Microsoft Needs More Than Nokia for Windows Phone to Succeed

It's looking increasingly as if Nokia might not get Microsoft where it wants to go in mobile.

Jan 25, 2014 at 8:00PM

Truly monumental changes are in the works at tech giants Microsoft (NASDAQ:MSFT) and Nokia (NYSE:NOK). Or at least that's what we're led to believe. With Microsoft's massive $7.2 billion purchase of Nokia's handset business set to close in the coming months, Microsoft and Nokia are both supposed to be looking toward newer and brighter futures.

Both Microsoft and Nokia reported earnings this week. Sadly for this turnaround narrative, the results, especially from Nokia, paint a far bleaker picture than perhaps many realize. I know, I know -- I'm as surprised as you that Microsoft would throw good money after a bad acquisition. I guess there's a first time for everything, right?

Msft

Source: Microsoft.

However, the current struggles at Nokia highlight some very ugly truths for Microsoft going forward, as it vies to become relevant in the mobile market that's essentially passed Microsoft by.

Nokia's nightmarish numbers
Nokia's fourth-quarter earnings were truly dreadful. Perhaps most importantly, as far as Microsoft is concerned, is that things at Nokia's handset business appear to be going from bad to worse.

For starters, it's worth noting that Nokia began reporting its handset business as a discontinued operation now outside its core business. For the quarter, revenue from discontinued operations fell 29% from Q4 2012, and 4.5% from the third quarter of this year. Equally alarming, Nokia's handset shipments also came in well short of what had been expected, declining to 8.2 million shipments during the quarter versus 8.8 million in the third quarter.

For the quarter, Nokia's handset division saw its non-International Financial Reporting Standards operating margin decline 6 percentage points from the year before to -7.3%. Its handset business is bleeding money.

Put in proper context, it seems Nokia is getting a pretty sweet deal here, swapping what's by far its most challenged business for more than $7 billion of Microsoft's cash, while Microsoft is about to acquire a total mess of a business. That would be fine normally, as the tens of billions of dollars of cash Microsoft generates each quarter make botched acquisitions like this easy to weather.

However, Nokia's importance to Microsoft was arguably more strategic than financial. Microsoft had planned to use Nokia as the partner that helps drive what will be its glorious resurgence in the mobile space. But as we saw with Nokia's recent report, Microsoft's grand ambitions are likely crashing and burning in front of its very eyes.

Garbage in, garbage out
Since virtually all models involve a fair deal of assumptions, even the most sophisticated model can generate an outrageous outcome if it's based on unrealistic expectations. And in comparing Microsoft's ambitions for Nokia versus the current business realities at the Finnish smartphone maker, Microsoft's comeback plans are looking more and more like a pipe dream.

In the short term, the deal is almost assuredly going to be a money-loser for Microsoft. In its acquisition presentation, Microsoft estimated it would need to sell roughly 50 million Nokia smartphones to hit its operating income breakeven point. But in the full year Nokia reported on Thursday, it managed to sell only 30 million handsets. And especially with handset sales actually losing momentum in the fourth quarter -- traditionally the strongest quarter for smartphone sales -- it's hard to imagine how Microsoft will hit its breakeven point anytime in the near future. 

Msft Nok Acquisition Slide

Source: Microsoft.

However, it gets worse when looking at the long term.

By 2018, Microsoft is targeting a 15% share of the global smartphone market, which, at that point, will have growth to 1.7 billion units. This means Microsoft believes it will be able to grow its smartphone sales to roughly 255 million units, or about Apple's market share, even as Nokia's handset sales are declining in the present.

Msft Nok Acquisition Slide

Source: Microsoft.

In arriving at a final value for the deal, Microsoft estimates the Nokia handset deal will result in a net present value of between $15 billion and $30 billion. But again, this is predicated on Microsoft's achieving operating margins of 5% at the low end, and 10% at the high end. But again, remember, Nokia's handset business saw its operating margin decline meaningfully to 7.6% in its most recent quarter.

We're seeing a common thread emerge here -- that there's a gaping chasm between the current state of affairs at Nokia and what Microsoft believes it will be able to achieve with Nokia going forward.

A tall order indeed
Now, I'm all about being an optimistic, so forgive me for saying that this seems largely unachievable for Microsoft from where I'm sitting.

But it does.

Microsoft needed to make a bold move to demonstrate that it's serious about growing its presence in mobile. But from the look of things today, Microsoft will need to move far beyond just Nokia to achieve its desired 255 million shipments in five years' time.

In fact, it's been widely rumored that Microsoft has been in active discussions with other smartphone OEMs, such as Sony, Samsung, and many others, about possibly expanding their own portfolios of Windows-based smartphones in the year ahead.

However, as Microsoft prepares to bring Nokia's handset business under its corporate umbrella, it's looking more and more like a botched deal from the start. And that's something that should have Microsoft investors up in arms at the prospect of yet another botched billion-dollar buyout.

Apparently, history does repeat itself with Microsoft.

A much better bet than Microsoft for the year ahead
There's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Fool contributor Andrew Tonner owns shares of Apple. The Motley Fool recommends Apple and owns shares of Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers