In a move that shocked few, Microsoft (NASDAQ:MSFT) has announced the acquisition of Nokia's (NYSE:NOK) Devices & Services business and key licenses to support it. Microsoft has committed to pay 5.44 billion Euros, roughly $7.2 billion, to increase its synergies in the mobile space as well as accelerate its share of the profit and growth in the mobile space. But will the gains justify the price?
Where does Windows Phone stand?
As it stands, the Microsoft/Nokia smartphone partnership has been doing well, although it remains far behind the market leaders in the space. Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOGL) are the leaders, while Microsoft is scrambling to solidify itself as a credible third option. While recent data shows Windows Phone has caught and passed BlackBerry (NASDAQ:BBRY), beating the falling Canadian company is no longer as meaningful as it once was.
According to Gartner, in the most recent quarter Microsoft's Windows Phone held the third slot, beating the flailing BlackBerry operating system by more than one million handsets.
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What does Microsoft stand to gain?
On paper, the move makes a lot of sense. Nokia has helped push Windows Phone from little more than an afterthought to a legitimate, if distant, third choice. There's also the fiscal side of the partnership, which saw Microsoft making large payments to Nokia to support the Windows Phone platform. Microsoft's complete strategic rationale can be found here, but here are the highlights:
- Increases per device gross margin from less than $10 per unit to more than $40 per unit
- Focuses marketing investment
- Integrated hardware R&D and design
- Uses offshore cash
- Saves on the quarterly platform support payments to Nokia ($250 million in the most recent quarter)
Are there potential downsides?
As seen above the company stands to gain significantly but it must address several issues. The biggest is the fact that this may hinder the spread of Windows Phone. While the Nokia alliance certainly was a driving factor for Windows Phone, other manufacturers have produced their own Windows Phone-based devices. More importantly, a keystone of Android's success has been the number of manufacturers building phones based on Google's OS. Will Microsoft's current licensees be willing to compete head to head with the company?
Google's acquisition of Motorola Mobility might provide the best insight, though the acquisition is just beginning to bear fruit. Android has still dominated the landscape and the major handset maker isn't Google. It is Samsung, the Korean conglomerate that has its hand in just about every corner of consumer tech. As it stands it doesn't look like direct competition is really causing many issues, which works in Microsoft's favor, although it may be an issue in the future. For what it's worth, the company's Executive Vice President of Operating Systems, Terry Myerson, confirmed in a blog post that the company is still interested in licensing Windows Phone to OEM partners and working closely with them.
Another issue is what the partnership can deliver from an earnings standpoint. Microsoft expects gross margins to rise significantly and that the synergies between software and hardware design can help bolster their market share. In their strategic rationale Microsoft points to a $45 billion opportunity in the smartphone space based on 2018 estimates of worldwide smartphone shipments. That's a huge opportunity, but one that hinges on an optimistic assumption: 15% market share.
To put that in perspective, Apple which shipped almost 32 million smartphones in the second quarter, had just 14.2 percent of the worldwide smartphone market. Microsoft's share, including the other OEMs producing Windows Phones? Just 7.4 million devices for 3.3 percent of the market. Can Microsoft pull off a major coup? It may be able to but as it learned from the Surface, it will not be an easy road.
The bottom line
In the end, the success of this acquisition hinges on the company's ability to continue building on its current momentum. Windows Phone has produced 78% year over year growth and managed jump into third place a feat that many tech companies would love to pull off. If Microsoft can maintain the pace it stands to gain tremendously, but that is a big if. With a CEO change on the horizon and the competitive nature of the smartphone space it is hard to say how much of an impact it will have in the near-term. Long-term, even if it doesn't reach its lofty target of 15 percent market share, the company stands to gain as long as it has a piece of the pie.
Chris Moore has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.