Microsoft’s €5.4bn acquisition of Nokia’s devices business was both long predicted and a bolt from the blue, coming so soon after its chief executive Steve Ballmer announced his retirement. Here Mr Ballmer explains the logic of the deal to investors.
Steve Ballmer is taking big picture. “The PC is the most important device, the most productive device on the planet, and will continue to be so. For us to fulfil the vision of what we can do for our customers, we have evolved our thinking. We need to be a company that builds a family of devices, with integrated services.”
We started the cloud transformation 5-6 years ago.
The Nokia deal is transformational in giving us the capability to do physical devices alongside the work we do with OEM people for virtual devices, on Windows PCs.
Also buying Nokia’s Here platform: when you think about the high value services of the future, mapping and location services are essential.
Why are phones important?
“Devices help services and services help devices…. We see great opportunities for revenue upside in our Bing services but the device opportunity is perhaps the best opportunity for pursuing users in very large numbers.”
“The phone is the most intelligent device on the planet. We do think there will be innovation in hardware and software, that will give us opportunity to bring market share in the phones and the device. That brings with it profit opportunities. I believe there will be financial rewards to the bold and innovative as we pursue it.”
“As we do today, we will support Microsoft services on Galaxy and iPhone. But we cannot do a full and first class experience on those platforms. We run the risk that Google or Apple will foreclose our ability to innovate, to do distribution or to impose economic terms.”
Ballmer describes this as an offensive and defensive move.
This should raise the tide of the ecosystem, he says, which will improve the gap on developer mindshare, which he admits is lacking.
“We absolutely think this acquisition improves our OEM opportunity. A flagship product with which to blaze trails in this market, while OEMS can address the diversity of markets out there.”
“It’s a different model than the PC model but i’m pretty excited about how we can balance our own devices and get help from OEMs.”
Ballmer believes that Microsoft and Here can become a real competitor to Google Maps, which he says partners are keen to see.
Now over to Amy Hood, Microsoft’s CFO, who is going through the finances. The purchase price will be paid using offshore cash and Microsoft does not think it will impact the continued return of cash to shareholders.
Under the commercial deal previously in place, Microsoft captured less than $10 per device. By owning devices and services business, Microsoft will be able to capture and utilise the entire gross profits of the device, which for Lumia was around $40 in the most recent quarter. Operating income breakeven will be reached when they sell 50m – from 7.4m in the latest quarter. The per-unit profitability is significantly better for Microsoft than Nokia, Ms Hood says.
“With this acquisition, we have an opportunity to fundamentally change the economic structure of our mobile business.” The commercial deal showed positive early momentum, so this was the right time to make the acquisition, she says.
Now over to Brad Smith, Microsoft’s general counsel, who will talk about the patent licensing part of this deal.
“Even if you are able to secure licenses, if you aren’t creative in the way that you put all this together, you can drive up your cost” due to patents, he says. For some companies, patent costs are more than 10 per cent of a device’s bill of materials, he says.
Nokia’s patent portfolio is one of the two most valuable in the industry, says Smith, alongside Qualcomm.
This deal puts Microsoft in position to have the most cost effective patents of any company in the smartphone space, says Smith. Now back over to Ballmer.
How do companies make big acquisitions work? A good question posed by Mr Ballmer. He says that the last two years have helped Microsoft and Nokia to do that. “I don’t know if we would be here if we hadn’t already operated under our collaborative agreement to do so much great work,” Ballmer says.
Most of the Nokia leadership team is moving over to Microsoft, including Stephen Elop, who will run the integrated devices organisation. Phone device R&D will be centred in Finland. Marketing and software and services will be consolidated. The Nokia sales team will stay intact – Microsoft needs those operator relationships.
Mr Elop takes the mic. “At Nokia we’ve been building momentum around our Lumia devices,” he says. According to IDC, Nokia’s handset market share was at 14 per cent in the second quarter of 2013.
“We already know each other, we’ve learned how to solve problems together, and we share the same broader goals,” says Mr Elop of the move from partnership to ownership.
Elop says Nokia has “exciting innovation” and a “strong plan for execution… can accelerate momentum”.
Ballmer is paying tribute to the design and quality of Nokia’s devices. “We have work to do for market success but we have created absolutely first rate products,” he says, despite the app gap and needing greater differentiation.
Brad Smith is talking about regulatory approval. He’s confident it will go through by the first quarter of calendar 2014, due to complementary assets coming together, rather than competitors. He’s pitching the combined company as a more effective competitor to Android and iOS. “We will be a stronger number three and regulators like it when the number three competitor in the market has a better opportunity to challenge the two market leaders,” he says.
Now over to Q&A with analysts. The first is on tablet strategy, and whether Microsoft needs to double down more on first party hardware?
Ballmer: we see opportunities in both first party and OEMs, particularly on Intel Atom-based products, where more products are coming this holiday. Doesn’t sound like a radical change in strategy there.
The same analyst is asking about lower-price phones?
Lower priced phones are a strategic priority for the next generation of Windows Phones, says Terry Myerson.
Ballmer says that the reorg is “absolutely intact” after this deal.
How much will go to OEMs in future?
Today Nokia is well over 80% of all of our phones. I don’t foresee that changing in the short run, but as the market grows, additional percentages will go to OEMs, says Ballmer.
Question: Nokia’s 32,000 employees, plus Microsoft’s 99,000 is a considerable bulk of employees – any opportunity for rationalisation?
Microsoft: Nokia does not outsource as much of its manufacturing as others so 18,000 employees are directly part of the manufacturing business. There are incremental benefits from the joint sales team but Microsoft wants to get to “one voice” in marketing – a hint of staff cuts to come in Nokia’s marketing team?
Ballmer: we see three distinct opportunities to do better as one company than two.
1. Branding and messaging. “We can probably do better in consumer naming than the Nokia Windows Phone Lumia 1020,” says Ballmer.
2. Divide comes at expense of innovation. There would have been a bigger bet on the 1020 with hardware software and services integration.
3. The combined company will be more agile.
What’s the pitch to developers?
Terry Myerson says that Microsoft will offer both HTML5 and native apps, and unique opportunities to monetise. “Developer reception in some areas is better than others,” he says.
Ballmer says that driving volume will be key. “We know we have a long way to go. the key is offering enough reasons to buy and drive volumes to attract a broader developer ecosystem.” He expects all the platforms to embrace HTML5 which would remove a barrier to entry.
And that’s the end of the analyst call.
Steve Ballmer and his team believe that Microsoft and Nokia can do together what they’ve failed to do apart: build serious market share, perhaps even reaching number 2 in the smartphone platform market; turn a good profit from the devices when they start shipping in higher volumes; combine hardware, software and services in a way that will exceed the Microsoft experience on iOS and Android; and sing the virtues of one brand and one company with one full voice.
But at the same time, Mr Ballmer went to great pains to stress that Microsoft wants to continue to work with third-party manufacturers, who make up a fifth of the Windows Phone market. Google seems to have pulled that off with Motorola so far: can Microsoft and Nokia, when they are already coming from a much weaker position than Android? We will find out next year after the acquisition closes.