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U.S. Business The Nokia deal: Microsoft’s last shot at a mobile future

Microsoft CEO Steve Ballmer, left, and Nokia President and CEO Stephen Elop unveil the Nokia Lumia 920 and Nokia Lumia 820, Nokia's first devices for Windows Phone 8, at a press event in New York, Wednesday, Sept. 5, 2012.

Diane Bondareff/AP

Microsoft Corp.'s portfolio is littered with the corpses of unimpressive or failed mobile products. The question is whether Nokia Corp.'s handset business can bring the software giant's wireless strategy back to life.

Microsoft on Tuesday agreed to pay €5.4-billion ($7.2-billion U.S.) for the Finnish company's ailing phone business and license its patents for 10 years. While the timing was a surprise, the deal itself is hardly a shock. The two companies had been integrating their mobile businesses since early 2011, when Nokia's Canadian CEO and former Microsoft executive, Stephen Elop, agreed to use Microsoft's Windows phone operating system for its new devices.

The partnership failed to save Nokia, whose handset sales have fallen by half since 2008, the year after Apple Inc. challenged the dominance of Nokia and BlackBerry with the launch of its phenomenally successful iPhone. Today, Apple and phones powered by Google's Android operating system, notably Samsung's, utterly dominate the smartphone market.

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There are some good reasons for the Microsoft deal, which will see Mr. Elop return to Microsoft as the head of its integrated devices business. Analysts note that the all-cash purchase price is relatively small. At its peak in 2007, Nokia's market value was about $250-billion, mostly because of the market-leading success of its mobile phones. The purchase price represents about 1/35th of Nokia's peak value or a mere 10 per cent of Microsoft's annual sales.

The deal will also give Microsoft the ability to manage the business as one, and capture all the gross profit from Nokia devices. Microsoft now earns less than $10 from the sale each Nokia phone.

By owning Nokia's handset business, that will rise to about $40 for the top Nokia phones, such as the new Lumia. But Microsoft is way behind in the wireless game, and unless it can sharply boost sales of Nokia phones, the deal will go down as another Microsoft dud.

At last count, handsets that use Microsoft's operating system (largely Nokias) had only about 3 per cent of the market. That may rise, owing to the critical success and rising sales of Nokia's new Lumia phones, but some analysts doubt Microsoft will ever challenge Apple and Samsung.

"The new company has a long road ahead to establish Windows Phone as a viable competitor to Android and Apple's iPhone," said Ian Fogg, head of mobile analysis at IHS Electronics & Media. "In the second quarter of 2013, Nokia shipped just 7.4 million Windows Phones compared to 31.2 million iPhones and 185 million Android smartphones. IHS forecasts that unless Microsoft speeds Windows Phone innovation, in 2017, Windows Phone will comprise just 5 per cent of overall smartphone shipments."

Microsoft has a poor history in the mobile devices market. Under Steve Ballmer, the Microsoft CEO who recently announced he will resign in 2014, the company launched the Zune music player, which went nowhere in spite of positive critical reviews. Its first and only handset experiment, the Kin, was also a dud; it was yanked in 2010 after only two months on the market and $1-billion in development costs. Sales of Microsoft Surface, a range of tablets designed by Microsoft and launched a year ago, have been well behind expectations.

A former Microsoft senior executive, who did not want to be quoted by name, said he had low hopes for Windows-equipped Nokia phones under Microsoft's ownership. "As to the success of the deal, I see little chance," he said. "They're just entirely unsuited to this market. … They're not good at consumer/mobile, and they never will be. And even if/when Microsoft improves, Apple and Google will cement their platforms such that competition isn't really possible."

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The early view of Microsoft investors was not positive. Microsoft shares fell about 6 per cent while Nokia shares rose, at one point, by about 40 per cent. While covering short-sale positions can explain some of the rise, investors appear happy that Nokia is getting rid of a money-losing business that seemed to have little chance of regaining its former glory. Nokia on Tuesday said its first-half margins without the handset business would have been 12 per cent; with it, it was only 4 per cent.

In spite of the formidable difficulties in competing with Apple and Android, Microsoft's view is that the Nokia deal presented the best, and maybe only, chance to make a splash in the mobile market. "We run the risk that Google or Apple will foreclose our opportunity to innovate," Mr. Ballmer said. "The device opportunity is perhaps the best opportunity for pursuing users in very, very large numbers."

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