Seeking Alpha
Long/short equity, contrarian, deep value, event-driven
Profile| Send Message| ()  

Microsoft (MSFT) Windows 8 has taken a lot of flak since its release. Some of the most critical have been Apple (AAPL) devotees, who chide Microsoft for not making its operating system as "user friendly" as OS X or iOS, the desktop and mobile versions of the Apple OS.

There is no doubt that in mobile devices Apple has been an early leader even if it has been overtaken by Android in the past few years. Windows, while a laggard, is expected to grow steadily in mobile, perhaps achieving something close to a 10% share of the tablet market by 2017 according to IDC.

(click to enlarge)

In the PC market, however, Windows has dominated for many years and that trend seems intact. Windows 8 has not been widely adopted yet, but has nonetheless passed Mac OS X since June of this year. Other versions of Windows comprise the lion's share of the OS market in PC's with Windows 7 continuing to grow share despite the introduction of Windows 8.(click to enlarge)

In smartphones, Windows has been very slow out of the gate but is now showing signs of growth in key markets. While Android commands the vast majority of smart phone systems and Apple's iOS holds second place, Windows phone is beginning to show growth in Europe where by July 2013 it had reached an 8% share. Windows phone penetration in the United States and in China has been barely measurable by contrast

.(click to enlarge)

Microsoft is betting that its acquisition of Nokia's handset business will change all that. It has developed a strategy of integrating the user interface of the Windows OS across all platforms and optimized the UI for touch screen use. Nokia entered the fray with its 2011 strategic partnership with Microsoft, followed more recently by Microsoft's agreement to purchase the Nokia handset business. The question is whether it will fare any better as a division of Microsoft than it did as part of Nokia.

(click to enlarge)

I think it will. A key reason why I think Microsoft will succeed parallels Android's success. The vast majority of smart phone users in the world market are price conscious. Android phones are available at every price point in every market from a variety of vendors. Windows phones are less available, but they are very competitive on price.

It is useful to have a look at where the market is and where it is likely to be in a few years. eMarketer forecasts that 5 billion people will use smart phones by 2017. In summary, they mean everyone old enough to hold a phone in their hands it seems, since the world population is about 7 billion.

(click to enlarge)

Importantly, the growth in smart phone usage will be predominantly in Asia. North American markets are already saturated with forecast growth barely 5% through 2017 with the addition of only 17 million users. Europe is about the same, adding 56 million users to the 672 million who now use a smart phone. But Africa and the Middle-East and Asia-Pacific will add well over 500 million users over the next 4 years.

These are markets characterized by underdeveloped economies by and large with a sizeable proportion of the population living below the poverty line. The per capita GDP of India is $1,501 and that of China is $6,071. In most African nations it is even less. Most of the population of Asia and Africa is unlikely to be in the market for an iPhone or a Galaxy S4 with the exception of the small proportion of higher income people in those economies. The ordinary Africans, Indians and Chinese are the target market for many new entrants selling Android phones and they are a target market for Nokia's Windows phones.

It is trite to say that the smart phone market will be mature by 2017. Even a dramatic increase in the birth rate worldwide (which is not expected) would not permit 5 billion users to grow at more than a small percentage annually. Demand will be primarily replacement demand. A large second hand market will very likely develop as it has in the automobile industry. There are over 1 billion automobiles in use worldwide but the new car market is about 65 million. With 5 billion smart phones in use and the useful life of a smartphone likely about quarter that of a car, one can expect the market for new smart phones by 2017 may be about 1,300 million. That is just 30% more than are sold today considerably less than the 1.7 billion IDC forecast for smart phone sales in 2017. Someone is clearly wrong. I think it is IDC.

For Microsoft with its Nokia smart phone division, the addressable market will comprise the full 5 billion users and, if it achieves a 10% share, it might sell 130 million phones a year based on my annual demand figure of 1.3 billion.

For the higher end devices, call it the top 10%, the addressable market will be 500 million users. Those users might well buy a new phone every two years given their means and desire to keep up with latest in technology. Even so, that comprises a market of only 250 million smart phones. The high end of the market will likely be more crowded and less profitable in 2017 than it is today.

That is why I believe Microsoft is on the right track with its Nokia purchase. Nokia has a world famous brand, a reputation for quality and a tradition of selling phones targeted at ordinary consumers where price is as or more important than features. The Windows phones are attractive and have excellent functionality. The further integration of the Windows User Interface across all Windows devices can only serve to enhance the appeal of the Nokia line.

I am long Microsoft.

Source: Why Smartphones Will Be A Big Win For Microsoft

Additional disclosure: I am long calls on MSFT and short calls on AAPL