Strong Patent Portfolio The Saving Grace For New-Look Nokia

| About: Nokia Corporation (NOK)

Nokia (ADR) (NYSE:NOK) shareholders finally approved the sale of the giant Finnish firm's mobile and smartphone division to Microsoft (NASDAQ:MSFT). You could say it's a win-win scenario for both firms. Nokia will finally get rid of its cash-sucking handset division, which has continued to be a major drag on profitability. Had Nokia discontinued the operations of its Devices & Services business in the third quarter, its net sales from other divisions would have come in at € 2.9 billion, € 2.8 billion lower than the total Nokia Group sales for the quarter. However, the operating margins of the Nokia Group non-IFRS segment would have improved dramatically from 3.8% to 11.5%, a whole 7.7 percentage points higher.

Microsoft will acquire Nokia's devices unit including the design, manufacturing, sales, distribution, operations, marketing and services units. That includes 32,000 Nokia employees and their talents. The deal will give Microsoft the right to use Nokia's brand on its feature phones and 8,500 Nokia patents for ten years. Thus Microsoft will gain Nokia's patent licensing contracts with IBM, Google's Motorola Mobility, Qualcomm (QCOM), Apple (AAPL), LG (LG), Nortel (OTC:NRTLQ), Kodak (NYSE:KODK) and Motorola Solutions (NYSE:MSI).

New-look Nokia

Many Nokia investors associate the firm mainly with its old identity as a respectable mobile phone manufacturer. But a peek into Nokia's revenue sources reveals that just 49% of its revenues were derived from its smartphone division in the first half of 2013. The rest came from Nokia-Siemens Network, the firm's mobile-infrastructure business, and Nokia's mapping business known as ''Here.'' The two divisions are real cash-cows for Nokia. But Nokia's IP Licensing portfolio is where I believe the company can potentially unlock real value for its shareholders.

IP Licensing a real gem

Nokia has an exceptionally strong patent portfolio, consisting of 16,000 issued patents and 4,500 patents pending approval. Its U.S. patents are quite young with about 13 years left before expiry. Only 10% of these patents are licensed, giving Nokia a good opportunity to license to the entire CE market (EU market) as well as the computer market.

Nokia's patents are regarded as some of the finest quality in the mobile market. Now that Nokia has sold its handset division and faces less danger of being countersued, it has greater bargaining power when negotiating patent licensing terms. This could add significant upside to its patent portfolio division currently valued at around €8.4 billion . Nokia can choose to renegotiate the deals that Microsoft has taken over once they reach their expiry dates. Investors should remember that Microsoft did not buy Nokia's patents outright, but rather was licensed to use them for ten year only.

Nokia does not currently license to all mobile players. After the Microsoft deal, the company will now be free to partner with vendors in Korea, Japan and China. Credit Suisse projects that if Nokia takes this route, its royalty base could potentially increase by as much as 40%. Nokia already gets about €500 million (about $675 million) in royalties from its IPR division per annum. A 40% increase will mean an extra €200 million (about $270 million) in royalties collected.

Cash back to shareholders

Nokia's interim president and current finance director Mr. Timo Ihamuotila recently pointed out that Nokia would give its shareholders more clarity on the company's strategy, capital structure and operating structure after the Microsoft deal is closed sometime during next year's first quarter.

Mr. Sami Sarkamies, a Nordea analyst, estimates that Nokia could return as much as €4 billion to shareholders in the form of special dividends in the next few years. That works out to about $1.46 per share, or an 18% capital gain calculated at the current $8.09 share price.

Here Maps faces considerable competition

Although Nokia's Here mapping business looks very promising, the reason why I remain less sanguine about it is the increasingly stiff competition it is facing from Google (GOOG) and Apple. Google recently acquired Waze, a firm that aptly combines GPS mapping and social media. Waze technology enables Google to offer a nifty driving experience. The service comes complete with warnings, and it is not difficult to see why it will give Nokia's Here a run for its money.

Apple has continued to invest heavily in mapping using its Mac OS Mavericks, updated iOS 7 as well as a raft of nip and tuck acquisitions. Both Apple and Google are intent on exploiting the concept of ''The Connected Car.'' The space already looks a bit crowded with companies such as Garmin looking to make their presence felt as well. Although Nokia's Here might gain some traction in this business, it might come at a considerable price, given the heavyweights in the space.

Bottom Line

Although Nokia will be flush with cash after the Microsoft deal, it would be a stretch to say that the company is completely out of the woods yet. On the brighter side, the firm's patent portfolio is in excellent shape will give the Nokia and its investors some downside assurance as the company continues to restructure. The firm will soon return to profitability and it would be advisable to hold the shares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Syncopy Research is a team of financial analysts. This article was written by Alex Kimani, the firm’s senior analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in the article.