Microsoft-Nokia Deal: A Tale of Desperation

Microsoft announced yesterday that it was acquiring substantially all of Nokia’s devices & services business. The stock market painted a fairly accurate picture of what this deal means – Nokia investors were relieved as the stock surged by nearly 35%, while Microsoft investors responded by driving the stock down by 5%. Based on my prior experience in technology M&A, I wanted to take a look at the motivations for the transaction and the viability of Microsoft’s long-term consumer strategy.

Let’s begin by taking a look at the deal terms. Microsoft will be paying Nokia €3.79 billion for its handset division (including 8,500 design patents) and another €1.65 billion in patent licensing. As a part of the deal, Microsoft will gain rights to the Lumia & Asha brands, but Nokia will retain the rights to the “Nokia” brand. However, Microsoft has licensed the “Nokia” brand, exclusively for use on low-end S30/40 feature phones.

Financial Perspective: Sell or Die Out

Nokia’s “Devices & Services” division generated revenues of almost €27 billion over the last 12 months. However, this included Nokia’s feature phone division which is practically worthless from Microsoft’s perspective. At best, Microsoft may have considered the Asha range to be relevant, while ignoring the rest of the feature phone portfolio. Using Lumia revenues for the last 12 months, the deal was valued at 1.09 times revenue (effectively €187 for every Lumia sold in the past 12 months). If we use Lumia/Asha revenue, the deal was valued at 0.71 times revenue. Earnings multiples in this case were irrelevant as Nokia was making operating losses.

This seems like a very low valuation (about half of Xiaomi’s), and yet Nokia investors seemed relieved. This is because Nokia could not have a received a comparable valuation from other potential buyers. Any other company would have had to take into account the financial impact of ending the Microsoft deal and moving to an alternate operating system.

But couldn’t Nokia have held out for a higher valuation? Microsoft announced that it was providing Nokia with €1.5 billion in “unconditional” financing, which means that Nokia was in significant financial distress. If they couldn’t reach a deal with Microsoft, they would have to sell to another company at a far lower valuation or consider bankruptcy. With this deal, Nokia’s financial position seems secure.

Strategic Perspective: Microsoft’s Desperation
Ever since Stephen Elop decided to tie Nokia’s smartphone future to the Windows Phone OS, the company has been Microsoft’s biggest and only relevant smartphone partner. However, over the last few quarters, it was becoming clear that the partnership had failed to deliver the financial results necessary to keep Nokia going. Any other move by Nokia would have essentially killed Windows Phone. Therefore, I have to conclude that this deal was borne out of desperation, not just for Nokia, but for Microsoft as well.

But why did Microsoft need to acquire Nokia’s feature phone business? My guess is that Nokia’s board insisted on selling the smartphone and feature phone units together. In any other case, it would have been practically impossible for Nokia to find a buyer for a standalone, loss-making and rapidly shrinking feature phone business.

What Does Microsoft Plan To Do With Nokia?