Seeking Alpha

Lei Guo's  Instablog

Lei Guo
Send Message
I am an individual investor investing for my own account. I look for names with deep discounts to their intrinsic values, or those with wide moats for long term holding. I like to read extensively to expand and deepen my knowledge of various businesses. I find the challenge to figure out... More
  • Nokia: Still Attractive After Microsoft's Purchase 1 comment
    Sep 5, 2013 10:43 AM | about stocks: NOK

    Recent announcement of Nokia's (NOK) sale of its Devices and Services business to Microsoft (MSFT) for 5.44bil EUR sent Nokia's share price up more than 30%. In this article, I will argue that Nokia's current price is still attractive for its remaining assets.

    Business

    Nokia's businesses include three parts: Devices and Services designs and sells both smart phones and feature phones, targeting different market segments; HERE is Nokia's proprietary map technology used in mobile devices, automobiles and enterprise solutions; NSN is a telecom infrastructure provider, focusing on mobile communication. In the sale's announcement, Nokia will sell its Devices and Services unit, but it will retain its portfolio of patents currently reported under the same unit.

    Investment Analysis

    Let's use the sum-of-parts method for the valuation. Numbers quoted below are denominated in EUR, except mentioned otherwise.

    The net cash on Nokia's balance sheet is 9.77bil cash - 7.09bil debt = 2.68bil, taking into account the upcoming 1.7bil debt to finance the acquisition of Siemens' share of NSN business. For the sale of the Devices and Services unit, Nokia will receive 5.44bil in cash and realize 3.2bil gain on sale. The capital gain tax from the sale will be 3.2bil x 26% = 832m, where the tax rate is assumed to be the same as that applied to the corporate earnings. So the net cash after the sale will be 2.68bil + 5.44bil - 832m = 7.29bil.

    For HERE, we can assume no value since its adjusted income for the second quarter is flat. However, as part of the deal agreement, Nokia will receive an undisclosed amount of license fee from Microsoft for the future usage of the HERE platform. HERE may actually become valuable but we can treat it as a free option for the valuation purpose.

    For NSN, Nokia's efforts in targeting the profitable countries, focusing on the growing mobile communication business and emphasizing the cost reduction already produce decent results. For the second quarter, its non-IFRS operating margin is 11.8%, a big improvement comparing to the margin of 0.2% in the same quarter a year ago. To value NSN, we can annualize the second quarter revenue of 2.78bil to get the full year revenue of 11.12bil. Based on the management's long term operating margin target of 5%-10%, we can assume the midpoint of 7.5% and estimate the operating income to be 11.12bil x 7.5% = 834m. The expected interest expense for Nokia group should be 340m (2012 interest expense) x 7.09bil (Nokia group new debt) / 5.39bil (Nokia group current debt) = 447m, and NSN's portion is roughly 447m x 2.8bil (NSN new debt) / 7.09bil (Nokia group new debt) = 177m. NSN's net income is (834m - 177m) x (1-26%) = 486m. Assuming a 10x multiple, we value NSN at 4.86bil. For the current and new debts, they are listed below for reference:

     

    Nokia group

    NSN

    Current

    5.39

    1.1

    New

    7.09

    2.8

    The final asset to value is Nokia's trove of patents. To highlight their importance to Nokia, Advanced Technologies-one of the three businesses in the new Nokia-will be focusing on the patent enforcement. To put a value on them, we can look at similar transactions happened recently. In 2011, Nortel sold its portfolio of 6000 patents for 4.5bil USD or 3.41bil EUR at today's exchange rate. In the same year, Google (GOOG) announced the acquisition of Motorola Mobility for 13bil USD or 9.85bil EUR, gaining its 17000 patents as part of the deal. Comparing to Nortel's and Motorola's, Nokia's portfolio contains more than 30000 patents, which some expert deems of higher quality and estimates to be worth more than 9.7bil USD or 7.35bil EUR. In fact, based on the patent related operating income of 128m in the second quarter, we can estimate its annualized net income to be 128m x 4 x (1-26%) = 379m. Since most of the patents will be in force in ten years' time, we can use a 10x multiple to calculate the value to be 379m x 10 = 3.79bil. After the sale of its Devices and Services unit, Nokia is likely to get more aggressive in enforcing its patents, since it will not be concerned of getting countersued anymore. As a result, its patent related income is likely to increase in the coming years.

    We can summarize Nokia's valuation in the below table, based on two different scenarios of valuating its patent portfolio:

    Patents

    3.79

    7.35

    Net Cash

    7.29

    7.29

    NSN

    4.86

    4.86

    HERE

    0

    0

    Sum of Parts

    15.94

    19.50

    Current MktCap

    14.69

    14.69

    Pct Chg

    9%

    33%

    Based on the valuation for the first conservative case, Nokia's current price has very limited downside. For the upside, it can be more than 30% when market realizes the value of its patents, especially after Nokia becomes more aggressive in enforcing them. I think this could happen in 1-2 years' time.

    Deal Closure

    Buying Nokia's shares right now runs the risk if the deal doesn't close, which is subject to the approvals from shareholders and regulators. Since both companies' boards already agree on the deal, the risk resides in the regulatory approval. Given the precedent of Google's acquisition of Motorola Mobile and Microsoft's significant termination fee of 750m USD payable to Nokia in the event that the transaction fails to receive necessary regulatory clearances, it is very likely that this deal will get approved in due time.

    Conclusion

    With the sale of its Devices and Services business, Nokia's valuation is anchored to the sum of the values from its net cash, NSN and the portfolio of patents. Once focusing on the patent enforcement, Nokia will extract more value for its shareholders.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Themes: long-ideas Stocks: NOK
Back To Lei Guo's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (1)
Track new comments
  • Yea luck nice in the future
    8 Sep 2013, 10:05 AM Reply Like
Full index of posts »
Latest Followers

Latest Comments


Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.