Microsoft’s Nokia Nightmare

Last week saw a lot of speculation regarding Microsoft’s possible acquisition of Nokia’s mobile devices business. The rumor was quashed by Stephen Elop speaking at the All Things D conference who denied there had been any discussion with Microsoft regarding an acquisition. Case closed then? Maybe not.

It is obvious just how strategically important the Microsoft deal is for Nokia. Its not overstating the situation to say that Nokia’s very survival and a major mobile handset vendor hinges on how effectively the transition to Windows Phone 7 is handled and how successful the resulting Nokia/Microsoft products are in the market place. There is little or no room for error.

While the same can not be said about Microsoft — the company is certainly not going to go out of business if the Nokia deal doesn’t pan out — In my view Steve Ballmer’s continued ability to bring the Microsoft board along with him on this windows phone investment binge does depend on Nokia’s success. Only Nokia can deliver WP7 the volume it needs to viewed as a viable third alternative in the smartphone operating system business — I’m sticking by my previous prediction of a paltry 1.25M WP7 unit sales to date. Nokia is being given «First among equals» status in the smartphone device manufacturer ecosystem because the future of Ballmer’s phone strategy — and perhaps his very position — depends on Nokia’s success.

[Update: 6/6/2011 — At last week’s All Things D conference AT&T's CEO Ralph De La Vega says that Windows Phone sales have not be living up to expectations.]

Last weeks announcement by Nokia that it would miss its second quarter forecast and that its business was now so unpredictable that it could not offer any new forecasts for the rest of 2011. The street dealt swiftly with that news by whacking 20% off Nokia’s stock price. That brings Nokia’s market cap down to around $24B. That’s 45% off its its peak in February 2011. Microsoft’s stock has trended in a very similar fashion since the Nokia deal was announced and took a sympathetic hit last week when Nokia warned. Both companies stock prices have been on the road to nowhere since the deal was announced but its the precipitous decline in Nokia’s stock price which should make Microsoft stock holders very worried. The reality is that if Nokia’s valuation continues to decline then Ballmer and team may be forced into acquiring Nokia.

At some price — not too far away from where it stands today — Nokia will — unavoidably — become a active takeover target. I’ll bet there are enough block shareholders who are disenchanted enough with Elop and Microsoft’s strategy to be dying to dump their stock for the right premium. Nokia’s book value stands at $5.37 and its closing stock price on Friday last week was $6.66. That’s way to close for comfort. Any further decline in the stock price and Elop’s days of being in control of Nokia’s destiny look numbered. Once the serious 3rd party acquisition discussions start Ballmer will be left with two very unpalatable choices: either let Nokia be acquired and risk the unravelling of the entire Nokia strategy — killing any hopes for Microsoft’s mobile strategy in the process — or acquire Nokia — acting as «White Knight» — to prevent the company falling into unfriendly hands; an act which would destroy the very core of Microsoft multi-OEM mobile business model.

Given Ballmer’s fanatical commitment to making sure Microsoft remains a viable player in the smartphone business I can see only one possible outcome if the scenario outlined above comes to pass: Microsoft will end up buying Nokia’s mobile business. Steve cannot afford for it to turn out any other way. The decision will be rationalized by the Microsoft leadership team as a realization that — just like the XBox gaming business — the only way to compete with Apple and Google was to have control of the complete end to end consumer experience and that owning a smartphone manufacturer gives them the opportunity to do that.

Everyone involved is going to deny that this is on the cards but in the end this is Microsoft’s likely Nokia nightmare and one they’re going to have to deal with sooner rather than later.

[Update: 6/9/2011 — Stephen Elop once again denies the company is up for sale while speaking at the Open Mobile Summit in London today. Again I would point out that while Nokia is not actively being offered for sale that is not going to prevent a hostile takeover attempt once the stock becomes too cheap to resist. The final decision may not be Stephen Elops to make.]

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