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Yesterday, the market saw the first major reaction to the Samsung (OTC:SSNLF) vs. Apple (NASDAQ:AAPL) verdict, from none other than Samsung itself. The tech giant shocked the market with the announcement of the ATIV S, the first WP8 smartphone. The news came as a shock to Nokia (NYSE:NOK) investors who were banking on the Lumia to be the first WP8 smartphone. However, we believe that this is good news for Nokia, as it reaffirms the company's faith in the Windows 8 platform. A lot, however, still depends on the hardware quality of the Lumia Pi and Arrow. The verdict in the Apple case has significantly increased the worth of Nokia's patents. We believe that NOK has a huge upside potential, and the Windows Phone 8 can trigger a turnaround for the company; therefore, we are moving to a buy rating for NOK.

Overview

The ramifications of the Apple vs. Samsung case are still being discussed and analyzed. There might be a difference of opinion on the possible after effects, but the significance of this event is agreed upon by all. Other than the obvious winner being Apple, a few other companies have also gained from this verdict. A couple of big winners are Nokia and Microsoft (NASDAQ:MSFT). These two might be the world's most recognized brand names, and their products have been dominating the market for many a year. For a significant period of 14 years, Nokia was the leading phone producer in the world, until it was overtaken by Samsung earlier this year. This prolonged market dominance has left Nokia with a rich portfolio of patents. Business models and other estimates aside, these patents alone are worth billions of dollars in value and bring in millions each year in the form of royalties. A large part of the portfolio consists of Standard Essential Patents. An unrealized fact is the increased value of these patents, due to the Apple verdict. Manufactures will be more careful infringing on technology, and cash-rich companies will become more aggressive in their patent acquisition strategies. In such circumstances, we believe that Nokia's patent valuation will increase significantly, as compared to our previous valuation. The perceived litigation problems for the Android platform have also made the Nokia-MSFT Windows 8 partnership seem more attractive.


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Source : Ycharts (10 Days Chart)

Since our last update on NOK, the stock has moved between $2.49-$3.25. The stock rallied after Friday's verdict came out, but has since slid back to $2.9. During the last couple of years, the company has posted consecutive losses. Samsung and Apple have been its biggest competitors. Recently, the management has tried to shake things up by reducing expenses in the form of layoffs, and closing down expensive European production facilities. A look at the fundamentals reveals that the debt-to-equity ratio of the company is higher than the industry average. There are no immediate concerns in terms of liquidity, as the quick ratio and current ratio are close to industry averages. The interest coverage ratio is also sound at 5.48. Standard & Poor, however, has downgraded Nokia for the third time this year; from BB+ to BB-. The rating agency also changed Nokia's business risk rating from fair to weak , and its financial risk rating from intermediate to significant . In response, the company ensured stakeholders that it had enough cash to last until it can orchestrate a business turnaround. The tech giant ended the quarter with approximately $11.5 billion in gross cash and approximately $3 billion in net cash. The company has also acquired a credit revolving facility, which will give it access to 1.5 billion euros ($1.8 billion) until March 2016.

Financial Strength Indicators

Company

Industry

Sector

Quick Ratio (MRQ)

1.18

1.72

0.88

Current Ratio (MRQ)

1.31

2.05

2.71

LT Debt-to-Equity (MRQ)

43.55

19.09

9.42

Total Debt-to-Equity (MRQ)

57.95

31.19

17.53

Interest Coverage (TTM)

5.48

5.95

68.43

Source: Reuters

Bearish Thesis

NOK will have difficulty raising affordable capital from the market, considering its dwindling stock price and bad credit rating. The gross margins have also gone down in an effort to increase sales.

Million (euros)

2Q2012

1Q2012

4Q2011

3Q2011

2Q2011

Total Revenue

7542

7,354

10,005

8,980

9,275

Gross Profit

1836

2,034

2,902

2,521

2,855

Gross Profit Margin

24%

28%

29%

28%

31%

Source: Reuters


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Source: Bloomberg, Qineqt's Calculations

If we look at the graph, we can see a dismal depiction of the recent performance. Sales and gross profit have reduced in the last five quarters. Gross profit margin has also decreased from 31% in 2Q 2011 to 24% in 2Q 2012. Last quarter, the company announced a net loss of $1.7 billion, missing analyst estimates of a loss of $784 million.

Nokia has tied its future to the success of its Lumia series and the Windows 8. As we mentioned in our previous update on Nokia, the Microsoft-Nokia partnership might not live up to the latter's expectations. Since then, Nokia has been given access to the Windows 8 platform; however, Microsoft gave Nokia's archrival Samsung a shot at the WP8 as well. Samsung, in a shocking move, shook up the entire industry by announcing its Windows phone. The Samsung ATIV S has raised expectations from next week's unveiling of the Lumia WP8 phones. Considering a longer Nokia-Microsoft relationship, it should be expected that Nokia will be far ahead of Samsung in terms of its technological compatibility with Windows. This will only be decided once the Lumia is unveiled. Nokia will announce the Arrow and Pi, in a joint summit with Microsoft on September 5.

Bullish Thesis

In our previous analysis of Nokia's patent value, we used Google's (NASDAQ:GOOG) acquisition of Motorola Mobility as a benchmark to estimate the value of Nokia's patent portfolio; this value came down to $2.3 per share. The Samsung vs. Apple verdict will have the most drastic impact on the value of Nokia's patents. Historically, Nokia has not been proactive in getting value for its patents. The company changed this policy by suing Research in Motion (RIMM), View Sonic and HTC (OTC:HTCXF) for infringement of 45 different patents. The verdict of its cases against HTC is expected in the third quarter, and in the current legal scenario, the verdict is expected to be in NOK's favor. We have already discussed the importance of Essential Patents to the legal war amongst smartphone/tablet manufacturers. Currently, Nokia holds more than 18.9% of the total Essential Patents on 4G/LTE. Although these cannot act as an entry barrier, they can still result in a big payday in the near future. Moreover, in 2008, Nokia signed up for a 15-year contract with Qualcomm (NASDAQ:QCOM) for the use of its patents in Nokia and Nokia Siemens. Therefore, the company has access to approximately 31% of all LTE essential patents. The company has already used this tool to get a billion dollar settlement from Apple, plus a $10 dollar royalty on each iPhone sold.

As we have discussed, the demand for the Windows 8 phone seems higher in a post-verdict world. The launch of the Samsung ATIV S should not worry Nokia investors. This is just an affirmation that Nokia had been right all along. The ATIV S is nothing extraordinary if we compare it with other Samsung phones. In a world where Samsung had not taken the lead on Nokia in releasing a Windows 8 phone, NOK would still have had to come up with a superior hardware, which could compete against the iPhone and Galaxy series. Therefore, in our opinion, the release might be positive news for Nokia. Although we have not personally tested the phone, it can be easily concluded that this was a hurried announcement, and thus the quality of the product can be a factor. This would give Nokia's Lumia products comparatively better reviews than Samsung' ATIV; which can be an important factor, as these are the first Windows 8 phones of each brand. According to Jack Gold of J. Gold Associates, Nokia will still be the primary driver of Windows 8 devices.

Analyst Opinion

As can be seen in the chart below, analysts have agreed on a "hold" rating for NOK over the last three months. The steady increase in the underperform rating can be considered troublesome, but there has been a slight increase in buys during the last month.


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Source: Yahoo Finance

Conclusion

We had given a hold rating for Nokia in our previous analysis. The primary factors behind the rating at that time were the uncertainties about access to the WP8, and the close proximity of the market price with our estimates of the patent price per share. Nokia will be launching its first WP8 phone next week. Samsung has already scrambled to get access to Windows, which is a testament to the manufacturer's interest in a rival platform, which will preferably take them to the consumer and not the courtroom. Cross licensing agreements between Microsoft and Apple bring more surety to the Windows 8, ensuring minimum legal hassle. In view of the court's verdict and the huge settlement of $1.05 billion, we believe that the value of Nokia's patents has increased. Cash rich companies like Google and Microsoft have already spent fortunes to build patent portfolios. Therefore, we are changing our hold rating for Nokia to a buy.

Source: Buy Nokia: Samsung's WP8 Launch Is A Good News For Nokia