Nokia / Microsoft – Course change

Smartphone margins are likely to imminently collapse.

• Rationale, the deal structure and recent actions all suggest that a substantial increase in investment in the Windows Phone ecosystem has begun.
• It seems like action is already being taken with the lowering of the price of the flagship Nokia Lumia 1020 by $100 to $199 with a two year contract.
• AT&T is matching this price and there is also a free camera grip being added to the bundle for those brave enough to take the plunge.
• If one looks back at last week’s announcement, several things stand out.
  • First. The only reason why it would be better for Nokia shareholders to no longer own the handset business would be if the business was expected to fail on its own.
  • Given Microsoft’s poor history in the hardware and handset markets (Xbox excepted), the only thing it brings to the table is deep pockets.
  • Greater integration will also help but the real issue here is that the platform needs massive investment in order to see proper success and there was no way that Nokia could afford that on its own.
  • Second. Microsoft has made available to Nokia €1.5bn of financing that is, in effect, a prepayment on the acquisition.
  • Nokia is not short of cash and so the only rational reason for this is a fund for Nokia to immediately ratchet up spending on Windows Phone.
  • Third. Everyone knows what Windows Phone is but no-one has the first clue why they should buy it.
  • This is a failure of both how the ecosystem is marketed but also the scale of that marketing.
  • Windows Phone is up against the vast resources of both Apple and Samsung and to make a dent, the volume and style both have to meaningfully cranked-up.
• As a result, I think it very likely that a large increase in investments in Windows Phone has already begun and that in the coming quarters one is going to see a collapse in Smart Devices profitability.
• Fortunately this no longer matters as the value of the device business has been crystallised and all that counts is what value can be derived from NSN, the patent portfolio and Here.
• I think it likely that the next 12-18 months will see the sale of the patent portfolio and the Here business leaving NSN and a pile of cash.
• I expect Rajeev Suri to be confirmed as the next CEO of Nokia over time and a large pot of cash to be returned to shareholders.
• This deal could be transformational for Microsoft if the company can fix the marketing issues and get users to adopt Windows Phone.
• It now has the money but does it have the talent?