Nokia (NOK) stock is up 40% today to give it a market cap of E15bn on account of the Microsoft (MSFT) deal that purchases the Device & Services (D&S) business for E5.44bn. Obviously it is great news for stockholders and silences the bears who had often assumed a negative value for D&S. Admittedly part of me would like to have seen the turn around in Device & Services play out as I believe it would have been extremely profitable for shareholders. Microsoft shareholders will now benefit from the turnaround going forward. It is a great deal for Microsoft and their assumption of 15% market share in 2018, and $45bn of revenues looks achievable. On a 20% gross margin, that would deliver them $9bn of gross profits per annum.
The good news as a Nokia shareholder is that within Nokia excluding the Devices and Services business there remains significant upside still. The market will uncover the value inherent in the remaining businesses. Nokia excluding Devices and Services has some serious growth drivers.
NSN should be valued at least at 0.7x Sales. This gets to an equity value of E8.5bn. NSN delivered an 11.8% non-IFRS operating margin in Q2 2013, however the company guides to a 7% margin. Also note in the Q2 results NSN increased their cost savings target by 50% to E1.5bn for 2013; this was ignored by the market as the bears did a disservice to their client base by spinning a negative story regarding Devices and Services. As a comparison, please note Ericsson's (ERIC) market capitalization is E30bn. However Ericsson's revenue base is only twice that of NSN and they both achieved a similar margin last quarter. As such there is upside to this estimate of E8.5bn for NSN as the stock market grows more comfortable with the sustainability of the margin post the turnaround.
The value of the patent portfolio has been underlined by Microsoft paying Nokia E1.65bn for an intellectual property license. Nokia has a significant patent portfolio with an average patent life of 13.8 years. This portfolio generates over E500m of income per annum. Importantly this deal removes restrictions on cross selling patents, providing further upside to this income number. Nokia spent E4.7bn on R&D in 2012. A significant amount of that money goes to creating patents which are then monetized through licensing agreements.
If one assumes a 10x multiple on the income generated from Patents, the division is worth approximately E5bn. As a comparison Nortel's patents were sold for $4.5bn, also Motorola Mobility (MSI) was arguably a patent lead deal and it sold for $12.5bn. There are U.S. listed patent companies which might serve as an interesting comparator for Nokia's patent division, however as of yet I have not looked into them.
Nokia's Maps business HERE is hugely undervalued by the sell side. The bears argue it is barely profitable, as such they value the division at 0.5x sales and give a paltry valuation of E500m. The reason HERE is barely profitable is that it spends 90% of Sales on R&D. This is a sensible strategy as Mapping is one of the most exciting growth areas in technology. The map on your smart-phone is becoming a point of differentiation between smart phone makers, and it is set to become the next platform for advertising & e-commerce. Alibaba's purchase of 28% of Autonavi (AMAP), Chinese largest mapping app is driven by the potential to integrate Alibaba's merchants into Autonavi's maps. Nokia owns one of three scarce global mapping assets. This view also explains my positive view on TomTom (TMOAF.PK) as detailed here. Let's assume HERE is worth E1bn however I think this value could explode higher.
Adding in the cash of approximately E7.9bn, the combined valuation of the above divisions gets to Nokia being worth E21bn versus the current E15.5bn market cap. However this does not account for value creation and growth of the remaining divisions, and is a static valuation based on today's metrics. I think the 35% + rerating of the Nokia market towards the inherent value of E21bn should occur quite rapidly as investors and analysts will now dig deeper into the other divisions and are not so focused on incorrectly valuing D&S. Also please note that Nokia has a large short base that accounts for approximately 14% of the market cap, approximately E1.5bn worth of shorts need to close. A lot of those short sellers are U.S. based institutions who will likely be forced to close their positions adding further momentum to today's price action.