Nokia-Microsoft: Too Early For An Acquisition

| About: Nokia Corporation (NOK)

I've been covering Nokia (NYSE:NOK) for a long time and I've written tens of articles regarding the company, covering its latest progress. I studied a lot of different aspects of the company and attempted to learn the company beyond the numbers. Sometimes, one has to understand more than just numbers to see where a company is going. Having studied the Nokia-Microsoft (NASDAQ:MSFT) partnership since the very beginning, I believe that there are parts in the Wall Street Journal's story that I can't find myself agreeing with.

I am not saying that the story is a complete lie, but I know that there are some details in the story that can't be true. The story claims that Microsoft has approached Nokia to purchase Nokia's smart phone business. However, Microsoft was concerned about a couple things which killed a possible deal. According to the story, Microsoft was worried about Nokia's price tag as well as its market prospects.

Before I even mention the story, I'd like to mention one thing. According to the story, Microsoft was not planning to buy all of Nokia. The company was only interested in Nokia's smartphone business. If Microsoft were to buy Nokia's smart phone business, the company would have to either keep or sell its remaining businesses (feature phones, Nokia Siemens Networks and "HERE", the mapping segment).

Here is why the story doesn't make sense to me as an educated Nokia investor:

1) At the moment, Microsoft doesn't need to buy Nokia more than Apple (NASDAQ:AAPL) needs to buy Foxconn. Currently, Nokia is fully committed to the Windows Phone project, and the company already produces the devices Microsoft desires. In many cases, Microsoft dictates the specifications of Nokia phones. For Microsoft, acquiring Nokia would serve no purpose at the moment. A possible Microsoft takeover has always been a part of Nokia's Plan B. However, it is too early to initiate the Plan B at the moment. If Nokia starts to burn through cash like it was doing last year, Microsoft can always step in to save Nokia, but this is not needed at the moment. While it is not highly profitable at the moment, Nokia isn't on the verge of a bankruptcy either. The company is able to reach breakeven at the moment, which means that Microsoft's help is not needed for the time being. As someone who has repeatedly said "Microsoft may acquire Nokia," I don't think Microsoft would do it this soon. It is very likely that Microsoft has approached Nokia for a possible buyout in the future as a backup plan.

2) Acquiring Nokia (either as a whole or part of the company) would expose Microsoft to the hardware business where the company doesn't have much experience. Sure, Microsoft has the Xbox and the Surface. However, we are still talking about a software company that generates very healthy margins and strong profitability from its existing products. It doesn't make sense for Microsoft to start producing hardware unless it has to. A few months ago, Terry Myerson, corporate vice president of the Windows Phone division, admitted that Microsoft was not interested in building a smartphone as long as its partners were doing a satisfactory job. Basically, as long as Nokia stays committed to the Windows Phone project (and doesn't go under) Microsoft will have almost no reason or motivation to take the matter into its own hands (by acquiring Nokia and becoming a smartphone builder). When Microsoft builds software, it can license the software and earn recurring profits on the product. Building hardware is much more complex as the company would have to deal with the supply chain, material costs and availabilities, warranty and return issues (and product recalls), not to mention the fact that the hardware business doesn't really provide recurring revenues. Once a product is bought, its revenue generation is completed.

3) The Wall Street Journal's story says that Nokia demanded a high price for its smartphone business which played a role in changing Microsoft's mind about acquiring the company. In one of my recent articles, I showed how Microsoft could buy Nokia practically for free. Currently, Nokia's market value is around $13-14 billion which is much below the company's "sum-of-all-parts" valuation (the company's cash alone totals $13 billion and some change). Now, we don't know the price tag Nokia supposedly put on its phone business but Microsoft could easily work around it by buying the entire company and then spinning-off Nokia's business units that it doesn't want to keep. If Microsoft were to spend $20 billion for buying Nokia, it could keep the company's cash, convert its existing debt into lower-interest debt (given Microsoft's strong credit rating), sell Nokia Siemens Networks and HERE. Given Nokia's current cash reserves, buying the company for $20-25 billion would be like buying it for free. The idea of Microsoft being scared away because of Nokia's asking price doesn't fully make sense to me.

4) The story also claims that Microsoft was deeply concerned with Nokia's market position and the small market share. This is what I had most trouble with believing. When we consider the fact that 84% of all Windows Phone devices sold globally are produced by Nokia, if Microsoft is truly worried about Nokia's market position, it is pretty much admitting that its Windows Phone project is dead. If anything, Nokia is the only thing that keeps the project alive at this point. If it wasn't for Nokia, Windows Phone wouldn't survive at all. If Nokia's market position is weak, it is just a function of the weak market position of the Windows Phone. Whether Microsoft buys Nokia or not, the future of the Windows Phone project is highly dependent on Nokia. This is why it doesn't make sense to believe that Microsoft backed away from buying Nokia due to concerns about the company's market position (which is basically the Windows Phone's market position). If Microsoft doubts Nokia's chances of gaining any significant market share, it should just cancel the Windows Phone project altogether.

5) If Nokia sells its smart phone business to Microsoft, what does it do with the rest of the company? Does it become a feature phone maker and continue losing market share to death, until the whole world eventually converts to smartphones? Will it follow the footsteps of Ericsson and focus on Nokia Siemens Networks alone? Will it become a mapping company? Without its smartphone business, Nokia wouldn't have much of a direction. In that case, why would the company sell its smartphone business instead of selling itself entirely? This makes little sense to me.

In conclusion, I don't believe that Microsoft is interested in buying Nokia at this point. If Microsoft eventually buys Nokia, it will be done to save Nokia from an imminent death. Because Nokia isn't in the death bed right now, and it is helping Microsoft gain market share, I expect Microsoft to keep the partnership the way it is for the time being. If Microsoft has to buy Nokia someday, it will be buying a pretty cheap company with a lot of potential. Many people believe that the company's patent portfolio alone is worth as much as its market value at the moment. We'll wait and see how this partnership turns out. So far, every prediction I've made regarding this partnership has come true and I hope that things continue to be that way in the future. I am still long 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.

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