On September 3, 2013, Wall Street awoke to a barrage of articles that reported Microsoft would be purchasing Nokia's wireless device business for $7.2 billion. Upon dissemination of the news, Nokia (NOK) stock immediately gapped up by more than 30%, to close the session above $5 per share. Alternatively, Microsoft (MSFT) declined toward $31.50, which was a prompt 6% loss in value. In retrospect, the writing had been on the wall telegraphing a mobile deal for at least the past two years. On February 11, 2011, Microsoft and Nokia announced broad plans to develop an integrated ecosystem as partners. The prior year, in 2010, Stephen Elop was named Nokia CEO after heading Microsoft's powerful Business division for two years.
The Microsoft - Nokia deal is eerily similar to General Electric (GE) and Jack Welch's botched attempt to acquire Honeywell (HON) in 2000. At the time, a legendary manager was attempting to make a lasting impression upon his company before riding off into the sunset. The test of time, however, may prove that Steve Ballmer is no Jack Welch. Over the past decade, the Microsoft business model has degenerated toward that of a utility. Real growth at Microsoft will remain difficult due to both the size of the company and its well-earned image as a beta follower. Microsoft has been dead money for 14 years and may continue to offer negative real returns over the next 18 months.
Ramifications for BlackBerry
As Wall Street digests news of the imminent Microsoft - Nokia takeover, traders will also turn their sights toward BlackBerry (BBRY). On May 29, 2012, BlackBerry issued a press release announcing that it had hired JPMorgan and RBC bankers to perform a "strategic review" of the company. The Wall Street Journal recently reported that BlackBerry has established a timetable of closing a deal to sell off this business by November of this year. Speculators have maintained the idea that Microsoft was an ideal candidate to take over BlackBerry throughout this strategic review period. Microsoft's proposal to acquire Nokia, however, leaves BlackBerry as the proverbial odd man out. BlackBerry now trades for $11 per share, which does calculate out to $5.8 billion in market capitalization. Microsoft is not likely to pay a premium above this BlackBerry valuation, considering the fact that Redmond just spent $7.2 billion to acquire the Nokia mobile division.
In any break up, BlackBerry executives and bankers may attempt to package handset and intellectual property together in a deal. BlackBerry may also offer up its operating system and BBM messaging programs as individual units for buyers. In all, these separate BlackBerry units combined for $84 million in losses during its Q1 2014 ended June 1, 2013. BlackBerry speculators holding out hope for any prospective buyout deal should consider liquidating their positions. Both Microsoft and Google (GOOG) have bypassed BlackBerry in favor of respective deals for Nokia and Motorola. Alternatively, a prospective Chinese buyer, such as Huawei Technologies, would be thwarted by security concerns out of American and Canadian officials. BlackBerry may ultimately be on the road toward bankruptcy at Waterloo.
The Microsoft - Nokia Partnership
According to a recent regulatory filing, Nokia already owed Microsoft more than $650 million in future royalty payments prior to the announcement of this takeover deal. A more calculating Microsoft may have considered allowing Nokia to fail before picking up assets on the cheap as a creditor. Nokia did stagger through $366 million in losses during its latest Q2 2013 ended June 30, 2013.
On August 7, 2013, research firm comScore released a report summarizing June 2013 U.S. smartphone subscriber market share. A quick review of the information would highlight the presence of a dominant Apple iOS - Google Android duopoly above this smartphone market. Taken together, Apple (AAPL) iOS and Google Android operating systems powered 91.9% of U.S. smartphone subscriptions during this latest quarter. Meanwhile, Apple and Samsung (GM:SSNLF) were the leading smartphone original equipment manufacturers (OEMs) with respective 39.9% and 23.7% shares of this market. The Microsoft - Nokia partnership has been a near non-factor within the smartphone industry. Nokia was not able to establish itself as a top-5 smartphone OEM while the Microsoft Windows platform operated a meager 3.1% share of U.S. smartphone subscriptions during the April 2013 to June 2013 quarter.
U.S. Smartphone Platform Market Share
March 2013 (%)
June 2013 (%)
1Q13-2Q13 (%) Change
The percentages are averages of data compiled during calendar quarterly periods.
Source: comScore (August 7, 2013)
Investors should also weigh in upon the idea that the Microsoft Surface tablet was a bust. In his August 4, 2013 Beta News piece, technology writer Wayne Williams unceremoniously dismissed Surface sales results as "pathetic." An August 5, 2013, press release out of International Data Corporation indicated that the Windows operating system powered a mere 2 million tablet shipments during Q2 2013. For the sake of comparison, Android and iOS combined to run 42.8 million tablet shipments during this latest quarter, which was a combined 95.1% of the market.
Microsoft, at its core, will remain a software business. Microsoft has typically categorized its operations according to Windows, Business, Server and Tools, Entertainment and Online Services divisions. Sales to original equipment manufacturers, such as Hewlett Packard (HPQ) and Dell (DELL), have historically generated between 67% and 75% of Windows division revenue. The Microsoft Business operating segment is somewhat of an adjunct to Windows. Microsoft Business is home to the Office software umbrella above Excel, Word and Power Point. Taken together, Microsoft Windows and Business divisions combined for $44 billion of the company's $77.8 billion in 2013 revenue.
On October 26, 2013, Microsoft brought its Windows 8 operating system to market. Windows 8 was engineered as a fusion between traditional smartphone, tablet and personal computer interfaces. All data, however, released out of research firm Net Market Share has indicated that Windows 8 has lagged significantly behind the much-maligned Vista operating system at similar points in both product life cycles. In total, the Windows operating system still drives more than 90% of all desktops. Windows 8 (7.4%) has recently surpassed Vista (4.1%), in terms of market share. Windows 7 remains the leading operating system with 46% of the market. Consumers have opted to maintain older Windows machines instead of upgrading to Windows 8.
On July 10, 2013, research firm Gartner estimated that the worldwide PC market has declined by 10.9% on a year-over-year basis to 76 million shipments during Q2 2013. During this second quarter, the Western European consumer personal computer market collapsed by 25.8% compared to the prior year. Meike Escherich, Gartner principal research analyst, indicated that the looming Windows 8.1 launch "will not fully compensate for the ongoing PC decline." The failure of Windows 8 and the lack of a halo effect above Microsoft will sabotage future smartphone sales and growth at the company.
The Bottom Line
On August 23, 2013, Microsoft issued a statement that Steve Ballmer was set to retire as CEO within the next 12 months. Upon this news, Microsoft stock immediately gapped up by 7.2% to close out the following trading session at $34.75 per share. In effect, Steve Ballmer's decision to step down added $20 billion worth of market capitalization to Microsoft. On September 4, 2013, Microsoft shares finished the day off at $31.20, for 6.7% in losses in the aftermath of the Nokia takeover announcement. Ironically, Steve Ballmer's announcement to retire literally paid for this Nokia deal, in terms of market capitalization. Ballmer, however, has saddled his yet-to-be-named predecessor with a handset business that will weigh down bottom line growth at Microsoft.
Again, Microsoft agreed to pay $7.2 billion for a Nokia device business that has deteriorated sharply over the past 18 months. Nokia reported sales of 7.4 million smartphones during its latest Q2 2013 ended June 30, 2013. This tepid Nokia smartphone sales performance is actually a 27% year-over-year decline. This Nokia handset division has already posted $100 million in losses through the first half of this year. Microsoft may be forced to write down a few billion dollars in property plant equipment and intangible assets if this Nokia takeover never materializes to turn real profits.
Going forward, Microsoft will manage business as usual for its shareholders. In effect, Microsoft is a utility that dominates a shrinking market. As such, investors can expect this corporation to continue returning larger amounts of capital to shareholders in the form of dividends and stock buybacks. The Microsoft Way will be no recipe for growth and competitive returns against the S&P 500. Shareholders would have been better served had Microsoft ultimately embraced historical catcalls from the Department of Justice to break up this corporation. Instead, Bill Gates and Company erroneously doubled down upon Nokia and "bigger is better."