Nokia Corp. (NYSE: NOK) is very close to closing in on its acquisition of Alcatel-Lucent S.A. (NYSE: ALU). Most analysts love the merger and see big upside for the surviving Finnish and French entity. So why did Bank of America Merrill Lynch decide to downgrade Nokia ahead of the deal’s closure?

The Merrill Lynch downgrade was to Neutral from Buy, and it was based mostly on the Samsung arbitration coming in below expectations. After Nokia’s guidance, it is now implied at a disappointing royalty rate of 25 basis points. The firm lowered its 2016 EBIT expectations as a result, but it also now sees lower visibility in Nokia’s 2018 earnings per share power.

Merrill Lynch has a $10.20 America depositary share (ADS) price objective for Nokia. This also comes with a lower visibility on the intellectual property rights generating profits.

What investors need to understand here is that this royalty stream for intellectual property and patents is one of the larger potential revenue streams out there for many tech companies, including Nokia. Lower values on intellectual property rights could present a serious problem ahead. Merrill Lynch’s report said:

As a result of the increase in recurring payments Nokia is guiding to a recurring revenue runrate of E800m (800 million euro), below consensus of E900m (900 million euro) for 2016 and below the BofAML estimate of E986m. We believe consensus and our estimates expected a royalty rate of 35 to 40 basis points, so this agreement is meaningfully below these expectations.

Commenting on the downgrade, Merrill Lynch’s report went on to say:

We believe with a major potential catalyst having disappointed, the stock is now less likely to outperform this year. Growth in the high-margin Technologies division was meant to be a major driver of earnings/EBIT and in our view has helped the stock trade at a material premium to Ericsson. We now believe that the risk is that this premium narrows as investors may feel less confident in Nokia achieving EPS of ~E0.6 by 2018. We hence lower our recommendation from Buy to Neutral and we will review our model.

The firm’s price objective is based on a probability-weighted average of four valuation scenarios on a pro forma basis for the proposed purchase of Alcatel-Lucent, and then discounted back to a 2015 valuation using a 7% weighted average cost of capital. Those scenarios are a bullish merger case, a base case of the merger, a bearish deal case and the base case of no deal.

Here is by how much Merrill Lynch was counting on this intellectual property right monetization:

Samsung/Nokia is the first major IPR monetisation milestone for Nokia. As the largest smartphone OEM by volume/second largest by value, Samsung likely received volume discounts so that we believe Nokia may be able to higher royalty rates from other mobile OEM’s in future negotiations/arbitrations. LG is already in arbitration and we believe the licensing agreement with Apple will expire this summer. Further the arbitration only covers standard-essential patents and we continue to believe that Nokia should be able to incrementally monetise its implementation patents as well. Having said all of that, the arbitration decision was meant to be a major catalyst for the stock and our previous work had suggested potential upside to expectations. This has not materialised and we will now likely see downgrades to consensus of at least cE100m to 2016 adj EBIT (the difference between SME consensus Technologies revenues of E907m and the new guided run-rate of E800m).

Nokia shares in New York were trading down 11.6% at $6.36 Monday morning, after closing at $7.20 on Friday. Its ADSs have a 52-week trading range of $5.71 to $8.37. Alcatel-Lucent was sucked down along with Nokia on Monday. Its ADSs were down 11.1% to $3.50 after a $3.94 close and in a 52-week range of $5.71 to $8.37.

Prior to Monday’s drop, analysts have been overwhelmingly positive of late on Nokia. The independent research firm Argus recently even gave up to 60% upside projections for Nokia after the Alcatel-Lucent acquisition.

As a reminder, almost all the necessary approvals for the Nokia acquisition of Alcatel-Lucent have been met. Expectations were almost certain that the deal would close, because the merger arbitrage on Friday was less than 1%.

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