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Microsoft's $7.1bn Nokia gobble: Why you should expect the unexpected

Lumias, Elop, Windows Phone 8, yes... but patently, it's about patents

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Scratch the Surface

Ballmer talked of opportunities for Redmond's partners in the wake of the Nokia gobble, but the likelihood is that with the Finns firmly in its back pocket, Microsoft is unlikely to sign up any more phone makers or take on new tablet manufacturers; quite the opposite, in fact: Microsoft’s other Windows Phone partners - Samsung, LG and Huawei - could be feeling threatened.

Surface Pro hero

Microsoft's Surface brainwave ... fondleslab meets laptop keyboard

They'll fear that Nokia will get preferential treatment in access to research, new features and sales deals. Now they’ll be assessing their options and looking for ways to loosen their ties to Microsoft. To their advantage, they aren’t major shippers of Windows Phone handsets: 81 per cent of Windows Phones sold were made by Nokia, with Samsung third a long way behind on 11 per cent, according to number crunchers at IDC.

In short, we expect Nokia to increase its share of the Windows Phone smartphone market.

Microsoft’s ownership of Nokia’s phone and device manufacturing facilities will also further complicate Redmond’s already strained relationship with PC manufacturers. The software giant sells its own homegrown Windows 8-powered Surface tablets, built by electronics giant Pegatron, pitting it against traditional computer makers also attempting to flog touchscreen Surface laptops-cum-slabs.

Despite stunning losses on the poor-selling Surface range, and over-ordering on parts to the tune of $1bn, Microsoft has said it remains committed to the Surface Pro and Surface RT. Its rationale for buying Nokia mentions a “family of devices with integrated services”. Before the Microsoft-Nokia deal was announced, rumours circulated that the Finns will make their own touchscreen Windows 8 Surface tablet.

That $7.1bn cash spend: You gotta spend money to make money

Microsoft’s taking a huge hit on buying Nokia, but claims it’ll pay off by trousering plenty of dosh from handsets. Microsoft claimed it makes less than $10 per Windows Phone sold, but post-deal, that will rise to $40 on “smart devices” per unit thanks to savings on integrated hardware, R&D, design and “focused marketing investment”.

Microsoft reckons it'll have shifted 1.7 billion smartphones by the end of 2018, with an “assumed market share” of 15 per cent bagging $45bn in annual revenue.

Companies rarely break out such numbers, and do so only to win an argument. As such, these numbers should be taken with a large pinch of salt. And it appears investors have done just that: when the stockmarket opened this morning in the States, the MSFT share price fell 4.61 per cent.

Patently, it's about patents

Of more relevance will be the money Microsoft makes on patents it will inherit from Nokia's mobile biz. Microsoft not only gets to cut the licensing bill it once paid to the Finns, but it can charge other companies royalties.

According to Microsoft the deal “provides significant value for Microsoft’s existing business, replacing after 2014 Microsoft’s existing annual license payment to Nokia”. Redmond will also get patents licensed to Nokia under a deal with ARM chip biz Qualcomm - potentially important for the continued production of ARM-powered Surface RT devices.

Microsoft is already raking in cash on patents: in the last year the US giant claimed $1.2bn in Windows Phone revenue, with an increase in “patent licensing revenue” in addition to sales of WinPho licences. Among those paying up are Samsung, coughing up $15 per Android phone, plus Foxcon, Acer, LG and Barnes & Noble.

Soon Microsoft will be in a stronger position to exploit its swelling library of patents to boost its bottom line, improving income while cutting costs.

Earlier today, pundits crowed that Ballmer was defying his critics for striking such an audacious deal; so much for the lame-duck CEO, his fans said.

But, the truth is, acquisitions never quite work as sold: Hewlett-Packard choked on Compaq, Dell fumbled EDS, and Microsoft killed aQuantive. In each case, the purchaser blew billions of dollars.

Not only is Microsoft’s betting its balls on a phone maker whose share of the smartphone market is going south while its earning are bathed in red ink, but Microsoft believes it can become a successful smartphone maker while at the same time assimilating that smartphone operation and its brains.

Microsoft’s track record on integration is not healthy - just look at aQuantive.

The dynamics of the market also mean that far from becoming a number-one player, the combined market shares of Microsoft and Nokia mean it’s looking a number-three, possibly a number two depending on whether Apple declines. Take a look at the graph below.

If there is a killing to be made, it’s likely to come from unexpected areas - patents.

The strongest possible of outcomes is that Elop becomes Microsoft’s next CEO.

It was Elop who was picked by The Reg as a contender for the Microsoft crown after Steve Ballmer announced last month he will retire within a year. Elop would bring four important qualities: knowledge of Microsoft, CEO-level experience in the “real world", knowledge of the phone market and contacts in that arena - something Microsoft is desperate to imbibe.

Ballmer hinted at an Elop ascendancy inside Microsoft. “Stephen will go from external [candidate] to internal,” Ballmer is quoted to have said in the Seattle Times. “The board will continue [to look at] all appropriate candidates through that process.”

When he joined Nokia, Elop was asked whether he was a Microsoft Trojan. Now he's delivered the handset maker to his former boss. But he was president of Microsoft’s business group before going to Nokia, but he barely grew revenue. Such was his lack of distinction, Elop merited a terse two-paragraph farewell email from his boss Ballmer, who called him a “good steward of the brand and business during his time”.

The broad smiles and promises of togetherness in September 2013 are a long way from the short, sharp email of September 2010, but the truth cannot be overstated: Microsoft and Nokia is marriage of convenience.

It’s a marriage of a software company that after two years’ hard work has scraped together less than four per cent smartphone market share, but is committed to plough on. For Nokia’s board, somebody will take away the pain of the past two years. Nokia’s stock actually rallied on news it was finally going to stop trading as an independent company.

Just don't expect it to work as sold. ®

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