Genuity looks at RIM / Nortel tie-up

Add myself to the list of Genuity Capital Markets’ research clients who are scratching their noggins about the story that Research in Motion (RIM:TSX) wants some of the Nortel assets. Here’s their overview:

· Wants to bid for Nortel assets – RIM announced that it is interested in bidding for Nortel’s CDMA and LTE access businesses and certain other assets for $1.1 billion subject to due diligence. However, RIM went on to say that it has been prevented from bidding by the process, as it was told that it could not bid on additional Nortel assets for one year. Given that RIM is interested in other Nortel assets, it finds this clause prohibitive. From our understanding, all bids are due by July 21 at 4:00 pm EST, with the auction being held on July 24. So far, the only other public bid is Nokia Siemens’ $650 million for Nortel’s CDMA and LTE business, and we believe not including other intellectual property. RIM is effectively appealing to the Canadian government to intervene in the bid process.

· Why does RIM want networking assets? Could be for the IP – The bid for Nortel’s CDMA and LTE access business is puzzling, as this is outside of RIM’s core area of expertise and the networking business is hyper competitive with a lower margin structure. Most companies in the networking space are not making any money. The primary reason for the bid, we believe, is Nortel’s intellectual property, as it has key patents in LTE and CDMA. In a press announcement a year ago, Nortel indicated that it was willing to sign licences for its patents that are equivalent to 1% of LTE revenues. If Nortel’s IP can generate that level of royalty from LTE, the patents could produce hundreds of millions in revenue per year. For example, if 100 million LTE handsets are sold by 2013 with an average ASP of $150, the potential royalty revenues would be $150 million.

· Strengthening IP portfolio to improve negotiating position – As we have mentioned before, RIM is buying patents to build its portfolio and strengthen its negotiating position with other wireless vendors to reduce its effective royalty rate. Essentially, RIM is using its balance sheet to substitute its relatively short history to build its patent portfolio. RIM has spent $1.3 billion on patents over the past two years (also includes Certicom acquisition), and another $270 million to settle with Visto. If the IP is the primary target, we could see RIM sell the network business. As of December 31, 2007, Nortel had approximately 3,650 U.S. patents and approximately 1,650 patents in other countries. It has been reported by industry analyst IFI Plenum that, in 2006, Nortel ranked 69th in terms of number of patents granted by the U.S. Patent & Trademark Office.

· Other reasons to buy – Potential reasons include: 1) RIM sees long-term integration between handsets and networking infrastructure as a potential competitive advantage with the move towards 4G wireless technologies like LTE; 2) the unit is highly profitable, as we believe it generated $2.1 billion in revenues and 20%+ operating margins in 2008 – although those numbers are declining; 3) the unit could have numerous tax assets; and 4) RIM would acquire a number of CDMA and LTE engineers to accelerate its own development of LTE devices (total is around 2,500).

· What other assets could RIM be looking at? – We believe RIM could be looking at other patents within Nortel or even Nortel’s enterprise PBX business, as it could facilitate integration between smartphone and enterprise voice systems. However, acquiring the PBX business would put RIM in direct competition with its partners such as Cisco and Avaya (which bid $475 million yesterday for Nortel’s enterprise business).

MRM
(disclosure – I own RIM)