As the acquisition of Nokia Corporation (ADR) (NYSE:NOK) (HEL:NOK1V)'s devices and services business by Microsoft Corp. (NASDAQ:MSFT) nears completion, investors and analysts are focused on the new Nokia Corporation (NYSE:NOK) (HEL:NOK1V). The new company will consist of the networking business NSN, the mapping app HERE and Advanced Technologies (R&D and patents business). Bernstein Research analyst Pierre Ferragu said in a research note to investors that Nokia Corporation (NYSE:NOK) (HEL:NOK1V)'s IP portfolio appears to be of good quality.
Nokia's patent portfolio similar to its competitors'
At first glance, the Finnish company's patent portfolio looks similar to its competitors Alcatel Lucent SA (NYSE:ALU) (EPA:ALU), Ericsson (NASDAQ:ERIC) (STO:ERIC-B) and Motorola/Google Inc (NASDAQ:GOOG). That's not surprising because they all have a similar pedigree with roots in the wireless and telecom industry.
But it's far behind Qualcomm Inc. (NASDAQ:QCOM). While other companies including Nokia Corporation (NYSE:NOK) (HEL:NOK1V) were busy focusing on TDMA, Qualcomm Inc. (NASDAQ:QCOM) strengthened its CDMA technology. It gave Qualcomm Inc. (NASDAQ:QCOM) a unique position in the licensing landscape. Bernstein thinks no other company today can build a similar position.
Valuing patents is a complex task. That's because a patent's licensing power is defined by how easily infringements can be demonstrated, the market it addresses and how difficult it is to work around. So, Ferragu focused on three things to estimate a valuation. First, the current annual revenues generated by patents. Second, the opportunities to increase licensing revenues. And third, potential downside.
Revenues from Nokia's IP portfolio
Bernstein estimates that Nokia Corporation (NYSE:NOK) (HEL:NOK1V) generates about 500 million euros ($679 million) in licensing revenues. Of that, about €200 million comes from Apple Inc. (NASDAQ:AAPL), €100 million from Samsung Electronics Co. Ltd. (LON:BC94) (KRX:005930), €50 million from Microsoft Corp. (NASDAQ:MSFT), €40 million from BlackBerry Ltd (NASDAQ:BBRY) (TSE:BB), and about €10-€30 million from HTC. It receives another €150 million from other industry players and vendors.
Bernstein estimated Nokia Corporation (NYSE:NOK) (HEL:NOK1V)'s IPR revenue on the basis of the Finnish company's reported revenue and earnings in "D&S other." There were also some adjustments made by Vertu, patent sales and one-off payments (chart below).
Opportunities for Nokia to boost IP licensing revenues
The Finnish company can increase its IP licensing revenue in five ways:
- Analysts believe that Nokia Corporation (NYSE:NOK) (HEL:NOK1V) is unlikely to benefit much from exiting its handset business when the time comes to renegotiate existing agreements. The deal with Apple Inc. (NASDAQ:AAPL) seems to be set in stone for the next few years. And weak players such as HTC, BlackBerry Ltd. (NASDAQ:BBRY) (TSE:BB) and others are unlikely to drive any upside because their own sales continue to shrink. Bernstein thinks only the agreement with Samsung Electronics Co. Ltd (LON:BC94) (KRX:005930) has the chance of upside.
- Additional licensing contracts with other emerging companies. Over time, Nokia Corporation (NYSE:NOK) (HEL:NOK1V) can sign contracts with Chinese vendors that account for 14% of the global smartphone industry. This opportunity represents about €50 million in licensing revenues. But it will take time to strike those deals.
- Nokia Corporation (NYSE:NOK) (HEL:NOK1V) has the potential to expand its licensing agreements beyond smartphone and tablets. Non-cellular devices with low ASP represent a €60 million licensing opportunity (chart below).
- Though non-essential patents have less licensing power, they could be a strong tool to defend differentiation and innovation. Many companies are trying to generate income from these patents. But recent patent infringement litigation show that they represent little scope to generate income.
- Continued R&D and new innovation. Qualcomm Inc. (NASDAQ:QCOM), which has an R&D budget of about $5 billion is witnessing a decline in its royalty rate over time. Even if Nokia Corporation (NYSE:NOK) (HEL:NOK1V) continues to spend heavily on research, it can only slow, not stop, the erosion of its patent portfolio's licensing power. Of course, a breakthrough innovation can't be ruled out. But something that doesn't exist yet can't be added into valuation.
Smartphone industry laggards such as Motorola, HTC, BlackBerry Ltd (NASDAQ:BBRY) (TSE:BB), LG Electronics and Sony Corporation account for €150 million of Nokia Corporation (NYSE:NOK) (HEL:NOK1V)'s total licensing revenues. And sales of these vendors are declining, down 29% in 2012 alone. So, these revenues may come under risk in the medium term.
Second, the licensing power of companies is eroding. For example, despite a heavy R&D budget, Qualcomm Inc. (NASDAQ:QCOM)'s average royalty rate has fallen from 5% to slightly above 3% (chart below). Nokia Corporation (NYSE:NOK) (HEL:NOK1V) will have to boost R&D production and come up with stronger licensing practices. But even those steps may slow down, but not prevent the decline in royalty rates.
Valuation of Advanced Technologies
Based on the above analysis, Bernstein analysts expect Nokia Corporation (NYSE:NOK) (HEL:NOK1V)'s patent and R&D business to grow at a 3.4% annual rate through 2018. Advanced