Three Reasons Microsoft Bought Nokia

| September 23, 2013 | Hit The Market | , | Comments Off

Earlier this month, Microsoft (NASDAQ: MSFT) surprised investors by announcing a $7 billion purchase of Nokia’s (NYSE: NOK) smartphone business.

The move is being hailed by some as a smart way for Microsoft to compete in the fast growing smartphone market. Others see the move as foolish, suggesting that Microsoft is investing good money in Nokia’s outdated and unpopular technology.

The market itself viewed the deal as it does with many high-profile acquisitions:

Shares of the target company (Nokia) surged on the news, rising 31%.

Meanwhile, shares of the acquiring company (Microsoft) fell 4.5%.

Regardless of the market reaction, there are a number of reasons why the deal makes sense. Here are three reasons why Microsoft bought Nokia mobile divisions:

1. Uniting Hardware and Software

Microsoft isn’t new to the mobile device market. Nokia has been its primary mobile phone partner, but the relationship hasn’t served either company well.

Because Microsoft has been producing software to be used in Nokia hardware, the interaction between the two has never been as seamless as it could be. Microsoft has never had the ability to control its hardware 100%.

Nokia has always risked becoming too dependent on one software partner, so its research & development dollars have been spread across platforms to keep options open.

By bringing hardware and software under one roof, Microsoft gains its best chance at success in the mobile market.

2. Following the market leaders

The undisputed champions of mobile devices and software are Google (NASDAQ: GOOG) and Apple (NASDAQ: AAPL).

Apple already controls its software, hardware and even distribution. Google purchased Motorola Mobility so that it could control the hardware on which its software is used.

By merging its existing software with Nokia’s hardware, Microsoft has followed in the footsteps of its primary competitors. Given the success that both Apple and Google have seen in this market, this seems like a winning strategy.

3. Nokia Mobile at a Discount

If Microsoft had executed this deal five years ago, the price it paid would’ve been very different. The Nokia assets that Microsoft is buying would have cost between five and ten times more back then. Even after the initial pop of 31%, shares of Nokia were down more than 90% from all-time highs.

One could argue that this means Microsoft is buying these assets at a deep discount. This is exactly the kind of deal that eventually pays off for investors as the real value of the assets is eventually realized.

Of course, the case could be made that, like Blackberry (NASDAQ:BBRY), Nokia has lost so much value because it has failed to innovate and is now selling dead technology. Only time will tell.

The Bottom Line

Despite Nokia’s technological shortcomings, this deal ultimately makes sense for Microsoft. The ability to optimize the Nokia hardware to operate Microsoft software will give Microsoft the best shot at competing in the mobile market.

Did Microsoft pay too much for these assets? Not only is Nokia down so much from its all-time highs, Microsoft will generate the $7 billion it is spending on the deal in just ten weeks of operations.

Not to mention the fact that $7 billion is less than 10% of Microsoft’s available cash.

Basically, $7 billion to boost its chance in the all-important mobile market is a drop in the bucket for the technology giant.

Would I go out and buy Microsoft stock on this news?

As one of the largest, most important and consistent technology companies, Microsoft represents a solid choice for any diversified portfolio. The decline in Microsoft’s stock price on the news reached roughly 7%. That said, the stock has already recovered much of this value and is now only 2% below its pre-announcement price.

As investors digest the news and realize that this is, in fact, a good thing for both companies, Nokia is up 71% from its pre-announcement price. This may well pose a good entry point for someone who was already interested in Microsoft stock.

And I reiterate, this purchase of Nokia’s mobile assets is probably Microsoft’s best shot in the mobile market.

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