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Microsoft rolls big, buys Nokia's phone biz

News analysis

(MoneyWatch) Microsoft (MSFT) will pay about $7.18 billion to Nokia (NOK) to buy the Finnish company's devices and services business and license patents for ten years, with an option to extend the use permanently. The all-cash deal, and an additional $2 billion in immediate financing, will use Microsoft's "overseas resources" for funding. About 32,000 Nokia employees are expected to transfer to Microsoft.

Microsoft CEO Steve Ballmer, who recently announced his upcoming retirement, called the move a "bold step into the future" in the company's press release, but it might more accurately be called a bold and desperate step. Gaining a strong foothold in phones and tablets is critical for the company's future. But will purchasing a line of business that has been crumbling to support software that has received a tepid reception actually make a difference to Microsoft's future?

Microsoft and Nokia announced a strategic partnership in February 2011. Back then the two said they would "jointly create market-leading mobile products and services designed to offer consumers, operators and developers unrivaled choice and opportunity." That was because each was flailing about and badly falling behind.

The move did next to nothing for Nokia, which has continued to thrash about. Windows Phone has now finally reached a 3.7 percent market share for the second quarter of 2013, according to IDC. It's in third place behind Google (GOOG) Android and Apple (AAPL) iOS. Still, after years now, even Apple is outselling at about a 4 to 1 rate, and Android has almost 80 percent market share.

What let Microsoft get even this far? Nokia. Although its Lumia line has done well (7.4 million units into resellers last quarter) and "accounted for 81.6 percent of all Windows Phone shipments during 2Q13," according to IDC, Nokia again saw plummeting revenue and handset sales in North America, an important market (particularly for Microsoft), dropped to 500,000 units from 600,000 the year before. And Nokia's total handset volume dropped by 27 percent, year over year.

That shows why both companies were desperate enough to make this move. Nokia couldn't maintain the rate of cash consumption by the device business (the stock jumped 40 percent on news of the Microsoft deal) and Microsoft couldn't afford its main driver of Windows Phone sales to go out of business.

But this is buying breathing room -- and, potentially, a replacement for Steve Ballmer if Nokia CEO Stephen Elop, formerly of Microsoft, rejoins the employer as a possible succession strategy. It isn't inconceivable that a Microsoft-driven set of devices could take off. It wasn't so long ago that Android device sales were pathetic and some people insisted that it could never catch Apple. And yet, Microsoft has failed to successfully market the Zune media player, the Kin phone, and the Surface RT tablet (the latter instigating a recent $900 million inventory write-off).

Buying a hardware manufacturer does not necessarily mean that Microsoft will become competent at selling hardware. The move will also increase tensions between the software company and its traditional hardware partners. According to Strategy Analytics, two big reasons for the lack of better progress for Windows phone has been licensing fees that were too high and a lack of support for the newest chip sets. Now those other vendors who would be necessary to blunt the advance of Android will correctly assume that Microsoft handsets have significant economic advantages, which could push them even more firmly into the Android camp.