How Do You Solve a Problem Like Nokia?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Generally speaking there are really only three positions on Nokia (NYSE: NOK). You may believe that the company will return to its former glory, that Microsoft (NASDAQ: MSFT) Windows Phone 8 will be a huge hit, and all the remaining shareholders will be vindicated. A second opinion is, that there's significant value in Nokia as a takeover target, and the stock can't possibly stay priced this low for long. The third option is, that the company has lost its way and eventually will be sold for pennies on the dollar. I've seen multiple articles using two of the three theories, but wanted to get a sense for myself if there is value in this company. Let's go over the arguments I've heard first, then I'll give you my take on how I see Nokia faring from here.

The Recovery Argument:

To be fair, I have yet to read an article by anyone on suggesting that Nokia will recover its former glory. For the company to become dominant in mobile phones again, will require Windows Phone 8 to impress customers of their need to switch from Google's (NASDAQ: GOOG) Android or Apple's (NASDAQ: AAPL) iOS. At last check, these two operating systems commanded 52.2% and 33.4% of the mobile market, and the likelihood of a late game competitor stealing significant market share seems highly unlikely. I've addressed Nokia's shortcomings in the past. I firmly believe that the company should spinoff or sell their networking business, and if Windows Phone 8 is a hit, the stock will do well. Considering that Nokia Siemens Network accounted for 75% of the company's operating loss in the last quarter, dropping this division seems like a quick fix. In fact, without this division, the company would have been free cash flow positive. However, expecting that Nokia will overtake either iOS or Android and become king again is probably a foolish (small f) idea.

The Sum of its Parts Approach:

This argument has become more popular as the stock has declined, and value investors try to figure out if there's more to the company than the current market price. In fact, Sean Williams of recently addressed this in an article where he noted that there was a 28% increase in shares sold short between the end of August and middle of September. He believed that this was partially due to the release of the iPhone 5, and stated he believes the company is worth more broken up than it is in its current state.

In this prior article, 3 different contributors weighed in their opinion of Nokia and its real valuation. Alex Planes suggested that the company's current market cap was right in line with its available cash and investments. He also said Nokia was similar to Motorola when it was acquired for $12.5 billion by Google. Sean suggested that the value of the company's cash, investments, patents, property and equipment was worth more than the current market cap. Of the three contributors, only Travis Hoium sounded the alarm that he was not convinced. He said that it was less likely that Apple or Google would go after Nokia's patents given their prior purchases. In summary, he said that he wouldn't want to own any of Nokia's businesses, as they were destroying cash, which would lessen the value of a potential takeover.

The Who Cares About Nokia Approach:

This approach is relatively straightforward, given the company's increase in short interest obviously some investors assume that the stock is set itself. The company has been too slow to adapt to the fact that consumers are choosing Smart phones, and even a hit with Windows Phone 8 will necessarily save the company. The thought is, even if Nokia were taken over, the company's value is not significantly different from the current market cap leaving no room for price improvement.

My Take:

While I respect the other writers opinions, I would rather run the numbers for myself to determine if there's value in the seemingly forgotten mobile phone producer. While it's possible the company could improve if Windows Phone 8 is a hit, I don't want to bet on that alone. Instead, I would rather have a backup plan of the company being worth more on paper than it is today. Since patents are one of the company's largest assets, let's take a look at what the reasonable value of Nokia's patent portfolio could be.

According to two different articles, Nokia has over 11,000 mobile patents, and possibly as many as 20,000 total patents or more. Considering that this gives us a wide range to work with let's split the difference and say that the valuable patents are 15,000. This would place Nokia very close to Motorola before it was acquired by Google, which seems to make sense given Sean's comments earlier. To get an idea of the value per patent, let's take a look at a few different deals that have been completed over the last few years:

<table> <tbody> <tr> <td> <p><strong>Seller</strong></p> </td> <td> <p><strong>Acquirer</strong></p> </td> <td> <p><strong>Number of Patents</strong></p> </td> <td> <p><strong>Total Price</strong></p> </td> <td> <p><strong>Avg. Value Per Patent</strong></p> </td> </tr> <tr> <td> <p><strong>InterDigital</strong></p> </td> <td> <p><strong>Intel</strong></p> </td> <td> <p>1700</p> </td> <td> <p><span><span><a href="/mhenage/2012/07/25/patently-undervalued/7876/">$375 mil.</a></span></span></p> </td> <td> <p>$220,000.00</p> </td> </tr> <tr> <td> <p>Motorola Mobility</p> </td> <td> <p>Google</p> </td> <td> <p>17,000</p> </td> <td> <p><span><span><a href="">$12.5 bil.</a></span></span></p> </td> <td> <p>$367,647.00</p> </td> </tr> <tr> <td> <p><strong>AOL</strong></p> </td> <td> <p>Microsoft</p> </td> <td> <p>800</p> </td> <td> <p><span><span><a href="">$1 bil.</a></span></span></p> </td> <td> <p>$1,250,000.00</p> </td> </tr> <tr> <td> <p>Nortel</p> </td> <td> <p>Apple, Microsoft, and others</p> </td> <td> <p>6,000</p> </td> <td> <p><span><span><a href="">$4.5 bil.</a></span></span></p> </td> <td> <p>$750,000.00</p> </td> </tr> </tbody> </table>

(since the Motorola deal wasn't just for patents, but for hardware manufacturing as well, I've assumed about half the deal was for the patent portfolio) 

The most reasonable way to get an average value is to eliminate the highest and lowest average values first. This leaves us with the Motorola deal and the Nortel deal to get an average, which comes to $558,823 per patent. If we use this assumption, the total value of 15,000 Nokia patents would be $8.38 billion. We will come back to this in a minute, but for now let's assume this value is reasonable.

The company shows cash and investments net of long-term debt of about $6.96 billion as of the last quarter. Though the company does have other assets, I'm going to assume that property and equipment would cover those liabilities and not include either. Essentially we are saying that Nokia is worth just the value of its patent portfolio plus its net cash and investments. The total of these two figures is $15.34 billion which is 62% higher than the company's current value. Even if we figure the patents are worth half as much, we still come out with a total of $11.15 billion, or 17.86% higher than the company's current market cap. Since this places no value on the rest of Nokia, it seems like a fair assumption the stock is undervalued. If you believe the rest of the company has value of its own, the time to buy is now.

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