On Thursday, Nokia (NYSE:NOK) published its 20-F report for the year 2012, which is an annual financial report published by foreign companies that trade in American stock exchanges. The report is 288 pages long and I have been reading it cover to cover while taking notes in order to understand the company better. While I was reading the report, something caught my attention. On 23rd page of the report, Nokia provided some details about the nature of its partnership with Microsoft (NASDAQ:MSFT) under the "known risks" section, and there were some interesting details which made me think twice about the partnership between the two companies. Let's take a look at it.
"The agreements with Microsoft may include terms that prove unfavorable to us or Microsoft could provide better support to another device manufacturer which produces devices that run on the Windows Phone platform."
This is very interesting because it shows that there aren't any written rules in the partnership that can protect Nokia in case Microsoft decides to play any games on the company. Of course, I am not saying that Microsoft will play any games on Nokia, but the two companies could have signed an agreement where Nokia gets some sort of special treatment from Microsoft since Nokia is the only company that let go of all ecosystems with the exception of Windows Phone ecosystem and placed all its eggs in one basket. Microsoft should have rewarded Nokia with a better contract which gives Nokia a special spot. Keep in mind that Nokia accounts for nearly 80% of all Windows Phone sales and how Microsoft's other partners also produce Android phones which can hurt Windows Phone ecosystem. I am just disappointed that Nokia acknowledged a possibility of Microsoft giving preference to another company over Nokia, which implies that Nokia is not well-protected by the agreements between the two companies.
"We license from Microsoft the Windows Phone operating system as our primary smart phone platform. Microsoft may act independently of us with respect to decisions and communications on that operating system which may have a negative effect on us. Moreover, if Microsoft reduces investment in that operating system or discontinues it, our smart phone strategy would be directly negatively affected by such acts."
In different parts of the report, Nokia acknowledges that it has very little control (if any) on the content and functionality of Windows Phone operating system. This was also evident with Lumia 900, which faced hardware limitations imposed on Nokia by Microsoft, and as a result, Lumia 900s were not upgradeable to Windows Phone 8 operating system because of the very hardware limitations imposed on Nokia by Microsoft. Again, if Nokia puts all its eggs in one basket and risks it all by partnering with Microsoft, it should have been given at least a little control over functionality of Windows Phone. After all, Nokia sells 4 of every 5 Windows Phones in the market and it should have a say in what functions go in the Windows Phone ecosystem.
"We may not be able to sufficiently influence Microsoft in bringing the features or functionalities for the Windows Phone platform that we deem most important, or Microsoft may otherwise focus on other areas of its business leading to reduced resources devoted to the Windows Phone platform or failures to implement features or functionalities. This may be heightened if our position in the partnership deteriorates, for instance through other companies using leverage to influence Microsoft, or if Microsoft chooses to develop its own mobile devices, including smart phones, or if Microsoft otherwise develops interests that are contrary to ours."
This statement item makes it sound like the partnership between Microsoft and Nokia is very dynamic and subject to change if certain things in the market change. The first part of the item is particularly interesting because it reiterates the idea that Nokia has very little control over functionality of Windows Phone ecosystem and it is left to Microsoft's mercy. The second part of the statement says that the relationship between Microsoft and Nokia may deteriorate if Nokia's competitors are able to influence Microsoft in a different way. A lot of people thought that Nokia was Microsoft's "favorite child" because of the personal friendship between Nokia's CEO Stephen Elop and Microsoft's CEO Steve Ballmer. This was helped by the fact that Stephen Elop used to be an executive at Microsoft before jumping to Nokia. It looks like the relationship between the two companies is not that special and the partnership was designed in a way that would favor Microsoft far more than Nokia.
I understand that the dynamics can change very frequently in a free market and many variables can play a role in partnerships between companies. I am not saying that Nokia and Microsoft should be tied together till death. On the other hand, I believe that Nokia's rights in the partnership could have been protected a lot better. If Nokia agrees to put all its eggs in Microsoft's basket and become the major contributor of Microsoft's operating system, it should have been allowed to enjoy special rights, such as being able to have a say in the operating system's functionality. I know that when a company lists business risks in its 20-F, it doesn't necessarily list things that will happen, but rather, it lists things that might happen. Still, this shows that there are a lot of loopholes in the partnership between Nokia and Microsoft that don't necessarily benefit Nokia.
"New business models require access and sometimes possession of consumer data. If we do not have such access within our own control, this may hinder our ability to pursue such opportunities. We may be required or choose to share with Microsoft personal or consumer data that has been made available to us, which could increase the risk of loss, improper disclosure or leakage of such personal or consumer data or create negative perceptions about our ability to maintain the confidentiality of such data."
I find this one also very interesting. It basically says that Microsoft has no obligation to share the consumer data it collected with Nokia, whereas Nokia might have an obligation to share its consumer data with Microsoft. This sounds like a one-sided agreement to me. More importantly, I saw several references to a possibility of a Microsoft made smartphone in the report. This is the first time Nokia officially acknowledged a possible Microsoft smartphone. Furthermore, Nokia admitted that a Microsoft smartphone would influence Nokia's revenues negatively.
I am definitely not saying that Nokia's partnership with Microsoft is a bad thing. I've always defended Nokia's decision to partner with Microsoft. The only problem here is that the specifics of the partnership sound like a one-sided partnership to me. The details of the partnership could have been drawn better.
All in all, I am long Nokia. If Windows Phone ecosystem will be successful, it will be because of Nokia.
Disclosure: I am long NOK, MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.