Microsoft (NASDAQ:MSFT) announced a $7.2 billion deal for Nokia's (NYSE:NOK) handset division, which the market swiftly dismissed, sending its shares down 4.6%. This reaction was a total over-reaction, and investors with a long-term perspective should appreciate the potential value of this deal.
First, even if this deal proves to be a stupid foray into hardware, the stock's reaction strains credulity. With its drop, MSFT lost $12.5 billion in value. Under the worst case scenario, Nokia has no value, and Microsoft just blew $7.2 billion. Right off the bat, the stock overreacted by $4.3 billion or 1.6%. There's also been a discussion about a better use of this cash, perhaps buying back shares or boosting the dividend. That argument is factually misguided. Microsoft is using cash trapped overseas to fund the takeover. If MSFT wanted to bring the cash back to the United States, it would pay a 35% repatriation tax. In a sense, this $7.2 billion acquisition had an opportunity cost of $4.7 billion (its value brought into the U.S.).
Idiotic U.S. tax laws have provided Microsoft with a decent margin of safety and essentially lowered the cost of the deal. Even if it turns out that MSFT overpaid for NOK by 10%, shareholders are still better off than under U.S. alternatives.
Nokia also provides Microsoft with a tremendous option value. We live in an increasing mobile world, and Microsoft needs to have some exposure to this market. Otherwise, mobile operating systems could chip away at its enterprise hegemony. We also live in a world where hardware and software are increasingly harmonized and sold together. Apple (NASDAQ:AAPL) (iOS and iPhone) and Google (NASDAQ:GOOG) (Android and Motorola) have done so successfully in the consumer space while Oracle (NASDAQ:ORCL) has done the same in the enterprise space. Owning Nokia allows MSFT to integrate Windows perfectly into a phone.
Further, the suggestion that Nokia is beyond saving is overly pessimistic. Lumia sales were actually up 32% last quarter to 7.4 million. That figure is nearly triple the shipments of the latest BlackBerry (NASDAQ:BBRY) devices in the past quarter (2.7 million). For an upstart phone, that is not a horrible figure, and with Blackberry hemorrhaging cash and market share, now just might be the perfect time for Nokia to regain its position. Microsoft also has the financial wherewithal to fund a massive advertising campaign to build awareness. The firm could even sell the phone at cost or provide an incentive to the carriers to sell the Lumia while other handset makers require a cash subsidy. Such an action would build carrier buy-in and provide the Lumia with prime selling space within stores. Once the Windows mobile ecosystem is built, it could raise prices and profit from this investment.
The fact is we live in a mobile world, and any technology companies without exposure to mobile face an existential threat to their core business from cannibalization. Entrance in the mobile market is vital for Microsoft's future and Windows' continued dominance. This Nokia deal is an inexpensive way for Microsoft to build a mobile beachhead. With the money trapped overseas, there was little opportunity cost while the avoided taxes provide a cushion. Microsoft also can forcefully push the Nokia devices to carriers with financial incentives to build a larger customer base, entrenching them within the Windows ecosystem. Microsoft now has a plausible mobile strategy, and the stock should not have dropped twice as much as the deal value. Trading 10x earnings with tons of a cash and mobile potential, I'd use this dip to buy MSFT.
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.