On February 10, 2011, Microsoft (NASDAQ:MSFT) and Nokia (NYSE:NOK) issued a press release that outlined broad plans to build out a global ecosystem. General terms of this agreement designated Nokia as the original equipment manufacturer for a new lineup of handsets. In exchange, Microsoft agreed to supply the marketing cash and Windows software for this partnership. The Microsoft-Nokia alliance was established as one wing of a greater ecosystem that now includes personal computer, smart phone, tablet, and entertainment devices.
Microsoft's fortunes, of course, remain heavily associated with the performance of the personal computer market. The Microsoft-Nokia alliance came into being as a means to ultimately spark innovation at two separate companies that have been unable to generate real growth for shareholders since the late 90's. The recent failure of Windows 8, however, is especially devastating to the long-term prospects of Nokia shareholders. Microsoft is not living up to its part of the bargain, as it has failed to create any halo effect that may drive smart phone sales at Nokia.
Windows 8 Specifications
On October 26, 2012, Microsoft launched Windows 8. At the time, an overzealous Robert Johnson of Beta News preordained Windows 8 as "revolutionary." The Windows 8 launch event marked the first major software update out of Redmond being brought to market in over three years. The Windows 8 software release also arrived in conjunction with the Surface tablet and Nokia Lumia smart phone product launches. Upon launch, Windows 8 was notable for its touch screen and tile format that integrated smart phone, tablet, and personal computer interfaces together beneath one umbrella. As part of the new look, Windows 8 also became infamous for the conspicuous absence of the traditional Microsoft Start Menu.
Over the past year, legions of detractors have gone on the attack against Microsoft and its new operating system. Dan Rowinski of TabTimes already ridiculed Windows 8 software as a "boondoggle." Rowinski has also dismissed Microsoft as an "arrogant tech company that believes it should succeed just because it put a lot of work into a product and throws a lot of money behind it." Commentator Kevin Williams described the Microsoft Way further as "heavy handed and out of touch with user needs." In many circles, Windows 8 has been compared to New Coke, which was also perceived as a misguided attempt to sweeten a traditional brand.
On July 18, 2013, Microsoft reported its fourth quarter and full-year financials for fiscal 2013. Microsoft posted $78 billion in 2013 revenue, which was a 6% increase above the prior year. The results included one $900 million charge related to Surface RT "inventory adjustments." Wall Street was clearly not impressed. Traders dumped Microsoft stock to $31.40, for a 13% loss immediately following the release of the company's 2013 annual report. Microsoft's failed efforts to energize the PC market have also sabotaged turnaround efforts at Nokia.
PC Market Collapse And Nokia
According to May 2013 Net Market Share data, Windows 8 sales have lagged significantly behind the much-maligned Vista, at similar points throughout the first eight months of both product life cycles. At the time of the Net Market Share report, Windows 7 and Windows XP remained the most dominant operating systems, as they combined to run an 82% share of all personal computers. Taken together, the statistics and commentary may indicate that consumers and institutions have preferred to maintain Windows 7 machines, instead of upgrading to Windows 8. On August 7, 2013, research firm Gartner issued a statement indicating that the Western European PC market suffered through 20% year-over-year unit sales declines during the second quarter of 2013. Western European consumers, who represent leading indicators for the industrialized world, curtailed PC unit purchases by roughly 26% during the same period. Prior to the release of these numbers, Steven Sinofsky, 23-year head of Microsoft Windows, had already stepped down. Going forward, the catcalls to replace CEO Steve Ballmer will only intensify in volume.
The inevitable Windows 8.1 update and its associated re-entry of the Start Menu will change nothing. Unfortunately for Nokia, Microsoft's inability to energize the PC market will have dire consequences for Lumia Windows phone sales. Microsoft has consistently dominated its market niche. As such, Microsoft can effectively afford to introduce vanilla software updates that still force the hand of PC makers to roll out new computers. Because of this market dominance, Microsoft has generated an average of $29 billion in cash flow from operations over its past three fiscal years, while paying out larger portions of cash as dividends. Although robust, Microsoft's cash hoard is not to be confused with risk-taking and real bottom line growth. Microsoft's beta follower strategies are reflected within share prices that have barely budged from $25 over the past decade. Right now, Nokia is teetering upon the precipice of bankruptcy and operates with little time to lose. Nokia needed a home run out of Windows 8, instead of what may prove to be a base hit, at the very best.
On August 7, 2013, research firm comScore released its report summarizing June 2013 U.S. smart phone market share. This comScore report presented averages of data calculated from the quarter spanning between March 2013 and June 2013. The Google (NASDAQ:GOOG) Android - Apple (NASDAQ:AAPL) iOS duopoly then powered 92% of the U.S. smart phone subscriber market. At the bottom of the heap, Windows is still fighting simply to stay relevant, and build upon its meager 3% share of the smart phone operating system market. For its second quarterly period ended June 30, 2013, Nokia did report record sales of 7.4 million Lumia smart phone units. For the sake of comparison, Apple shipped 31 million iPhone units during the same time frame. The now flagship Lumia 1020 Windows smart phone will do nothing to change the dynamics of this market. Consumers need more than the mere presence of the much lauded Lumia 1020 41-megapixel camera, in order for them to be convinced to exit out of the Android and iOS ecosystems.
The Bottom Line
On June 19, 2013, The Wall Street Journal reported that "people familiar with the matter" claimed Microsoft was engaged in "advanced talks" to acquire Nokia. Terms of the deal allegedly broke down after Microsoft balked at paying a premium significantly above Nokia's then $15 billion in market capitalization. For its most recent second quarterly period, Nokia reported $370 million in losses. The Nokia $35 billion balance sheet included $23 billion in liabilities, which broke down further into $12 billion worth of intangible book value.
Going forward, Nokia may begin writing down parts of $8.7 billion in goodwill, other intangible assets, and property, plant, and equipment, if these assets cannot ultimately be leveraged to turn a profit. Each of these line items has lost significant value compared to this point in 2012, when this group accounted for $10.2 billion worth of Nokia assets. Most likely, these intangible assets were depreciating sharply over the past year, because Nokia reported a net gain of only $64 million in cash flow from the sale of fixed assets and businesses through 2013.
Nokia stock is a strong sell. Cash-rich partner Microsoft has already refused to acquire the Nokia business at the negotiating table. Redmond's token efforts to enhance a poorly received Windows 8 software platform have doomed Nokia shareholders to future losses in value. Nokia cannot "float the note" forever.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.