Microsoft (NASDAQ:MSFT) is struggling to gain market share in smartphone platforms with Windows Phone. On the other side, the company is earning billions from rival platform Android. According to Nomura Analyst Rick Sherlund, Microsoft is generating nearly $2 billion a year in revenue from Android patent royalties. The analyst believes that the Android revenue has a 95% margin, so it's pretty much all profit. That is five times what the company makes from Windows Phone, its own mobile platform. Microsoft developed Android years ago and the company doesn't have to spend any more on keeping up to date.
Microsoft is a company in transition, evolving its business model from a company that vended software, to a firm that instead sells services on a subscription basis and devices. Android patent revenue is part of the company's entertainment and devices division (EDD), which includes Xbox, Windows Phone, Skype and Android royalties. Sherlund also says that Microsoft is using its Android cash to disguise the losses in its EDD division.
Microsoft has signed patent licensing deals with a wide range of manufacturers of Android devices, which include Nikon, Hon Hai, ZTE, Pantech, LG, Huawei, Compal, Samsung, HTC and more. Android patent deals help the company to generate profit without the need to build new products, or conquer new markets. Vendors who sign deals with Microsoft pay an undisclosed licensing fee for using its patents. Microsoft doesn't reveal details about earnings from royalties in its financial statements but the technology industry expert says Android smartphone makers pay between $5 and $10 to Microsoft on every sold device. According to rumors, HTC pays $5 while Samsung pays $10 per Android phone sold to Microsoft.
According to Gartner, Android shipments worldwide will increase from about half a billion units in 2012 to nearly 1.5 billion units in 2017. Android market share has increased from 79% in the second quarter of 2013 to 82% in the third quarter of 2013. Microsoft is on its way to making big money from Android If Gartner's project proved accurate.
If Microsoft gets an average royalty of $1 per Android the company would generate $430 million from these royalties in 2013. Microsoft is estimated to collect somewhere near $8 per device, however, meaning its royalty fees could total $3.4 billion in 2013. According to Microsoft, 80% of Android smartphones sold in the US and a majority of devices sold throughout the world are now covered under its various agreements. The company claims more, and additional licenses will increase the percentage in the future. If Microsoft gets an average royalty of $8 per device on 75% of Android devices sold then the company will make as much as $9 billion from Android royalties in 2017. Microsoft's current price/earnings ratio is 14.08. Android income in 2017 would add nearly $127 billion to the company's market cap.
Earnings from Android royalties would increase with the inclusion of royalties collected from Android powered Tablet sales. Microsoft will continue to make massive revenue from Android as more and more android handset makers are surrendering to Microsoft and agreeing to pay anything between $5 to $13 on each Android handset sold.
Microsoft is not only making money from Android devices sold, but also from a range of other companies that use exFAT file format. Microsoft has deals with Sharp (for TVs), BMW, Volkswagen and Nikon which pay the company a significant revenue each year.
Microsoft clearly is a leader in capturing the market for mobile operating systems. Android income is a material profit source for the company. Android market will continue to grow thanks to heavily invested OEM's like Samsung, LG, SONY, HTC, as a result Android income will be key for Microsoft's revenue and profit growth in the coming years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.