Microsoft And Nokia: The Blind Leading The Blind

by: Kofi Bofah

On July 18, 2013, Nokia (NYSE:NOK) released an interim report for its second quarterly and semi-annual period ended June 30, 2013. For this latest second quarterly period, Nokia reported sales of 61.1 million handset units, in total. Of this amount, Nokia shipped a record 7.4 million Lumia phones for the period. Despite these record sales, Nokia posted $365 million in losses during Q2 2013. Wall Street was clearly not impressed, as traders promptly dumped Nokia stock to $3.89, for a 4.4% loss on the session.

The following day, on July 19, 2013, Microsoft (NASDAQ:MSFT) released its very own fourth quarterly report for its fiscal 2013. The report confirmed fears of a weakening PC market and Windows sales. On this news, Microsoft shares lost an immediate 11% in value to close out this session at $31.40. These recent event were also confirmation that the Microsoft - Nokia partnership is a failure in leadership. Microsoft and Nokia shareholders should sell out now - to avoid further losses. At best, Microsoft is a zero-growth utility stock that pays dividends. Instead of risking capital in the technology sector strictly for income, a consumer staples stock, such as Coca-Cola (NYSE:KO), offers a much more favorable risk versus reward profile.

Terms of the Agreement

On February 11, 2011, Microsoft and Nokia issued a public statement documenting broad plans to partner up and build out a new global ecosystem. By definition, this partnership was designed to be mutually beneficial. At the time of consummating the deal, Microsoft was exploring new strategies to effectively grow its bottom line away from bread and butter software licensing, while Nokia was simply hoping to maintain survival and relevance. Terms of the agreement effectively specified that Microsoft would put up the Windows software and marketing cash, in exchange for near exclusive rights to power Nokia hardware. For Nokia's part in the deal, the company established itself as a node within a Windows ecosystem for telecommunications, computing, and entertainment.

Shortly after the ink dried on this deal, however, Microsoft had forged alliances with both Samsung (OTC:SSNLF) and Huawei Technologies to also hawk Windows platform phones. Yes, Microsoft is notorious for throwing its own partners beneath the bus and forcing them into direct competition against each other as original equipment makers. Cynics, of course, may speculate that this partnership was simply one move within a calculated series of transactions to ultimately deliver Nokia to Microsoft.

Prior to the partnership agreement, Nokia introduced Stephen Elop as its chief executive officer, on September 9, 2010. On June 19, 2013, The Wall Street Journal reported that "people familiar with the matter" indicated that Microsoft held "advanced" talks to acquire Nokia. Acquisition talks allegedly broke down over price and Nokia's flagging position within the smartphone market. If anything, the recent collapse of this prospective deal signals a lack of leadership at the top - from both Nokia and Microsoft executives. Taken together, these two former heavyweights have been unable to build a machine that can effectively compete against the likes of the Apple (NASDAQ:AAPL) iOS and Google (NASDAQ:GOOG) Android ecosystem juggernauts.

The Web 2.0 Ecosystem

Again, the smartphone is the financial and physical focal point for a Web 2.0 ecosystem that includes Internet access, music, social media, and word processing. The Apple iPhone is clearly the crown jewel of this Web 2.0 movement. On October 31, 2012, Apple released a financial report for its 2012 fiscal year ending September 29, 2012. To close out its latest fiscal year, Apple reported sales of 125 million iPhone units. This performance adds up to $80 billion, or more than half, of Apple's $157 billion in 2012 net sales. Certainly, the blockbuster success of the iPhone also helps to drive sales for MacIntosh portables and iPad tablet computers. This halo effect, or goodwill, is the keystone building block upholding Apple's now $400 billion in market capitalization. Meanwhile, Google has also built out a formidable ecosystem of its own - to include the Nexus tablet, Samsung Galaxy smartphone, and of course, Search. Google Android and Apple iOS are the leading ecosystems of this Web 2.0 era, by far.

For Microsoft and Nokia, emotionally jarring fits and starts characterize the strategic playbook of this alliance. Wall Street traders should recognize a distinct pattern of Microsoft cash fueling marketing hype prior to each product launch. Following product launch, the next quarterly earnings report will confirm yet another failure to meet sales projections, and traders will dump stock, until the next Lumia or Surface prototype intrigues speculators to start the cycle anew. Rather than function as beta copycat, Microsoft and Nokia executives and engineers must actually create fresh product for growth. This modern-day Abbott and Costello duo will degenerate further as laughing stock, if Google Glass and Apple iWatch emerge as revolutionary product lines.

On June 28, 2013, research firm comScore released its report summarizing May 2013 U.S. smartphone subscriber market share. This report averages data for the three-month period spanning between February 2013 and May 2013. Again, statistical and empirical data indicate that Nokia and Microsoft are losing this technological arms race. In fact, Microsoft Windows and the effectively defunct Nokia Symbian operating systems lost a small part of their already meager 3% smartphone market share relative to the prior quarter. Taken together, the Google Android and Apple iOS duopoly now powers a staggering 91% of the smartphone market. On the other side of the ledger, Apple and Samsung are a respective one and two as original equipment makers. The Microsoft - Nokia partnership is quietly biting the dust. At this junction in time, nothing short of a Buffalo Bills versus Houston Oilers 3-35 miracle comeback can salvage the account balances of Microsoft and Nokia shareholders.

The Bottom Line

Microsoft's rejection of Nokia at the eleventh hour may serve as evidence that Redmond is not willing to pay a significant premium above the original equipment maker's $15 billion in market capitalization. Nokia recently closed out its Q2 2013 books with $35 billion in assets above $18 billion in liabilities on the balance sheet, which breaks down further to $17 billion worth of intangible assets. The asset side of the equation does include $6.3 billion in goodwill, $490 million in other intangible assets, and $1.8 billion in property, plant, and equipment. In theory, these assets will depreciate towards zero, if Nokia fails to turn annual profits. At worst, Nokia is worth roughly $8.5 billion, or $2.30 per share, in tangible book value.

Again, for Q2 2013, Nokia lost $365 million. Nokia tallied these losses despite the fact that Microsoft makes $250 million in "platform support payments" to the company each quarter. Nokia now owes a net $650 million to Microsoft. If anything, Microsoft is positioned to take over remaining scraps of Nokia on the cheap, as a top creditor in bankruptcy court. The failure of the Windows brand to spark growth will ultimately force the hand of Stephen Elop, Nokia CEO, to take real risks and energize Nokia. The logical decision would be to go on the offense, and at least entertain offers to further develop and integrate the Android operating system. In any event, Windows engineers have failed to build out a viable third wheel alternative within the smartphone market. Nokia must save its own self.

Most likely, Microsoft will partner up with another struggling original equipment maker, to follow in the footsteps of both Google and Apple and hawk Windows through glasses and watches. As an effective utility stock, Microsoft generates more than enough cash flow to haphazardly throw dollars into yet another prospective growth story that never materializes.

Disclosure: I am long KO. 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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