Microsoft: Facebook Deal Means Massive Upside Potential Now

| About: Microsoft Corporation (MSFT)

Just weeks after shelling out $1 billion to acquire patents from [[AOL]], Microsoft (NASDAQ:MSFT) has agreed to sell off a majority of those patents to Facebook (NASDAQ:FB). Its sale will help recuperate for the cost to buy the patents in the first place, and Facebook is set to pay Microsoft $550 million.

The move establishes an expensive, and potentially very powerful, partnership between Microsoft and Facebook, as both companies will have license to use any and all of the 925 patents that Microsoft purchased. Both companies have agreed that neither will sue the other for use of these patents, the details of which the companies have decided not to disclose.

Patents have become a hot ticket purchase in the tech industry, recently. Giant corporations continue to find new legal issues with patents, the ownership of which gives a company a large advantage in the courtroom, should something arise with intellectual property disputes.

Now, it's true that Microsoft will not stand to profit from Facebook's use of these patents. It may, however, one day profit from the ability to employ the same technology and intellectual property-based ideas as Facebook. What works for Facebook can then be used by Microsoft for, perhaps, equaled success.

We don't know what the patents contain, other than some basic ideas. We do know that they are considered very valuable, which is why it took Microsoft $1 billion to collect them. That price tag was Microsoft's bid, which was larger than other bidders such as Amazon (NASDAQ:AMZN), eBay (NASDAQ:EBAY), and even Facebook. The bid was an all-or-nothing deal, and Microsoft has seemingly found a way to make some of its money back, while still enjoying the benefits.

Moreover, the fact that Facebook initially bid on the patent package tells us that this is something it truly wanted. Microsoft enters this deal with a willing party and the two can continue to enjoy the patents together. The beauty of it all is that currently Microsoft and Facebook don't truly compete, other than buying up expensive patents like this. The two can use these mutually owned patents and seemingly never clash in the industry, at least for now. There's no telling, though, where Facebook may expand to after its IPO.

Facebook is expected to have this unprecedented public offering in the near future, and Microsoft has aligned itself well with the powerful social network. The move can be seen as a way to combat the rise of Silicon Valley rivals Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL). Each of these giants have taken to buying up patents itself to "beef up" its portfolio for use on the defensive in legal battles, or, in some cases, on the offensive.

This is not the first time Microsoft has worked closely with Facebook. The software giant first worked out a deal with Mark Zuckerberg's online networking site in 2007, and provided its helping hand in advertising. For that bit of help, Microsoft took an equity stake of $240 million, or 1.6% of its then-$15 billion evaluation. The partnership may be something akin to the wise old master helping to nurture the young prodigy as it comes up. We will have to wait and see if this round of agreement works out as well for both companies. My expectations is that it will, as the mutual ownership of the patents ensures the companies keeping out of each other's legal laundry for years to come.

The agreement comes at a great time for both companies as each continues to profit. Facebook announced a first quarter revenue of over $1 billion, up 45% and experts now see its IPO valued at something near $100 billion. Microsoft has over performed analyst's predictions so far for 2012, and its price target continues to rise.

Microsoft is making other moves aside from the patent arrangement. The computer giant has started opening its own stores in malls around the country, making a move to compete with Apple's popular storefronts. In fact, Microsoft seems so keen on adopting Apple's strategy here that many of these new Microsoft stores will be near Apple ones. Experts hail the move as an important one for Microsoft, as it needs to demonstrate it has competitive products to offer to Apple's line.

But Apple's not the only worry. Microsoft still competes, too, with Google. And Google's Android line of phones have been selling so well lately that the company will once-again introduce online sales. Google attempted to make this move two years ago, and failed. Android phones, especially those produced by Samsung, are competing well with Apple's iPhones now, however. Google is hoping to earn enough profit from phone sales that it may not to rely so heavily on online advertising.

The sales of Microsoft's Windows Phone has been less than promising, though Nokia, a retailer of the Windows Phone, is confident that will soon change. Either way, with sales of Microsoft's Xbox declining, the company will need a new cash cow. Apple reigns king in phone technologies, with Google tagging behind. The question is if there is enough room for Microsoft to fit in an industry crowded by these two and other tech giants like Sprint Nextel (NYSE:S).

My opinion is that Microsoft is never going to find the kind of success it would like in phones. It just did not get going fast enough, and it would require an enormous undertaking at this time to challenge the Android or iPhone. Tablets are an option, but too many companies have tried and failed with it. Besides, Google is expected to release its new tablet soon and that may, like phones, turn into a largely two horse race at the top.

The Facebook deal is important, if for nothing else than a reminder that Microsoft still has the cash and technological wit to nab patents while they're the hot ticket. It will remain to be seen what comes of the patents, but, for now, being in Facebook's corner seems like a good idea. Microsoft may find itself a partner for the longer-term, and while Apple, Google and Amazon keep ballooning, it may well need that young gun.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.