Microsoft's (NASDAQ:MSFT) acquisition of Nokia's (NYSE:NOK) device and services unit, given for granted by the Redmond company, that is already advertising the Lumia range without any Nokia logo, is actually pending shareholders approval.
In a recent filing, the Finnish company finally discloses some information about the negotiations behind the curtain and several key details of the deal, ahead of its extraordinary general meeting at which Nokia's shareholders will be asked to approve the proposed transaction with Microsoft.
While there had already been press speculations about some of these aspects, it is interesting to get some official, firsthand knowledge of what really happened.
In this article, we'll go through some selected items that, in our opinion, shed an interesting light about how Nokia arrived at the decision of selling its mobile business, probably its "lesser evil" option.
If you do not want to go through the parts of the filing we will be quoting, you may skid the next 4 paragraphs.
What happens if the deal is not approved by Nokia's shareholders?
If the Sale of the D&S Business is not confirmed and approved by our shareholders at the Extraordinary General Meeting, we will not sell the D&S Business to Microsoft International at this time and we will continue to conduct our business in the ordinary course and evaluate all available go-forward strategic alternatives. In addition, both Nokia and Microsoft International will have the right to terminate the Purchase Agreement and we would be obligated to pay Microsoft International or its designee a damages fee equal to EUR 37,900,000 [$ 51 million].
If the Purchase Agreement is terminated because our shareholders do not confirm and approve the Sale of the D&S Business at the Extraordinary General Meeting and we receive a competing proposal to acquire control of at least 20% of our voting securities or all or a material portion of the D&S Business that has not been withdrawn prior to termination of the Purchase Agreement and within one year of termination we consummate a transaction with regard to any competing proposal, we would be obligated to pay Microsoft International or its designee an additional fee equal to EUR 113,700,000 [$ 153 million] less the EUR 37,900,000 damages fee if previously paid to Microsoft International or its designee.
Further, if the Sale of the D&S Business is not approved by our shareholders at the Extraordinary General Meeting, the Patent License Agreement will not become effective and we will not receive the EUR 1.65 billion payable under the Patent License Agreement from Microsoft (EUR 100 million of which is payable as consideration for Microsoft's unilateral right to extend the term of the Patent License Agreement to perpetuity). In addition, Microsoft will not become a licensee of Nokia's HERE location platform.
If the sale is not approved, Microsoft might become Nokia's largest shareholder
After we made our election to issue all three tranches of convertible bonds on September 6, 2013, Microsoft International notified us that, should the Sale of the D&S Business not be consummated and assuming that Microsoft International retains ownership of all the bonds and converts all the bonds into Nokia shares at their respective initial conversion prices, Microsoft International would hold 367,524,324 Nokia shares and voting rights, representing 8.9% of Nokia's total issued shares (calculated assuming the number of Nokia's total issued shares remains unchanged as of today's date and taking into account the conversion of all bonds into shares). Microsoft International's decision to exercise its conversion right would have a dilutive effect on our other shareholders and could make Microsoft International our largest individual shareholder.
Background of the Sale of the D&S Business
On April 21, 2011, Nokia and Microsoft entered into the Existing Commercial Agreement pursuant to which Nokia would adopt Windows Phone as its primary smartphone platform and deliver mapping, navigation, and location-based services to the Windows Phone ecosystem in order to help bring Windows Phone and Nokia's products to a larger range of price points, market segments and geographies.
In June 2012, Nokia launched a strategic planning process at the request of Nokia's Board of Directors to review Nokia's relationship with Microsoft, including the Existing Commercial Agreement.
Discussion of a potential strategic transaction between Nokia and Microsoft began in more concrete terms in February of 2013, when Steve Ballmer, Chief Executive Officer of Microsoft, called Risto Siilasmaa, Chairman of Nokia's Board of Directors, to suggest a meeting to discuss the possibility of deepening Nokia's and Microsoft's partnership.
Nokia's Board of Directors determined that Mr. Siilasmaa should be the principal point of contact and conduit for negotiations with Microsoft in order to assure that Nokia's independent directors exercised appropriate control over the strategic review. The strategic review included, among other things, whether to continue to execute Nokia management's current strategic plan, whether to seek to amend the terms of the Existing Commercial Agreement, whether to continue using Windows Phone as Nokia's primary smartphone platform or whether to adopt an alternative, whether to sell all or part of the D&S Business and whether to sell all or part of HERE.
On July 24, 2013, Microsoft and Nokia entered into a non-binding Letter Agreement with respect to a Sale of the D&S Business, which governed the terms of the negotiation process with respect to the Sale of the D&S Business (the "Letter Agreement").
[O]n September 2, 2013, Nokia's Board of Directors held a meeting at which representatives of J.P. Morgan then presented J.P. Morgan's financial analyses of the EUR 5.44 billion in cash to be paid to Nokia in connection with the Sale of the D&S Business, the Patent License Agreement, and the option to extend the term of the Patent License Agreement to perpetuity, and orally rendered its opinion.
After further discussion, Nokia's Board of Directors, having determined that the terms of the Purchase Agreement and the Sale of the D&S Business, were fair to and in the best interests of Nokia and its shareholders, approved and declared advisable the Purchase Agreement and the Sale of the D&S Business.
Reasons for the Sale of the D&S Business
In evaluating the Purchase Agreement and the Sale of the D&S Business, Nokia's Board of Directors consulted with our senior management, as well as our outside legal and financial advisors, and considered a number of factors, including the following material factors:
- the fact that Nokia's Board of Directors undertook an extensive strategic review and considered a wide range of strategic alternatives and scenarios prior to approving the Sale of the D&S Business and recommending that our shareholders confirm and approve the Sale of the D&S Business, including but not limited to changing the platform for Nokia's smartphones, selling some or all of the D&S Business to other potential acquirers and amending the Existing Commercial Agreement;
- the fact that in connection with its assessment of strategic alternatives, Nokia's Board of Directors also considered whether to terminate the Existing Commercial Agreement before its full term and focus on adopting another smartphone platform. While the Existing Commercial Agreement does not fully restrict Nokia from developing and using other mobile operating systems, this agreement contains certain limitations as well as financial incentives to encourage Nokia to continue using Windows Phone as its primary smartphone platform.
- Notably, Nokia has been receiving quarterly platform support payments in recognition of the unique nature of our partnership with Microsoft and our contributions to the partnership, including our substantial commitment to the Windows Phone platform. In connection with its determination and analysis of the Sale of the D&S Business, Nokia's Board of Directors carefully considered terminating the Existing Commercial Agreement and analyzed the financial and operational implications, including the considerable costs associated with transitioning to a new smartphone platform
Our take on the deal
It is now relatively easy to describe the Microsoft/Nokia partnership as a failed one, that had to be turned into either something different (Microsoft taking complete control of it), or was at risk of imploding.
The filing shows that the BoD evaluated that going Android at this time was also a challenge, given the company's relatively weak financial position and the fact that Nokia would be a late adopter of this OS.
Microsoft, on the other hand, could not afford being remembered as "the partner who brought the largest handset producer to the verge of bankruptcy."
Nokia's plan B: buy us or disappear from the market
Nokia's relative strength in its negotiations with Microsoft was its, de facto, "monopoly" on WinPhones. The company represents about 80% of sales of this platform.
For Microsoft, it's "make or break" time in mobility. Time will tell if Nokia's acquisition will represent the inflection point for the company. We are skeptical the Redmond company is pursuing the right strategy.
Nokia's best deal with its former CEO, Elop, at the time of separation
Nokia estimates that Elop's golden parachute will amount to €18.8 million ($25 million). The Finnish company, however, will only bear 30% of this cost, with the rest being paid by Microsoft.
Technically, Nokia will "authorize" Mr. Elop to work for Microsoft (again), and thus save most of this expense:
Mr. Elop is subject to a covenant restricting him from working for certain specified competitors of Nokia, provided that upon Mr. Elop's commencement of employment with Microsoft, Nokia will waive his competition restriction as to Microsoft.
It may sound bizarre that Nokia took the time to negotiate a few million saving on a transaction worth $7.17 Billion - however, some little details at the time of separation sometimes may say a lot about how a company feels about a former manager. As noticed before, the Board had already determined that Mr. Siilasmaa, instead of Mr. Elop, was the right person to conduct negotiations with Microsoft for the potential sale of the device division.
Getting rid of its device unit, Nokia is unlocking value for its remaining businesses
As The Value Perspective notes, Nokia got rid of its money-losing device unit at a very good price, and the company's shareholders seem to have been so relieved by the good news that the valuation of the remaining parts of Nokia are now at risk of an optimistic counter reaction:
With most pundits reckoning Nokia got a good price from the Microsoft deal, clearly it has not only been an eventful summer but also a profitable one for the company. It is not unreasonable to infer from the €1.5bn funding line that Nokia may have needed it to be.
This brings us to the last piece of intrigue in the story - for now at least - being that Nokia's purchase of 50% of NSN for €1.7bn obviously values the whole of NSN at €3.4bn. Yet, at the time of writing barely two months later, the market is valuing Nokia's equity at over €16bn.
Given we know what the handset business is being sold for, that means the rest of Nokia's operations - of which NSN is currently by far the biggest part - are being valued at around €11bn by the stock market. We simply point out that there seems to be rather a large difference between Siemens view of what NSN was worth and the value currently being placed on it by investors.
We expect that Nokia's shareholders will approve the deal, and we believe that it will take some more time before the market will be in a position to fully evaluate Nokia's remaining business value - the main reason why we still remain on the sideline.
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.