Nokia (NYSE:NOK) and Xiaomi, once dubbed the "Apple of China", recently signed a business collaboration deal and a multi-year patent agreement. The two companies will cross-license each other's cellular standard essential patents, and Xiaomi will acquire certain patent assets from Nokia.

Nokia will provide network infrastructure equipment to Xiaomi to expand its data centers. The two companies will also collaborate on optical transport solutions for data centers, and eventually explore other opportunities across the Internet of Things (IoT) market. Let's take a closer look at what the deals mean for both companies.

Nokia's Experience Center at MWC 2017.

Nokia's Experience Center at MWC 2017. Source: Nokia.

How this helps Nokia

After Nokia sold its handset manufacturing business to Microsoft (NASDAQ:MSFT) in 2014, its networking equipment business (Nokia Networks) became its primary source of revenue. It expanded that business by acquiring Alcatel-Lucent last year, which made it the third largest networking infrastructure equipment vendor after Huawei and Ericsson.

However, that business has been sluggish in recent quarters due to tough competition and reduced spending from wireless carriers. Selling infrastructure equipment to a big customer like Xiaomi could strengthen that business, which saw its revenue fall 6% annually last quarter while accounting for 91% of Nokia's top line.

Meanwhile, Nokia's highest growth business is its licensing unit (Nokia Technologies), which it formed following the Microsoft deal to house its patents. The unit's revenue rose 25% annually last quarter, but only accounted for 5% of Nokia's top line.

Most of that growth came from Nokia's purchase of connected fitness device maker Withings, but some of it also came from licensing deals for new Nokia-branded tablets and phones. Licensing patents to Xiaomi would certainly bolster that business.

How this helps Xiaomi

Xiaomi was once the top smartphone maker in China. But over the past two years, it fell behind Huawei, Oppo, and Vivo as their devices saturated the market across multiple price tiers.

Unlike Huawei, which generates some of its smartphone revenue overseas, Xiaomi remains mostly confined to the Chinese market due to its lack of overseas patents. If Xiaomi starts selling smartphones in a developed market like the U.S., rivals like Huawei and Samsung would crush it with patent litigation. That's why Xiaomi bought nearly 1,500 patents from Microsoft last year, and why it's also eager to license Nokia's patents.

Xiaomi's Mi TV 4.

Xiaomi's Mi TV 4. Source: Xiaomi.

Xiaomi is also diversifying away from smartphones toward IoT devices, which already include smart TVs, set-top boxes, air purifiers, water purifiers, rice cookers, robot vacuums, fitness trackers, and even shoes. Many of those devices were developed by companies Xiaomi invested in, which are collectively included in its "Mi Ecosystem". That ecosystem now reaches over 60 million connected devices, with eight million devices being used on a daily basis.

To gather and analyze that data, Xiaomi needs bigger data centers. Back in February, Xiaomi hired Nokia to connect seven data centers in Beijing to reduce bottlenecks and expand its private cloud. Therefore, Xiaomi's decision to buy more networking infrastructure hardware from Nokia isn't surprising.

The road ahead

Back in 2013, Xiaomi CEO Lei Jun told Reuters that he didn't want his company to be compared to Apple. Instead, he stated that Xiaomi was more like Amazon (NASDAQ:AMZN), since "Xiaomi selling mobile phones is like Amazon selling Kindles."

Just as Amazon uses cheap hardware like the Kindle, Echo, and Fire TV set-top box to lock in users and gather data, Xiaomi aims to build an IoT ecosystem that generates revenue from add-on services and the data gathered from those products. It also might eventually expand its core smartphone business to the U.S. and other mature markets. Working with Nokia might help it achieve those goals over the next few years.

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