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Does MS-Nokia deal make sense?

Executive Summary
Microsoft announced yesterday that it will be acquiring Nokia's devices and services division. Microsoft will pay 3.79bn for Nokia's devices and an additional 1.65bn for the rights to Nokia's patents (which remain Nokias property). Its a bold move that confirms the software company's intention to compete with Apple and Google duopoly as a "devices and services" player. As part of the deal, a total of 32,000 Nokia staff and the CEO Stephen Elop will join Microsoft, Elop will be rejoining Microsoft after leaving the company in September 2010. Nokia will also receive 1.5bn of "immediate financing. Nokia was the dominant player in the feature phone market but missed the transition to smartphones. It was surpassed first by Apple and later by Samsung and companies using Google's Android OS. Today, Microsoft is acquiring a struggling company with huge financial difficulties and troubles in maintaining its business in mature markets. Nevertheless, there are signs that this move could make business sense: Nokias flagship smartphones are registering encouraging results, especially in emerging markets. Windows Mobile OS is gaining market share at the expense of RIMs Blackberry. Nokia devices still have potential to penetrate the market, even if it will be hard to break into the Android-iOS dominated market head-on as the 3rd major alternative. This acquisition could fit well with Microsofts new Devices & Services reorganization strategy: Nokias expertise on devices and the access to its patents could help MS to effectively challenge Apple and Google with mid-to-high-end device and service propositions targeting consumers and businesses. Finally, Nokias strong position in emergent markets and its global distribution network could give Microsoft a substantial competitive advantage in entering those strategic markets with either mobile devices or others MS products and services

Microsoft is acquiring a struggling company with huge financial difficulties and weak position in mature markets
5.44bn to take over Nokias Devices & Services business and license patents and other IP
Microsoft announced yesterday that it will be acquiring Nokia's Devices & Services division. Microsoft will pay 3.79bn for Nokia's Devices and an additional 1.65bn for the rights to Nokia's patents (which remain Nokias property).

Nokia remains a struggling company in a weak financial position and low gross margin on its devices business
In 2Q2013 Nokia shipped 53.7 million mobile phones 1, but despite improved smartphone shipment, the majority of volume was made up of feature phones (46 million units). Due to Nokias focus on low to mid end smartphones, they are experiencing a low gross margin level from its device sales. The chart below2 shows how Nokia is struggling to extract a sufficient level of gross margin from its smartphones (especially with latest windows 8 Lumia devices)

What has Microsoft actually acquired?

The agreement still requires Nokia shareholders and regulators approval but here are the main terms of agreement: As part of the acquisition of Nokias Devices & Services division (for 3,79bn), a total of 32,000 Nokia staff will join Microsoft, including 4,700 based in Finland. Microsoft will pay an extra 1,65bn to access Nokias patents and other IP. Microsoft will also be granted the license to use Nokias

1 2

http://www.forbes.com/sites/chrisversace/2013/08/22/watch-high-as-well-as-low-end-pressures-for-nokia/ Company Data, GWC estimates

Flash News by Greenwich Consulting | Does MS-NOKIA deal make sense?

HERE geospatial services in all its products. These IP assets are the key element of the deal as they could be successfully leveraged by MS and even beyond the phone/smartphone business (Bing, Skype, Azure) Stephen Elop, the current CEO of Nokia, will rejoin Microsoft, which he left in September 2010 to take over the Finnish company. He is expected among the leading candidates to become the next CEO of Microsoft, after the announcement at the end of August by Steve Ballmer that he would retire within 12 months. Microsoft will provide 1.5bn of "immediate financing" to Nokia, which reveals the critical financial situation of the Finnish company, whose debt has already been reduced to "junk" status.

This acquisition complements Microsofts new Devices & Services reorganisation strategy; it makes business sense for MS to acquire Nokia
Thanks to its partnership with Microsoft, Nokia devices running Windows Phone OS have gained substantial market share and have become the 3rd Mobile OS behind iOS and Android
Nokia is on course to be the third name among major smartphone manufacturers. The Lumia branded Windows Phone handsets are progressively making Microsofts mobile OS the 3rd player behind Apples iOS and Googles Android. This has been achieved at the expense of RIMs Blackberry which continues to lose market share. It seems that the strategy of high end flagship devices helping to sell mid to low end devices is working. However, the enthusiasm for Windows Phone platforms remains unevenly distributed: As we can see in the chart below3, in Europe market shares are above 8% yet it remains extremely hard for Windows Phone to penetrate other strategic markets such as China and the US.

Source : Kantar World Panel

Flash News by Greenwich Consulting | Does MS-NOKIA deal make sense?

Smartphone OS Sales Share (%)

By solving Nokias cash problem Microsoft is tactically trying to maintain this positive trend in Windows phones adoption: it tries to prevent the only significant Windows Phone OEM4 from exiting the market or switching to another OS provider. However, this alone will not change the sales of Windows Phones and will require further investment in order to speed up MS mobile OS adoption

Microsoft is transforming into a "devices and services" company and Nokia could complement this reorganization strategy: its expertise in devices and IP assets could help MS to effectively challenge Apple and Google on this field.
In July 2013 Microsoft announced a reorganization of the company. The company is planning to expand their offering of devices and services5. The goal is to provide an integrated multi-device experience (across tablets, PCs, and smartphones) by fully leveraging Microsoft's assets. This is a very substantial reorganization as until now MS staff worked in independent and product centered teams. The chart below sums up the vision Microsoft COO Kevin Turners vision of what the company is set to become with this reorganization 6.

Nokia Devices account for more than 80% of Windows Phone devices shipment: http://blog.adduplex.com/2013/05/adduplex-windows-phone-statistics.html 5 Press release - July 11th, 2013, Text of an internal email from Microsoft CEO Steve Ballmer to employees: http://www.microsoft.com/en-us/news/Press/2013/Jul13/07-11OneMicrosoft.aspx 6 Extract from a presentation held by Microsoft COO Kevin Turner during Bernstein Researchs Strategic Decisions Conference (June 2013)
Flash News by Greenwich Consulting | Does MS-NOKIA deal make sense?

In Microsofts new organization, all operating systems (Windows, Windows Phone and Xbox) would belong to one organization, called Operating Systems Engineering Group and all hardware (Surface and Xbox) to another called Devices and Studios Engineering Group. Thus we think this acquisition is coherent with Microsofts new organization, as Nokias expertise on devices and its IP assets can be easily integrated and would help Microsoft to effectively challenge Apple and Google by launching mid-to-high-end devices and services propositions aiming both consumer and business. Nokia's mapping and imaging services are recognized solutions by the industry. Microsoft could offer this beyond its mobile devices and also include them as add-on services for cloud solutions such as the Azure platform. This will enable Microsoft to compete with Google in this field. Azure services are also Microsoft's main asset to gain significant share in the IaaS/PaaS market from Amazons AWS (with some substantial advantages such as Bing, or Nokia mapping and geospatial assets)

Nokias strong position in emergent markets and its global distribution network could give Microsoft a substantial competitive advantage in entering those strategic markets
Microsoft Surface tablets and Xbox may have shown Microsoft the importance of distribution channels to a hardware manufacturer. With the Nokia acquisition, Microsoft will gain one of the largest and most efficient distribution channels that they could leverage not only for mobile devices but also all other Microsoft devices (tablets, Xbox etc.) Moreover, Nokias strategic positioning in low to mid end handsets is coherent with the forecast evolution for smartphone market: the chart below7 shows that global smartphone penetration is expected to be driven by the low-end segment.

Source : Greenwich Consulting analysis and estimates based on OVUM & Strategy Analytics data, 2012

Flash News by Greenwich Consulting | Does MS-NOKIA deal make sense?

Worldwide Smartphone shipments (million units)

Finally, the Finnish manufacturer has a very strong image in emerging markets and its low to middle end strategy shows encouraging success. The acquisition would allow Microsoft to successfully enter these markets either with low to mid end smartphones or with other devices and services. Experts are expecting emerging markets to be the main source of growth for smartphone penetration in the coming years as we can see in the forecast below8

2012-2017 forecast of Smartphone shipments and penetration rate in two main regions

Conclusion
Acquiring Nokia is a tactical move from Microsoft: It can be seen as an attempt to maintain the positive adoption trends for the Windows Phone by preventing the only significant Windows Phone OEM from exiting the market or switching to another OS. But beyond the short term considerations Microsoft is buying substantial and recognized IP assets and device expertise which would fit well into its new Device & Services oriented reorganization strategy. If successfully conducted this merger could finally make Microsoft account among the most important players in both devices and services markets.

Source : Greenwich Consulting analysis and estimates based on OVUM & Strategy Analytics data, 2012

Flash News by Greenwich Consulting | Does MS-NOKIA deal make sense?