Will Microsoft And Nokia Truly Deliver In 2012?

Includes: AAPL, BB, GOOG, MSFT, NOK, T
by: VancouverBull

Microsoft (NASDAQ:MSFT) and Nokia (NYSE:NOK) tell an unlikely love story of two entirely different firms.

Microsoft has an attractive single digit P/E at present, good EPS growth, a healthy growing dividend and provides a virtually unrivaled level of safety and stability for a stock.

Nokia was long considered equally stable, but the advent of smartphones, especially Apple’s (NASDAQ:AAPL) iPhone, exposed some structural weaknesses with the company, and the share price was decimated as a result. Nokia is still the world's largest manufacturer of mobile devices and a former leader in mobile software. Four years ago you would have paid in excess of $35 dollar for one share of Nokia, today it’s a little over $5 and slowly climbing after a brutal decline in 2011. Nokia’s fortunes are seemingly changing quite rapidly given the initial success of the Lumia 800 (and 710) with Northern European consumers and carriers alike. Nokia’s share price shows a P/B of 1.2 and a P/CF of 5.3, and seems a prime candidate for a substantial recovery in 2012.

Microsoft’s share price is hovering around the same level as four years ago, but don’t let this fool you. Diversification is the name of the game for Microsoft nowadays, although Windows PC and Office franchises collectively still accounts for nearly 60% of the firm's revenue. The server and tools business contributes 24%. But the firm's other businesses now includes the Xbox 360 video game console, Bing Internet search, business software, and last but not least software for mobile devices.

Nokia knows how to build high quality phones, but lacked a competitive OS. Microsoft builds outstanding software, but lacked sufficient support from within the telecom industry. Microsoft was looking to buy itself global mobile distribution. Simply put, what Yahoo was to Bing, Nokia is to Windows Phone.

Microsoft struck a much-publicized partnership with Nokia in 2011, and executives at both companies have high hopes that their handsets will catch on with consumers. At this week’s International Consumer Electronics Show [CES] in Las Vegas, Nokia introduced the sleek metallic Windows Phone called the Lumia 900 that will be sold by AT&T (NYSE:T) in the United States. Unlike other handset makers creating devices with Microsoft’s software, Nokia is not also developing Android phones. Talking about Windows Phone in his CES 2012 keynote, Ballmer said: "If you take a look at it, other phones give you a sea of applications that are your view of the world. Windows Phone is the first phone that puts people first…prioritises people. It's all laid out there front and centre. As things change it all gets put there together for you”. The keynote showcased the Nokia Lumia 900.

As was written in The New York Times: "We are doing our best work for Windows Phone,” said Stephen Elop, the chief executive of Nokia and a former Microsoft executive. While the customers’ verdict is still unknown, the group that developed Windows Phone has already profoundly affected Microsoft itself, influencing work on other consumer products. The next major version of software for PC’s, Windows 8, will look a lot like Windows Phone, which Microsoft hopes will help it work better on tablet devices. A Windows Phone-like makeover was also part of the new software update for Xbox, which along with Kinect is one of Microsoft’s few consumer hits.

Bill Flora, one of the designers of Windows Phone, said the care that Microsoft took in designing its products had changed vastly since he joined the company out of art school in the early 1990s. “Now, instead of 80 percent of its efforts being unenlightened, just 20 percent are unenlightened,” said Mr. Flora, who recently left Microsoft to form his own design firm in Seattle.

The tale of how Microsoft created Windows Phone starts with the introduction of the iPhone, in 2007. To Joe Belfiore, now 43, an engineer who oversees software design for Windows Phone, that was the spark. “Apple created a sea change in the industry in terms of the kinds of things they did that were unique and highly appealing to consumers,” Mr. Belfiore said in an interview at Microsoft’s campus here. “We wanted to respond with something that would be competitive, but not the same.”

Microsoft had been an early player in smartphones with Windows Mobile, software that ran on devices made by Samsung (OTC:SSNLF), Motorola (NYSE:MMI) and others. But one word describes its early effort: complicated. Windows Mobile had a complex array of on-screen menus, including a start button for applications that was borrowed from Windows PCs. The software ran on sluggish devices that had physical keyboards and, in some cases, styluses.

Once the iPhone exploded into the marketplace, Microsoft executives knew that their software, as designed, could never compete. So in December 2008, Terry Myerson, who had just taken over engineering for the mobile group, convened a meeting that members of his management team came to call the “cage match.” With a prototype of a new Windows Mobile phone on a table, Mr. Myerson, a no-nonsense engineer , led a heated debate over whether any of the software could be salvaged. No one was leaving the room until the issue was resolved, he said. Seven hours later, the meeting finally adjourned. By then, a consensus had emerged that there wasn’t much technology worth saving. “We had hit bottom,” Mr. Myerson, who is now 39. “That frankly gives you the freedom to try new things, build a new team and set a new path,” he added. The decision was to start from scratch, a move that had serious consequences. Not only did it delay a Windows phone, it gave Google an opening to woo Microsoft handset partners to Android.

Charlie Kindel, a longtime Microsoft manager who joined its mobile team in early 2009, compared the pain caused by starting over to the predicament of Aron Ralston, the hiker who amputated his own arm in 2003 after it was it pinned under a boulder in the Utah desert. “This boulder comprised of Apple and Blackberry (RIMM) rolled on our arm,” said Mr. Kindel, who left Microsoft last summer. “Microsoft sat there for three or four years struggling to get out.”

Mr. Myerson also had to rebuild the mobile team and Mr. Belfiore was his first major hire. Mr. Belfiore is a rare breed of Microsoft executive: he joined the company in 1990 fresh out of college and stayed, even as others fled to work for companies with more pizazz. For much of his career, Mr. Belfiore worked on the design of Windows and Internet Explorer, the kind of Microsoft software that is everywhere but not always admired for innovation. But he was also known for spending hours testing Microsoft technologies outside the office to see how they could be simplified.

In recent years, Mr. Belfiore earned a reputation in the company for working on more adventurous projects, even if they sometimes bombed in the market. Before he joined the mobile group, for instance, he oversaw design of Zune, Microsoft’s ill-fated answer to the iPod. A version of the product released in 2009, the Zune HD, was praised by reviewers for its spare design that featured elegant typography and snappy, animated screen transitions as users flipped around music collections. But the Zune HD came out years too late, well after the iPod had cemented its lead.

Mr. Belfiore took over the mobile group in early 2009, just as designers were finishing up the earliest prototypes for Windows Phone. In those prototypes, Mr. Flora drew inspiration from the signs in airports and other transportation hubs. He borrowed the emphasis on clarity, clean typography and broadcast-quality transitions between screens from Zune, which he had worked on with Mr. Belfiore. The ideas gradually gelled into a software design language that Microsoft calls Metro.

But there were challenges beyond design. Microsoft had to take a fresh approach to working with phone makers so it could have its slick new software function properly. Unlike Apple, Microsoft doesn’t make its own hardware. Before it restarted its mobile strategy, Microsoft did little to ensure that its handset partners were putting its software on devices that could run it well.

No longer would that be tolerated. Microsoft gave its handset partners detailed specifications of the types of technical innards required, including processors with certain amounts of power and screen technologies. Handset makers grumbled about the rules, but the result was phones that ran better. “It’s not just about software,” said Albert Shum, general manager of the design studio for Windows Phone. “It’s about the whole end-to-end experience.”

When senior executives got their first look at the software, Mr. Myerson said, there was “some hesitancy.” Steve Ballmer, Microsoft’s chief executive, didn’t like that the first screen that appeared after turning on the device contained oversized type that cut off the day of the week. (Wednesday showed up as Wed.) Revisions were made. But the group was given its creative freedom. And the critics, at least, have approved the final results. “It looks like nothing we’ve seen before from Microsoft,” said Michael Gartenberg, an analyst at Gartner, the technology research firm. “The company is being somewhat bold and saying what worked for them in 1992 won’t work now.”

Still, last summer, Mr. Ballmer told Microsoft investors that he was disappointed with Windows Phone sales. In mid-December, he named Mr. Myerson, the engineering head, to take full control of the group. He charged Mr. Myerson with improving the Windows Phone advertising campaign and relationships with wireless carriers. A software update for Windows Phones in the fall added a number of improvements to the product, including basic editing functions like copy and paste.

But this year is crucial; it will show whether a respected product is enough to help Microsoft make up for lost time. Even if it feels good to be a favorite of tech critics for a change, Microsoft needs a blockbuster in the mobile business, not a cult hit. “Entering the market so late with this experience has created some special challenges for us,” Mr. Myerson said. “I think if we were there earlier it would be different.”

The New York Times report also had these reviews: “GORGEOUS,” raved The Huffington Post, “Best-looking smartphone operating system in the industry,” gushed Slate, “Far superior to most if not all the Android smartphones,” said TechCrunch describing Nokia’s Lumia 800.

If the current hype is any indication, Microsoft and Nokia seem on the right track for a successful year, which should translate in attractive shareholder returns on both stocks.

Disclosure: I am long MSFT, NOK.