Many probably believe that it is too soon to bet on Nokia’s (NOK) turnaround solely based on its smartphone business. Even though the Lumia Windows Phone 8 smartphones have seen healthy holiday quarter sales, and the recently launched Lumia 620 is showing a lot of promise in the mid-level market, there is no knowing how long Nokia will be able to sustain the initial demand, considering how well-entrenched iOS and Android have become as mobile ecosystems.
However, while Nokia is primarily viewed as a handset manufacturer, it has other business interests as well, which is why it makes sense for an investor in the company to not lose sight of the ongoing turnaround in the other divisions. A lot of the future upside in the stock could still come from a potential growing demand for the company’s Lumia Windows Phones. But we believe that even a small improvement in the handset business, together with its increasing initiatives to monetize patents and the ongoing turnaround in its telecom equipment joint venture with Siemens, Nokia Siemens Networks, will add enough value to the company to support our $5 price estimate for the stock.
Our market share estimates for Nokia indicate that the company will continue to lose share in the emerging markets, albeit to a smaller degree as compared to the recent past. In the developed markets, where Nokia has suffered most of its recent reverses, we expect the market share loss to continue in the near term, but the situation to gradually improve in the outer years of our forecast period, as the Windows Phone potentially gets more popular. It is due to our less than enthusiastic outlook for Nokia’s handset business that we believe the emerging market sales account for about 15% of Nokia’s value, and the developed markets less than 10%.
However, Nokia’s huge patent portfolio brings a lot of value to the table. As a result of the high R&D spend Nokia incurred over the last decade, the company has 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 in Europe. In terms of quality as well, Nokia’s patents stand out, as the company seems to have played a key role in developing 4G LTE standards, and has close to 19% share of the standard-essential LTE patents used worldwide. (LTE Standard Essential Patents Now and in the Future)
It is on the back of its strong patent portfolio that Nokia managed to sign on Apple (AAPL) as a licensee in 2011, after filing a patent infringement lawsuit against the iPhone maker in 2009. Last year as well, Nokia continued its litigious strategy adding BlackBerry (BBRY) as another patent licensee, and suing HTC (HTCCY.OB) and ViewSonic for violating the use of some of its patents. As a result, the company is now earning a steady royalty income from its patents at an annual run rate of over $600 million. If we assume this to hold over the average remaining term of its U.S. patents, which is 13.8 years, discounted cash flows (12% discount rate) show that the patents would be worth at least $4 billion in value. This alone would comprise more than a quarter of its current market capitalization.
LTE Transition Propping Up NSN
Nokia’s infrastructure JV with Siemens, Nokia Siemens Networks, is also turning a corner after a restructuring that has not only helped operating margins improve, but also restored focus on its wireless business. As a result, NSN is fast emerging as the leader in the ongoing LTE transition around the world, and has taken share away from competitors recently. As of Q3 2012, NSN had succeeded in increasing its market share to about 20% share of the wireless infrastructure industry, only 2% behind #2 player, Huawei. It now expects to reclaim its #2 spot, behind Ericsson, by the end of 2013.
Apart from revenue share gains, NSN is also benefiting from a major restructuring initiative, which was announced in late 2011. As a part of the restructuring, NSN is aiming to cut around 17,000 jobs and achieve a total of 1 billion euros in savings by the end of 2013. Simultaneously, NSN is selling off non-core assets and increasing focus on wireless broadband, which has strong long-term growth trends as opposed to the relatively stagnant landline market. As a result of the reshuffle, NSN has performed really well in 2012, returning to operating profitability in the last two quarters of the year. This is a big positive sign that the company’s cost-cutting initiatives are taking hold. Consequently, the division has generated positive cash flows for four straight quarters now, and accounts for about 35% of Nokia’s fair value by our estimates.
Disclosure: No positions.