Microsoft's Inevitable Nokia Purchase Adds Little Lustre

Microsoft will acquire the mobile phone business and related patents of Nokia Corporation for a total cash consideration of EUR5.44bn (US$7.12bn). Microsoft seeks greater freedom to propagate its Windows Phone software for mobile devices and maximise its earnings potential from that intellectual property portfolio. As Nokia accounts for more than 70% of all Windows-powered mobile devices shipped every quarter, taking control of the company will allow Microsoft to remove 'friction' that has impeded Windows 8 adoption on mobiles and accelerate innovation. Although BMI expects Windows' market share will increase markedly as a result, we do not share Microsoft's optimism that the acquisition will deliver the kind of margins needed to survive in the hardware sector.

Microsoft will buy the Nokia Devices & Services business for EUR3.79bn; this includes design teams, manufacturing facilities, sales and marketing resources and support platforms. A further EUR1.65bn will be paid for related patents and intellectual property. Around 32,000 employees will transfer to Microsoft on completion of the deal which, pending shareholder and regulatory approval, will close in Q114. Nokia will be left with its core mobile infrastructure business ( NSN ) and its location information services unit, Here .

With handset shipments amounting to 61mn in Q213, Nokia remains the second-largest handset vendor in the world, well ahead of nearest rival Apple (7.2%) but now well behind market leader Samsung Electronics (25.4%) according to BMI 's Consumer Electronics industry research team. Nokia's market share has tumbled rapidly over the last three years, o wing to a lacklustre smartphone portfolio that has been eclipsed by Samsung's Android-powered Galaxy smartphones and Apple's high-end iPhone. Its share of the smartphone segment - an area it once dominated with its Symbian platform - now stands at just 3.3% of a Q213 market estimated at around 225mn.

Nokia Still Relevant But Mainly In Emerging Markets
Handset Market Share By Vendor, Q213

Microsoft's Inevitable Nokia Purchase Adds Little Lustre

Microsoft will acquire the mobile phone business and related patents of Nokia Corporation for a total cash consideration of EUR5.44bn (US$7.12bn). Microsoft seeks greater freedom to propagate its Windows Phone software for mobile devices and maximise its earnings potential from that intellectual property portfolio. As Nokia accounts for more than 70% of all Windows-powered mobile devices shipped every quarter, taking control of the company will allow Microsoft to remove 'friction' that has impeded Windows 8 adoption on mobiles and accelerate innovation. Although BMI expects Windows' market share will increase markedly as a result, we do not share Microsoft's optimism that the acquisition will deliver the kind of margins needed to survive in the hardware sector.

Microsoft will buy the Nokia Devices & Services business for EUR3.79bn; this includes design teams, manufacturing facilities, sales and marketing resources and support platforms. A further EUR1.65bn will be paid for related patents and intellectual property. Around 32,000 employees will transfer to Microsoft on completion of the deal which, pending shareholder and regulatory approval, will close in Q114. Nokia will be left with its core mobile infrastructure business ( NSN ) and its location information services unit, Here .

Nokia Still Relevant But Mainly In Emerging Markets
Handset Market Share By Vendor, Q213

With handset shipments amounting to 61mn in Q213, Nokia remains the second-largest handset vendor in the world, well ahead of nearest rival Apple (7.2%) but now well behind market leader Samsung Electronics (25.4%) according to BMI 's Consumer Electronics industry research team. Nokia's market share has tumbled rapidly over the last three years, o wing to a lacklustre smartphone portfolio that has been eclipsed by Samsung's Android-powered Galaxy smartphones and Apple's high-end iPhone. Its share of the smartphone segment - an area it once dominated with its Symbian platform - now stands at just 3.3% of a Q213 market estimated at around 225mn.

In order to justify its investment in Windows 8 as a mobile platform, Microsoft needs more Windows-capable devices in play. Taking control of Nokia will certainly help with that ambition, but the company must be careful not to shut other vendors out of the Windows ecosystem. Historically, vendors such as HTC , LG , Lenovo , TCL and ZTE have also supported Windows, but they have found that their Android-powered devices have found greater favour with consumers already deeply engaged with supplementary Android services and applications. Microsoft will have to work hard to win back disaffected hardware partners. As Android devices typically offer greater profit margins, owing to the lower licensing fees charged by Android's backer, Google, this will be one of the greatest challenges faced by Microsoft.

The smartphone market is growing faster than the overall market for mobile handsets. BMI estimates that smartphones now account for a little over 50% of all handsets shipped per quarter, and that proportion is rising as lower monthly subscription charges and falling voice, messaging and data rates encourage more customers to choose smartphones over standard feature phones. The vast choice of digital content supported by the Android and Apple operating systems (OS) is another incentive for customers looking for always-on, accessible-everywhere services.

This may be why Windows 8 as a mobile OS has yet to gain traction. As BlackBerry has found to its cost - and as newcomers Sailfish and Firefox may yet also discover - a paucity of content can be a massive disincentive to prospective smartphone purchasers. Although Nokia has worked hard to develop impressive next-generation devices such as its flagship Lumia smartphones, those devices have lacked impact with consumers owning to scant support provided in the form of Windows-compatible applications.

BMI has argued repeatedly that designing an appealing device is only part of the problem faced by device manufacturers in this highly competitive market (leaving aside the complicating factor of device and OS-agnostic 'free' over-the-top (OTT) applications market) . Vendors need to ensure that there is a wide choice of content available to prospective device owners and that popular entertainment, social media and productivity applications are supported from the very start. Windows 8 is still considered to be lacking in this regard, hence the tail-off in Nokia smartphone shipments of late.

Burning Platform Smoulders On
Nokia Quarterly Handset Unit Sales (LHS) And Handset Average Sales Prices (EUR) By Type (RHS)

Nevertheless, it is clear to see that Microsoft is seeking to emulate the success of its bitter rival Apple as a fully integrated product provider. Apple controls the design, development and manufacturing of its iPhones and iPads, even going so far as to acquire semiconductor manufacturers and technology companies owning key mobile device technology patents to ensure it has a frictionless path to growth and can maximise profits . Unusually, despite its closed value-added services and applications ecosystem, Apple is thriving and benefits from a large and generally loyal user base. It will be difficult for Microsoft to successfully and profitably emulate Apple's strategy.

Nokia's most successful product line is its low-cost feature phone family, which remain popular in emerging markets worldwide where advanced mobile networks and services are still lacking and where high-cost products such as smartphones remain beyond the reach of most consumers. This is a moderate cost, low margin business for Nokia as its Q213 average sales price (ASP) of EUR26 shows. Nevertheless, with many consumers and businesses in emerging markets still using legacy Microsoft products for computing and communication, this is where the Nokia opportunity is greatest, BMI believes. Smartphones are slowly finding traction in emerging markets in Asia, Africa and Latin America and low-cost, modest functionality devices will offer the most attractive openings to handset vendors over the next five years.

Microsoft has set itself the goal of achieving a 15% share of the global handset market by 2018, generating US$45bn per year from this business . Its current partnership with Nokia - announced in February 201 1 - earns Microsoft US$10 gross margin per handset sold. By taking control of Nokia and accelerating device sales, that figure could rise to US$40 per unit, Microsoft believes. But this would then run the risk of putting too many Nokia-branded handsets beyond the reach of many consumers in emerging markets. Low-cost Chinese manufacturers ZTE, Huawei and Lenovo have already set their cap at conquering the low-margin emerging market segment.

BMI therefore retains the view that, although the acquisition of Nokia by Microsoft was inevitable (a move we predicted when the companies first announced their strategic alliance - see our online service 'New Windows For Nokia, But Can The House Stay Standing', February 11 2011 ), it adds little lustre to Microsoft and offers more potential downside risk than upside over the medium to long term given the fast-changing market dynamics.

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