Nokia receives a commission from Apple (AAPL) on all iPhone sales. Nokia generates $646 million a year in patent revenue. This number is expected to grow as on November 28th, it was announced that Nokia won a patent dispute against Research in Motion (RIM), the manufacturer of BlackBerry. RIM will likely be forced to pay Nokia royalties on every BlackBerry sold. Android manufacturers will also likely settle with Nokia in the coming future, as they use the same technology that Apple does. This additional revenue, combined with Android’s projected market share of the growing smart phone market would value the revenue from Nokia’s patent portfolio well over $1 Billion. Intellectual Property Analyst Florian Mueller predicts that HTC will settle with Nokia and agree to pay licensing fees since HTC recently has settled with both Apple and Microsoft and Nokia has brought 32 cases of patent infringement against HTC, the first of which began in Germany on 11/21/12. If HTC pays Nokia even half of what they pay Microsoft (MSFT), then Nokia will generate over $800 million annually from HTC alone. Nokia’s dominance of the necessary patents for 4G is similar to the dominance Microsoft held on 2G/3G patents, which MSFT successfully converted to an estimated $3.2 Billion in annual patent revenue. Nokia reported total revenue of 38.6 Billion Euro’s last year. If their patent revenue increases to match the levels previously seen by MSFT, as Florian Mueller predicts, that would be an increase of 1.98 Billion Euros, or 5.1% of total revenue.
Nokia is finally seeing their massive expenditures in Research and Development pay off. In the last 11 years, Nokia has spent over 10 times what AAPL has spent on Research and Development. The estimated lifespan of Nokia’s patent portfolio is approximately 13.8 years. This means that Nokia will be generating revenue off of their patents for the next 13.8 years. Intellectual Property analysts Envision have valued the future cash flows generated from Nokia’s US patents at approximately 3.8 Billion dollars. The Wall Street Journal valued the entire patent portfolio at close to $6 Billion (including European patents). This would value Nokia’s patents at about 1.40 a share, or about 44% of current share price.
More importantly for Nokia shareholders however, is that based on the precedent transaction when Google (GOOG) bought Motorola Mobility’s patent portfolio, which controls 6% of all essential patents for 4G, for $12.5 Billion, Nokia’s patents alone are worth more than the current market value of the company. Nokia controls 18.9% of essential patents for 4G, a testament to the quality of their patents, and has the 2nd most mobile patents behind strategic partner MSFT with 15,897 US patents issued, and another 4,453 patents pending. Nokia also has another 20,000 foreign patents. Nokia’s patent portfolio is demonstrably more valuable than Motorola’s $12.5 Billion patent portfolio. Analysts have argued that the patent market is cooling off and that Google grossly overpaid for Motorola’s patents. Nevertheless, even if Nokia were to sell its patents for the same amount, $12.5B, that would value Nokia’s patents at $3.37 a share. As a public company, Nokia’s board bears a fiduciary responsibility to the shareholders, the owners. Because of this duty to act in the best interests of the shareholders, before Nokia would be to declare bankruptcy, they would attempt to sell the company, or at least the patent portfolio. The value of Nokia’s intangible property would give Nokia a break-apart value greater than current market price. This gives investors a margin of safety, because investors can purchase the stock at current levels and still profit from the buy-out which would most likely result if the Lumia fails and Nokia becomes distressed.
By: David Emami
This article is part 1 of 4.