Tales From Nokia: Patents Kidnapped By Wicked Trolls Or Saved By Kindly Godfathers? (Part Two)

| About: Nokia Corporation (NOK)
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This article is the second of two articles about how Nokia's (NYSE:NOK) 4GA-LTE patents were acquired by Sisvel International. In the first article the background to the mysterious sale was discussed with some information about what kind of patents Nokia has. In this second article I try to discover how much Nokia actually received for the portfolio of patents and come to some surprising conclusions.

So what was the wedge? For how much cash DID Nokia sell the family jewels to the patent trolls?

Now the plot thickens, because those of us who study Nokia's Q1 financial reports and transcripts of the earnings report Q. & A. session don't remember reading anything about this at all.

Here's Timo Ihamuotila, Nokia's Chief Financial Officer.

Then shortly on our IPR royalty income before we move to the quarter. In our press release today, we disclosed that we estimate that our current annual IPR royalty income run rate is approximately EUR 0.5 billion, and it has been growing over the past year. This is reported within Devices & Services Other, together with Vertu and spare parts. This clearly shows that we are effectively monetizing our industry-leading IP portfolio.

Clearly Mr. Ihamuotila's command of English does not extend to the exact meaning of the word "clearly". Nowhere is there anything like: "By the way, in January we sold our patent portfolio to some patent trolls. It was freezing here in Finland that week and our public relations people all stayed home, so we never got the news out. Sorry about that."

So on to the Q. & A. session. Surely we get to the truth now.

Gareth Jenkins - UBS Investment Bank, Research Division.

And then just secondly, Timo, you mentioned disposals or potential disposals. Could you give a sense of where you feel those could come from and whether you'd sell the IPR portfolio?

Timo Ihamuotila, Nokia's Chief Financial Officer.

Okay. And then on the disposals. So first of all, of course, we are looking at everything, not only IPR. But then when you look at IPR, so we need to look at IPR in these different patent families. We need to have strong enough representation for Nokia in each of the patent families for our defensive purposes.

Simultaneously, we can look at, as we have done in the past as well, certain patent family combinations where we can take some patents which are valuable or which could be more valuable outside Nokia than inside the company still keeping our strength. But it is unrealistic with the current business model to say that we could sell the whole IPR portfolio somehow.

Well, that is as clear as mud too, and still no mention of Sisvel. What are they thinking? What are they trying to hide?

But surely they could not conceal this information altogether. We can just look at the financial report and see how much they made in Devices and Services Other. Here's the relevant table from Nokia's earnings report.

But where is Devices and Services Other? There is nothing until we come to the footnotes.

Note 5: Relating to operational and reporting structure: We adopted our current operational structure during 2011 and have three businesses: Devices & Services, Location & Commerce and Nokia Siemens Networks and four operating and reportable segments...

... Devices & Services also contains Devices & Services Other which includes net sales of our luxury phone business Vertu, spare parts and related cost of sales and operating expenses, as well as intellectual property related royalty income and common research and development expenses.

But why are the earnings of the significant Other not shown? Surely Note 6 must have the information we want.

Note 6: Relating to average selling prices (NYSE:ASP): ... Devices & Services Other net sales includes net sales of Nokia's luxury phone business Vertu and spare parts, as well as intellectual property royalty income. Smart Devices ASP represents Smart Devices net sales divided by Smart Devices volumes. Mobile Phones ASP represents Mobile Phones net sales divided by Mobile Phones volumes.

So the income from patents and royalties is averaged out per phone sold and then buried in the numbers, which means that one cannot tell how much of the Devices income comes from sales of devices and how much from patents, and any lump sum that might have been received from Sisvel is completely invisible.

Why does Nokia do this? Well, obviously they do not want investors or competitors to know how much they make from patents, or how much they are making or losing on the phones and devices that Nokia actually sells.

However it does mean that:

  • There is no argument to be made along the lines of: "OK, Nokia is losing money on phones, but at least it has the patent income to keep it afloat." No, the patent income is already folded into the loss on the phones.
  • In the event of bankruptcy the notion that Nokia's patents are worth billions is in question, because it doesn't look like they own the title to them any more.

On the other hand, this deal with Sisvel may be a way of protecting Nokia from a hostile takeover by a large, nouveau-riche, 4G-patent-poor manufacturer of cell phones, such as Apple (NASDAQ:AAPL)?

So was there a lump sum received for the patents which were "acquired" in the first quarter, or is it just an agreement to Apple proof the patents for safe keeping, administer tolls, keep books, sue the pants off infringers, and collect royalties that will save Nokia administrative and legal expenses and make more money for Nokia?

This question is deeply worrying, because if a large lump sum was received and rolled into the sales figures for devices, then the net sales for devices for the last quarter might be much lower than they appear. Add this to Nokia's general evasiveness about the Sisvel transaction, and one's nose gets the distinct impression that there is a dead rat under the floor boards.

How this secretive deal might work out might be much better indicated by an earlier patent giveaway, when in September, 2011 Nokia gave away 2,000 patents to Canadian outfit Mosaid. Toronto's Financial Post reported this:

Mosaid acquired 2,000 advanced wireless patents originally filed by Finnish phone maker Nokia Corp. on Thursday... Instead of paying cash for the portfolio, Mosaid agreed to give its contract partners - Nokia and Microsoft Corp. - two thirds of all licensing revenues to come from those patents, which the company expects will easily exceed the approximately $1-billion in total revenue Mosaid has generated over the past 36 years.

More than 1,200 of the Nokia patents relate to wireless technology already commonly used, known as GSM (2G) or HSPA (3G), as well as more advanced long-term evolution (LTE or 4G) standards that wireless carriers are only now beginning to implement. The
other 800 relate more broadly to wireless implementation standards.

"Also, LTE phones by definition will have to be backward compatible with 3G technologies, so when that becomes the standard, it will infringe not only our 4G patents but our 3G patents."

Over the next five years alone, Mosaid estimates approximately $500-billion in revenue will be generated by the sale of devices that infringe the company's new wireless trove. On average, those patents will last for another 10 years and span the markets of 49
different countries.

"So we'll be going after some global revenues of some very large companies here," Mr. Lindgren said.

"We're going to go after this stuff and assign any reasonable royalty rate that you can imagine."

Probably we will never know the details for sure, but it will be interesting to compare the Q2 financials for Smart Devices with the Q1 results to look for clues as to how the patent strategy is working out.

Disclosure: I am long NOK, AAPL.