Microsoft's Assumptions Are Wrong

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Nokia (NYSE: NOK  ) just released its fourth-quarter and annual earnings report, and the smartphone shipment numbers aren't so great. The Wall Street Journal reported that in fourth-quarter 2013 Nokia shipped 8.2 million Lumias, compared to 8.8 million in the previous quarter. Microsoft (NASDAQ: MSFT  ) is purchasing Nokia's devices division for about $7 billion, so the quarter-to-quarter drop isn't good news for either company.

Microsoft is building its smartphone future on the Nokia deal, and the latest numbers show that may not be a wise move.

This shouldn't surprise Microsoft
Back when Microsoft made its bid for Nokia, it released a presentation showing that it would need to sell about 50 million Nokia smart devices to make the operating income for the devices division break even.

Here's a look at that slide in the presentation:

Source: Microsoft.

Obviously, with Nokia selling 30 million units this year, the company fell far short of that. But that shouldn't' have been that big of a surprise to Microsoft. Let's assume for a minute that Nokia had a great quarter of Lumia sales and moved 10 million-12 million devices. That still would have only put the company at 32 million or 34 million units shipped for the entire year, still far short of the 50 million.

Microsoft's projection a few months ago was an estimate of where the company needs to be after it has fully taken over Nokia's devices, and not necessarily a number Nokia needed to hit before that. Of course, increasing shipments from 30 million to 50 million won't be an easy task for the company, but at this point it doesn't have much of a choice.

The real problem
One of the glaring issues with Nokia's fourth-quarter results is that the holiday season usually spikes consumer interest in smart devices, but that wasn't the case here. Though fourth-quarter Lumia sales were up from the same time a year ago, they dropped sequentially -- even though Nokia introduced new Lumia devices just before the holiday season.

This drop in in smartphone shipments is part of a bigger problem that's starting to take shape for Microsoft. Back when it proposed the deal to buy Nokia's devices business, Microsoft estimated that it would be able to take 15% of the smartphone market by 2018. For comparison's sake, Strategy Analytics estimates Apple held just more than 13% worldwide smartphone market share in the third quarter of 2013.

Here's another slide from Microsoft's presentation:

Source: Microsoft.

Based on the estimate of total worldwide smartphone shipments of 1.7 billion in 2018, Microsoft would need to ship about 255 million units that year to hit the 15% mark. So that means that over the next four years, Microsoft is going to go from having about 30 million Windows Phones shipped to 255 million. Not a likely scenario.

To help boost its market share, Microsoft is reportedly lowering the Windows Phone licensing fee so that companies like Sony, Samsung, and ZTE will sell devices running the OS. Samsung recently said it's working on a flagship Windows Phone to be released this year and Sony has said it wants its phones on more than just the Android OS.

But even if Microsoft is able to get a few OEMs on board, achieving the 15% market share is still going to be near impossible. With the Nokia deal expected to officially close sometime this quarter, Microsoft investors may be wondering if the company overpaid for a devices business that may never achieve the tech giant's lofty goals.

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Read/Post Comments (7) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 25, 2014, at 11:04 AM, lee654 wrote:

    I think MSFT made a great deal!

  • Report this Comment On January 25, 2014, at 11:51 AM, Drichter wrote:

    They're on the right track. All it would take is one or two big hits and people will start to realize how good the OS is.

    The biggest obstacle right now is availability. I and a coworker were outright lied to about the availability of Lumia 928s from Verizon on two separate occasions, and in both cases they attempted to sell more expensive Android and iPhone alternatives.

    The coworker gave in and bout the iPhone, a decision he says he now regrets. I called back an hour later and spoke to another worker and the Lumia was magically back in stock.

  • Report this Comment On January 25, 2014, at 11:51 AM, Drichter wrote:

    Bought... why the heck does this site not have an edit button?

  • Report this Comment On January 25, 2014, at 12:24 PM, TMFAeassa wrote:

    Nice article. Spot on, IMO.

  • Report this Comment On January 25, 2014, at 1:39 PM, robglobster wrote:

    BGT MSFT 45 minutes before market closed on earnings day. Just a hunch, but from what I've seen in Universities is that Office still sells like hot cakes off the shelves and all the kids are using these products. I don't really care, I use both systems.

  • Report this Comment On January 25, 2014, at 2:12 PM, techy46 wrote:

    Microsoft is going to become a devices, services and software enterprise with the world's #1 enterprise software ecosystem. That's something neither Apple, Google or Samsung can match. So Microsoft could sell 12 million game consoles, 24 million tablets and 36 million smart phones next year long with 120-240 million copies of Windows 8. That's another 200-300 million Windows users on top of the existing 1-1.2 billion users isn't it. If Microsoft keeps doing that with growth for the next 3-4 years they'll have over 2 billion Windows users that will want to subscribe to Office 365 like me. Hey Fools, if MS get just 200 million Office 365 users paying $10 per month that's some serious revenue and profits isn't it.

  • Report this Comment On January 25, 2014, at 9:12 PM, cool8man wrote:

    I'm pretty sure you are supposed to compare sales YoY or from year to year; not by sequential quarters. Year to year Nokia Lumia sales went from 13M in 2012 to 30M in 2013 (more than doubled).

    In the 4th quarter YoY for Nokia Lumia went from 4.2M to 8.2M (almost double). The reason you don't compare sequential quarters is because of seasonality; in this case retailers overstocked Lumia in Q3 for the Q4 holiday season. Actual sell through and activations of Lumia phones increased dramatically in Q4 over Q3 even though retailers ordered fewer phones in advance of the upcoming Q1 (slow season). Last quarter there were about 8.2M Lumia's shipped and 10M sold through (excess inventory from previous quarter).

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Chris Neiger

Chris has covered Tech and Telecom companies for The Motley Fool since 2012. Follow him on Twitter for the latest tech stock coverage.

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