Microsoft Is Not Ready to Pull the Plug on Nokia’s Android Smartphones

Earlier this year, Nokia Corporation (NYSE: NOK  ) surprised many people when it announced that it would launch its own line of Android smartphone--the Nokia X series of handsets. This seemed a tad confusing given that Microsoft (NASDAQ: MSFT  ) , which now fully owns Nokia's devices business, has been trying hard to push its flagship Windows Phone platform.

In an even more surprising turn of events, Microsoft may itself now push out a Nokia X successor, if certain unconfirmed rumors turn out to be true.

According to the report, Microsoft will address the lack of a soft home button in the Nokia X range of phones, a feature that is common to all Android devices. X devices do not typically have Android's scroll down notifications, but instead sport a Fastlane hub for messages and media, similar to Nokia Asha's, that can be accessed from the home screen.

Nokia X2 specs
Possible hardware specs for the Nokia X2 (Nokia X's successor) have already surfaced in China. According to a new benchmark, Nokia smartphone fans can look forward to the Nokia X2 packing a Qualcomm MSM8210 1.2 GHz processor. The phone will also feature 1 GB of RAM, and 4GB of storage. These features will put Nokia X2 in line with Motorola's --now owned by Lenovo -- low-end Android handset, the Moto E. Still, the Nokia X2 will be a reasonable step up on the higher-end Nokia XL, which sports a 1GHz dual-core processor, 768 MB RAM, and 4GB of storage.

According to Stephen Elop, Microsoft's head of devices, the reason why Nokia X users cannot download apps from Google Play is because Microsoft wants them to connect to its own cloud, and not to Google's.

How will Nokia's smartphone business impact Microsoft?
Microsoft made changes in the way it reports its revenues last summer, which makes it almost impossible to do a direct comparison to check and see how its different segments have been growing over the past two years.

But, looking at the new structure, we can see that Microsoft's business is dominated by enterprise software and services. Microsoft makes the bulk of its money from ''Commercial Licensing.'' This segment covers windows server products, as well as volume licensing editions of Windows and Microsoft Office. The segment labeled ''Commercial Other'' is dominated by Microsoft's rapidly growing enterprise services, most notably Windows Azure, and the commercial editions of Office 365.

Source: Microsoft 10-K

On the consumer side (represented by the blue slices), the ''Consumer Licensing'' segment encompasses Microsoft Office for home and small business users, OEM Windows licensing, and Windows Phone. The ''Consumer Hardware'' segment consists of Surface products, Xbox hardware and Xbox Live subscriptions, and PC accessories (keyboards, mice, etc). The ''Consumer Other'' category rolls up Windows online store, Windows Phone online store, Xbox games and services, brick-and-mortar Microsoft stores, Office 365 Home Premium subscriptions, and online advertising (mostly from Bing).

Commercial and consumer licensing generate the bulk of Microsoft's profits. All the other categories are also profitable in the aggregate, despite having sub-segments that are either losing money, or barely managing to break even.

Nokia's handset division recorded sales of $3.57 billion in fiscal 2013 (both smartphones and feature phones). Smartphone ASPs, or average selling prices, have been declining over the years. Windows Phones now have an ASP of around $300, while Android phones ASP clock in at $270.

Source: Gartner, February 2014

Nokia accounted for 82% of all Windows Phones shipped in 2013. This is great news for Microsoft, since according to the IDC, Windows Phone shipments are expected to grow at almost three times the rate of Android phones in the coming years. This will ensure that the division continues growing rapidly. Windows Phones also sport a higher ASP than Android smartphones.

Operating System

2014 Shipment Volumes

2014 Market Share %

2018 Shipment Volumes

2018 Market Share %

2014-2018 CAGR %

Android

950.5

78.9

1,321.1

76.0

10.7

iOS

179.9

14.9

249.6

14.4

10.2

Windows Phone

47.0

3.9

121.8

7.0

29.5

BlackBerry

11.9

1.0

5.3

0.3

-22.6

Others

15.1

1.3

40.7

2.3

32.7

Total

1,204.4

100.0

1,738.5

100.0

11.5

Shipment Volumes in Millions

Source: IDC Mobile Tracker, Feb, 2014

Nokia shipped 30 million handsets in fiscal 2013, more than double the number of units it shipped in fiscal 2012.This means that the average ASP of its handset mix (both smartphones and feature phones) clocked in at $119.

Assuming that the ASP of Nokia's handset mix holds steady at $119, and shipments grow at 30% over the next 12 months, the division could realize a revenue of $4.64 billion over the next 12 months. It will also grow Microsoft's ''Consumer Other'' category, where Windows Phones fall under, by 75%.

The division's sales will grow Microsoft's overall revenue by 6% in the next 12 months, and possibly contribute a bigger percentage in the coming years since it's growing faster than Microsoft's other divisions.

Foolish bottom line
Microsoft seems to be following up on its new vision by supporting Nokia's smartphones in a bid to drive new growth in its cloud. The Nokia X phones do not jive with Windows, but they don't need to, as long as they push users to Microsoft experience such as Skype and Bing search. The new Nokia phone division will also grow the Microsoft's top line considerably.

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