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Skeptics Abound on Microsoft Deal

This article originally appeared Sept. 9, 2013, on Real Money. To read more content like this, + see inside Jim Cramer's multi-million dollar portfolio for FREE Click Here NOW.

The market really doesn't like Microsoft's (MSFT) deal to buy Nokia's (NOK - Get Report) phone handset business (and non-exclusive, 10-year licenses to Nokia's patents) for $7.2 billion. On Sept. 3, the day of the announcement, Microsoft shares tumbled 4.55%. The next day, Sept. 4, Microsoft dropped another 2.21% as of late afternoon trading.

How bad is this deal? I understand the market's skepticism -- after all Microsoft isn't exactly a nimble innovator. But I believe there are more positive things to be said in favor of the deal than what the market's reaction suggests.

Let's start with the reasons to be skeptical. Microsoft has just bought a phone business that is in free fall and is burning cash. Nokia owned the biggest share of the phone market until 2012, when it was caught by Samsung. Nokia's market share is now down to 14% vs. Samsung's 26%. Also, in developing countries, Nokia's sales of lower-end feature phones are under relentless attack from cheaper phones made in those economies.

Meanwhile, Nokia's smartphones running Microsoft's Windows Phone operating system have garnered just a 3%-to-4% market share. The lack of top-end sales and the erosion of feature-phone sales produced a cash-flow loss at Nokia in 2011 as earnings before interest and taxes came to negative $1.07 billion. That figure deepened to $2.3 billion in 2012.

Microsoft will have to come up with hot products that generate consumer excitement to turn that around -- not exactly a company strong point. The firm also will have to convince more developers to write apps for the Windows Phone operating system. They will also have to somehow manage a workforce of 32,000 in Finland without driving the best talent to flee in frustration with Microsoft's often stifling corporate culture.

Is that a daunting task? You bet. Is Wall Street right to be skeptical? Absolutely. But this deal is a long way from crazy.

First, Microsoft is getting Nokia's handset business for a bargain price. Microsoft is paying only 0.35x annual revenue for these assets. That's less than the 0.77x revenue Google (GOOG) paid for Motorola Mobility. And Microsoft will pay for the deal using cash from the $70 billion horde that it has sitting offshore. Bringing that cash back to the U.S. -- to pay out a special dividend to shareholders, for example -- would generate a big tax hit. So this actually a good use of cash.

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