Why Microsoft Grabbed Nokia's Devices

NEW YORK ( TheStreet) -- This week's announcement of Microsoft's ( MSFT) acquisition of Nokia's ( NOK) Devices & Services (D&S) business came as a bit of a surprise, despite earlier speculation of such an outcome. However, some industry pundits believe that Steve Ballmer's retirement decision would mean no strategic action would happen in the interim period until a successor would be found, which was also supported by the high short base of about 20%. On the other hand, the move might also signal that perhaps Stephen Elop is very much in contention for the new CEO role at Microsoft. Elop had left Microsoft (as the leader of the Microsoft Office product line) in 2010 to take on the Nokia CEO role, and will now run the Microsoft Devices business.

Back-envelope calculations suggest the premium paid was good, with Nokia Solutions and Networks (NSN) being valued at around €7 billion and Nokia's IPR at about €1.2 billion. Adding to that, Nokia's estimated net cash position of €2 billion at the end of 2013 and this week's €5.44 billion transaction price yields a pro-forma valuation of roughly €16 billion, which corresponds to €4.20 per share, compared to Monday's close of €2.98, a 41% premium.

The €5.44 billion in cash has two components: €3.79 billion for Devices & Services (D&S) and €1.65 billion for the patent licensing. Microsoft will also be able to leverage the Nokia brand for the next 10 years. The deal leaves Nokia pretty much as a telecom equipment manufacturer focused around NSN. Although NSN has done well as of late, there are questions about its longer-term sustainability, as it's remained focused on only a few elements of wireless networks (e.g. the Radio Access Network, or RAN equipment). Smaller scale and less diversification will mean that what's left of Nokia will trade at discounted multiples relative to its peers such as Ericsson ( ERIC).

On the Microsoft side of the equation, the key consideration is: will a hardware acquisition enable the company to strengthen its ecosystem and offer a more differentiated product? That was one of the rationales behind the Google ( GOOG) acquisition of Motorola in 2012, but on the other hand, the Android OS was already flying at that point in time, while the Windows Phone ecosystem is currently struggling to get a higher traction. In fact, the acquisition might make things a bit more difficult for Microsoft as it might lose support from other OEMs such as HTC, LG and Samsung, particularly considering Nokia represented only roughly 60% of the Windows Phone shipments.

In fact, it will be interesting to watch the reaction from the above-mentioned "pure handset" vendors and whether or not they will feel threatened by the fact that all three ecosystems ( Apple ( AAPL), Google and Microsoft) now have their own hardware and sales channels. The pure handset vendors will be keeping an eye on whether or not Google and Microsoft will introduce differentiated products in-house, which could potentially erode value from the likes of HTC, LG and Samsung.

Another interesting consideration is whether or not today's announcement helps or hurts BlackBerry ( BBRY). On the one hand, it does knock off two potential buyers from what was already a short list of potential suitors for the Canadian-based vendor. That said, today's transaction might also increase the value being placed on independent ecosystems, given the possibility that the pure handset vendors might want to seek this as an alternative to combat the tighter integration of in-house handsets developed by Google and Microsoft.

There likely will not be any major supply chain impacts, as Microsoft and Nokia had already been working closely together, and one would expect that the current Nokia sourcing team will stay with the handset business. Moving forward, Microsoft will have to decide if it should continue with the internal assembly lines that Nokia operates or if it should close factories and rely more on assembly outsourcing.

But, at the end of the day, this deal signals the importance being placed by Microsoft on mobility, as the vendor continues its shift towards becoming a software-led multi-product company. As part of that journey, Microsoft will have to show that it can master the Apple vertical integration device model, which includes devices, software and services. Today's acquisition represents a key step towards that goal.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Ronald Gruia is a Director at Frost & Sullivan covering emerging telecoms. He has spoken at conferences including Supercomm, CTIA, Intel Communications Summit and VON Canada.

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