Buy Nokia Now: Its Patents Alone Are Worth $2.3 Per Share

Jun.14.12 | About: Nokia Corporation (NOK)

On June 8th, we published our analysis on the potential winners and losers of the smartphone market. We recommended long positions in Apple (NASDAQ:AAPL) and Qualcom (NASDAQ:QCOM) and short positions in Nokia (NYSE:NOK) and Rim (RIMM). As we write this article, NOK's share are trading near 16 year lows of $2.34, down 20% from where we recommended the short position.

Investment Thesis:

We think that a challenging operating environment for Nokia has already been priced in. We are reversing our short recommendation in NOK because of:

1) Based on Google's (NASDAQ:GOOG) acquisition of Motorola Mobility, Nokia's patent value per share comes out to be $2.3.

2) Using a DCF analysis to calculate the value of Nokia's income stream from its patents, and assuming the current assets alone will be sufficient to pay the total liabilities, we estimate NOK's shares to be valued at a minimum of $2.6

3) In case, the cash rich Microsoft (NASDAQ:MSFT) plans to enter the mobile hardware space, it will be willing to pay a significant premium for Nokia's global presence and patent portfolio.

We think market will soon start to price in Nokia's acquisition causing a major upside in its stock price.

Trading Plan:

We recommend to buy NOK's shares now and use a stop loss of $2.2, 10c lower than its per share patent value of $2.3. For investors with more risk appetite we recommend using a stop loss of $2.

Does Nokia's acquisition make sense?

Nokia, a once biggest seller of mobile devices in the world, announced today that it is going to cut 10,000 more jobs as the smartphone division, which generates more than 65% of its revenues, continues to underperform. The recent job cut will bring the total number of job cuts to 40,000 since Stephen Elop took the office in 2010. Nokia also announced additional $1.3 billion charges by the end of 2013.

Nokia has lost 60% of its share value in the past 52 weeks as the Finish mobile phone manufacturer kept on losing market share due to tough competition from rivals Apple and Samsung (OTC:SSNLF). Falling mobile phone sales volumes is eroding Finish manufacturer's margins and putting significant pressures on its cash reserves. Nokia has burned nearly $2.7 billion of cash in the past five quarters, and market expects that the company is going to burn $2.5 billion more in cash in the next three quarters. Also, Moody's has cut Nokia by one notch, citing that the Finish manufacturer is facing structural challenges that may not be easy to address and declining trends in margins are expected to continue in the near future. Moody's further stated that, Nokia could face another downgrade if the new Lumia handset category fails to gain momentum.

In 1Q2012, Nokia recorded a 16% YOY decline in the mobile phone sales volume and a 35% YoY decline in the mobile phone segment revenues. Revenues were down by 30% on a year over year basis, and the company posted an operating loss of $1.7 billion.

It is worth noting that Nokia, once the largest manufacturer, has lost 4.4% of the world's mobile phone market share in a single year, and slipped to the second position in the first quarter of 2012 (Gartner). Samsung now leads the market with a 20.7% share in 1Q2012, compared to Nokia's share of 19.8%. Major downside for Nokia can be accrued to its failure to spur innovation in its products and to identify the changing industry dynamics.

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Nokia is currently trading at 0.7 times its trailing book value, at a 35% discount to industry's peers average of 1.1x. Cheap valuations have left Nokia vulnerable to buyout rumors in recent months by Microsoft historically, and Samsung recently. But it remains to be seen if Nokia is really valuable to Samsung or Microsoft in real terms.

Samsung is unlikely to buy Nokia, as the world's largest smartphone maker seems unable to generate much synergy from Nokia, but given Nokia's 10,000 patent portfolio, it may be attractive to Samsung as well.

If Microsoft is interested in stepping in the mobile hardware to compete actively with key rivals Google and Apple, than acquisition of Nokia makes more sense, as the company already has a global footprint. Google stepped into mobile hardware industry by acquiring Motorola mobility last year, however it remains to be seen how it is going to surcharge its mobile ecosystem. Nokia is still one of the top mobile phone manufactures of the world, and it's equity is cheap. Spending $10 billion on Nokia will not be a problem for Microsoft, considering the Redmond Pie based company generates much cash each quarter.

Another reason for Nokia's attractiveness is the wealth of the patents it owns and earns nearly $630 million in royalties from these patents. The Guardian, in a recent article, analyzes Nokia's position as a patent powerhouse, ranking it along with Qualcomm and Ericsson. If we value Nokia's patents based on Google's acquisition price of $750,000 per patent for Motorola Mobility, we can easily come up with a $8.85 billion valuation of Nokia's 11,800 patents. This is considered as the maximum value for Nokia's patents.

Nokia Value Estimation

No. of Patents

11,800

Estimated No. of Patents Granted Each Year

600

Est. Annual Income from Patents

$1,000,000,000

Estimated Life of Patents

11

Risk Free Rate (US Ten Year T-bond)

1.70%

Risk Premium

5%

Beta

1

Required Rate of Return

6.700%

Inflation

2%

Value Estimated at Required Rate of Return

$ 7,745,515,583

Current Assets (03/31/2012)

$ 28,350,300,000

Total Liabilities

$ 26,100,800,000

Net Value

$ 2,249,500,000

Total Value (Patents Value + Net Value)

$ 9,995,015,583

Shares Outstanding

$ 3,832,810,000

Share Value

$ 2.61

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Nokia's patent portfolio can also be valued using a DCF analysis with some assumptions. It is estimated that each year approximately 620 patents were annually granted to Nokia from 1996 - 2012 and an average life of patent is approximately 20 years. Therefore, average life of patents from 1996 to 2012 can be estimated using a weighted average of patents granted from 1996 to 2012. The weighted average can be used to find the estimated present value of the patents, based on current annual income stream from patents and a required rate of return. Based on DCF, Nokia's patent minimum portfolio value is estimated to be approximately $6.4 on risk free rate, and $4.88 on a required rate of return of 6.7%. Hence, we have estimated the range for Nokia's patent portfolio value between $5 billion to $8.8 billion.

Few analysts in the industry are also speculating about Microsoft possibly waiting for Nokia to run out of cash and then acquire it on even cheaper valuations.

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