Microsoft Out on $7B Limb With Nokia Mobile Buy

Nokia LumiaIf there was any lingering doubt that Corp. sees diminishing value in partnerships, it died in spectacular fashion on Labor Day, when Redmond announced its intention to acquire the smartphone business of its primary devotee, Finland’s Corp.

The end-of-Summer fireworks launched Microsoft into the handset-making business, adding a new wrinkle to the software vendor’s efforts to reinvent itself as a legitimate, full-featured competitor to Inc. and Inc. and leaving partners to wonder yet again where they fit into the company’s strategic plans.

In a letter to employees sent Monday night, lame duck CEO said Microsoft would pony up $5 billion for Nokia’s Devices and Services unit and pay another $2.2 billion to license Nokia’s intellectual property and use the Nokia brand on its for the next 10 years.

“This is a smart acquisition for Microsoft, and a good deal for both companies,” Ballmer wrote in the missive. “We are receiving incredible talent, technology and IP. We’ve all seen the amazing work that Nokia and Microsoft have done together.”

Part of that “amazing work” is alluded to in a 30-page slideshow Microsoft released along with Ballmer’s memo. Evidently dissatisfied with the two-year-old partnership that provides Microsoft a $10 licensing for every sale of a Nokia device sporting the Windows Phone operating system, The vendor is hoping to capture $40 per unit by owning the device manufacturing itself. That money is necessary, according to the internal presentation, to fund sufficient R&D to keep pace with the far-and-away market leaders Google and Apple.

Unspoken in the public relations materials, however, is the depth of the problem built into the Nokia partnership. The $10 licensing fee was supposed to offset a $250 million quarterly payment Microsoft gives to Nokia for marketing support. At the optimistic original target of 25 million handsets sold per quarter the deal would have been a wash. But Nokia has struggled to move even 7 million of its Windows-powered Lumia phones, leaving Microsoft with a $180 million bill each quarter with little to show for it.

And the prospects for improvement on those global sales numbers are not strong. Windows Phone devices suffer many of the same issues that plague floundering . Consumers shy away from them because there’s nowhere near the number of apps available for the platform as compared to Google’s or Apple . Developers meanwhile ignore the platform because there aren’t enough consumers using it to make it worthwhile  given the razor-thin margins in mobile app development.

“As smartphone penetration continues to grow, manufacturers will only be able to increase their sales by attracting users from competitors, which requires huge investments,” said analyst Francisco Jeronimo. “Nokia realized it didn’t have the financial resources to become the third alternative to Apple and in the smartphone segment. Instead of waiting to see whether that would change and eventually risk running out of cash, it decided to sell itself to the only company really keen to invest in Windows Phone.

“It was clear that both companies were moving at different speeds,” Jeronimo added. “Nokia has been able to launch several Windows Phone devices quickly [but] the development of the operating system has been slow and far behind other operating systems. Microsoft was relying on Nokia to make Windows Phone successful and Nokia was relying on Microsoft to grow the ecosystem.”

While the Nokia purchase is being portrayed, in Ballmer’s words, as “a bold step into the future and the next big phase of [our] transformation,” it also appears to add to the vendor’sgrowing list of third-place offerings that are sapping Microsoft’s still formidable profits. The company is still smarting from a $900 million fourth quarter write off forced by sluggish sales of its Surface RT tablet. And Microsoft’s Web services unit has lost nearly $11 billion since 2005, most due to the poor performance of its Bing search engine.

Other major acquisitions are also in question. It’s nearly impossible to tell whether Microsoft has recouped any of its $8.5 billion investment in in 2011. The voice and video chat service is now rolled up into the company’s Devices and Entertainment unit, shrouded by other elements like the Xbox gaming platform and Windows Phone.

One interesting side note to the Nokia acquisition: it brings former Microsoft executive and current Nokia CEO back into the Redmond fold. Elop has been mentioned by many in the industry as being on the short list of possible replacements for Ballmer, who announced late last month that he was planning to retire after 33 years at the software giant.

Microsoft’s acquisition of the Nokia mobile unit is expected to close in the early part of 2014 and must still be approved by shareholders and regulators.

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