44 1. AN INTRODUCTION TO MERGERS, ACQUISITIONS, AND OTHER RESTRUCTURING ACTIVITIES END OF CHAPTER CASE STUDY: MICROSOFT ACQUIRES NOKIA IN THE ONGOING SMARTPHONE WARS Case Study Objectives: To Illustrate • Common motives for corporate restructuring • Alternative forms of corporate restructuring strategies. Once the global leader in mobile phone handsets, Finnish based Nokia Inc. saw its fortunes dissipate as it failed to adapt to a worldwide shift to smartphones. In the wake of intensified competition from its Asian rivals for lower end phones, the firm's market share fell to 14% at the end of 2013, from a peak of 40% in 2007. To conserve cash, the firm was forced to suspend its dividend in 2013 for the first time in its 148-year history. In Finland, where Nokia is viewed as a technology icon, this news was greeted with shock. At one time, the firm's market value was almost 5% of the country's gross domestic product. The firm represented a major source of national pride. But its inability or unwillingness to adapt to a sea change in mobile technology proved to be its undoing. In an effort to jumpstart its move into smartphones, Nokia acquired Symbian, its supplier of smartphone operating system software, in 2008. At the time, Symbian has 60% share of the smartphone operating system market, but it was losing share rapidly to Apple. Nokia also announced its intention to give away Symbian's software for free in response to Google's decision in 2008 to offer its Android operating system at no cost to handset makers. As was Google with its Android smartphone operating system, Nokia was seeking to estab- lish an industry standard based on its Symbian software, using it as a platform for providing online services to smartphone users, such as music and photo sharing. Nokia was attempting to position itself as the premier supplier of online services to the smartphone market by dominating the market with handsets reliant on the Symbian operating system. Nokia also hoped to spread any fixed cost associated with online services over an expanding customer base. Such fixed expenses could include a requirement by content service providers that Nokia pay a minimum level of royalties in addition to royalties that vary with usage. Similarly, the development cost incurred by service providers can be defrayed by selling into a growing customer base. In many ways this strategy was doomed from the start. Nokia was pursuing essentially a "me-too" strategy by simply mirroring Google's strategy in offering the software free to app developers and other handset manufacturers. However, the Symbian operating system was infe- rior to both the Apple IOS and Google Android operating systems, putting Nokia at a serious competitive disadvantage. Finally, the success of their strategy was heavily dependent on Nokia's ability to convince other handset makers (Nokia competitors) to adopt their software. Increasingly viewed as pocket computers, smartphones outsold personal computers for the first time in the fourth quarter of 2010. The Apple iPhone and devices powered by Google's Android operating system had won consumers with their sleek touchscreen software and with an army of developers creating applications for their devices. In just 3 years, Apple had cap- tured the largest share of the smartphone market. These developments put Microsoft's core business, selling software for PCs, in jeopardy and eroded Nokia's market share in the smart- phone market. I. THE MERGERS AND ACQUISITIONS ENVIRONMENT CHAPTER DISCUSSION QUESTIONS 45 On February 11, 2011, Nokia's CEO Stephen Elop announced an alliance with Microsoft to establish a third major player in the intensely competitive smartphone market. Under the deal, Nokia adopted Windows Phone 7 (WP7) as its principal smartphone operating system, replacing its own Symbian software. Nokia and Microsoft were betting that wireless carriers such as Verizon, AT&T, and Vodafone would want an alternative system to iPhone and Android. The partnership seemed to hold considerable promise. Nokia remained a powerhouse in feature phones and, if it could successfully transition these devices to the WP7 operating system, it may be able to increase market penetration sharply. Android appeared vulnerable at the time due to a number of problems: platform fragmentation, inconsistent updates and versions across devices, and the operating system becoming slower as it is called upon to support more applications. WP7, at this time, has none of these problems. If customers become frustrated with Android, then WP7 could gain significant share. Nokia could have partnered with Google, as have many handset manufacturers. However, such a partnership made little sense. It would have required the firm to compete with the likes of Samsung, HTC and Motorola-all makers of Android-powered smartphones—by trying to differentiate themselves by cutting deals to offer certain content exclusively on their phones and enhancing the phone's user interface. Under the terms of the partnership agreement, WP7 would become Nokia's primary smartphone platform; Nokia also agreed to help to introduce WP7 powered smartphones in new consumer and business markets throughout the globe. The two firms also would jointly market their products and integrate their mobile application online stores such that Microsoft's Marketplace (applications and media store) would absorb Nokia's current online applications and content store (Ovi). Nokia phones would use Microsoft's Bing search engine, Zune music store, Xbox live, gaming center, and would work with Microsoft on future services to expand the capabilities of mobile devices. Since the deal was not exclusive, Microsoft would continue to have other hardware partners, and Nokia would continue to make some Symbian powered devices, at least until a WP7-based smartphone had proven to be a commercial success. Microsoft also agreed to invest about 1 billion dollars in Nokia over a period of years to defray development and marketing costs. The alliance enabled Nokia to adopt new software (WP7) with an established community of developers but that has sold relatively poorly since its introduction in late 2010. With the phase out of its Symbian operating system over a period of years, Nokia was able to substantially reduce its own research and development and marketing budgets. For Microsoft, the alliance gave it access to Nokia's extensive intellectual property portfolio in the mobile market to strengthen the WP7 system. For Microsoft, the deal also represented a major opportunity to boost lagging sales in the mobile phone market. The alliance also gave Microsoft access the world's largest phone maker and its huge brand recognition. While Microsoft gained backing for its Windows phone operating system with the deal, this would not guarantee success in the mobile phone market. Despite having been an early entrant into the smartphone business, Microsoft had been unable to gain significant market share. Over the years, Microsoft has struck deals with many of the world's best known cellphone manufacturers, including Motorola and HTC Corp. But these alliances were hampered by either execution problems or by an inability of Microsoft to prevent I. THE MERGERS AND ACQUISITIONS ENVIRONMENT 46 1. AN INTRODUCTION TO MERGERS, ACQUISITIONS, AND OTHER RESTRUCTURING ACTIVITIES 1 handset makers from shifting to other technologies such as Google's Android operating system. For example, after failing to deliver mobile phone technology that would compete with Apple and Google's innovative systems, Taiwanese handset manufacturer, HTC, lost interest in manufacturing smartphones based on what was then known as Windows Mobile operating system and now makes many different Android phone models in addition to devices powered by WP7. Even though Microsoft's Mobility software was substantially revamped and dubbed Windows Phone 7, it was only able to capture 2% market share in the fourth quarter of 2010 following its introduction carly in the fall of that year. To better implement the partnership, Nokia reorganized into two business units: Smart Devices and Mobile Phones. The Smart Devices unit would focus on manufacturing the new Windows Phone 7 devices. The Smart Devices business must compete in the smartphone market against the likes of those producing handsets powered by the Google operating system, Blackberry, and Apple with only the Windows Phone 7 powered phone. The Mobile Phones operation would continue to develop phones for Nokia's mass market. The mass market feature phone business represented Nokia's core business in which the firm would produce large volumes of phones for the mass market differentiated largely by their features. While this market had proven lucrative for years, it is now under increasing pressure from mass produced Chinese phones. Despite all the fanfare surrounding the formation of the partnership, investors expressed their disapproval of the deal with Nokia's stock falling 11% on the announcement. Similarly, Microsoft's shares fell by 1% as investors feared that the firm had teamed with a weak player in the smartphone market and that the 2-year transition period before WP7-based smartphones would be sold in volume would only allow Android-based smartphones and iPhones to get further ahead. Its potential notwithstanding, the partnership faced many challenges. Despite setting the industry standard for handsets, Nokia did not have a smartphone product comparable to Apple's iPhone (introduced in 2007) and Google's Android system (first shipped in 2009). With Samsung, HTC, and LG having invested heavily in Android-powered devices, they had little incentive to commit to WP7-based devices. Instead, these firms seemed to be inclined to use the WP7 system as an alternative to Android in its negotiations with Google threatening to shift resources to WP7. Furthermore, Nokia is a European company and Europe is where it has greatest market share. However, Microsoft has had a checkered past with EU antitrust authorities which sued the firm for alleged monopolies in its Windows and Office products. European companies have been much faster to adopt open-source solutions, often in an effort to replace Microsoft software. With the announcement of the alliance, there was the danger that Nokia would see a portion of its customers move into Android-based devices and into iPhones. The partnership's performance since its inception has been problematic. Its success was based on the premise it could rapidly develop a compelling smartphone and tablet combination powered by first Windows Phone 7 and later the Windows Phone 8 operating system that would be widely accepted in the marketplace and enable the sale of lucrative Microsoft content. Since 2011, Nokia has developed several Windows based phones which showed only tepid sales growth, despite good reviews from industry pundits. Eventually, friction developed after I. THE MERGERS AND ACQUISITIONS ENVIRONMENT CHAPTER DISCUSSION QUESTIONS 47 Microsoft introduced its Surface tablets in late 2012 undercutting Nokia plans to develop and market own tablet devices. Moreover, sharing of intellectual property held by the two companies was not nearly as seamless as had been hoped at the inception of the partnership. Development activities at the two firms overlapped as both Microsoft and Nokia were spending money on app developers, music stores, and other content required for the ecosystem (i.e., products and content using a common operating system). It soon became apparent that both partners would be better off operating as a single entity owned by one party. The partnership with Microsoft failed to be the panacea the two firms expected. Symbian sales collapsed and Nokia faced increased competition from Asian rivals at the lower end of the handset market. The firm was rapidly running out of options. At the same time, Microsoft was getting frustrated in its ability to transform the firm into a formidable mobile technology competitor. Most of Microsoft revenues and profits come from its Windows operating system, Office suite of software, and the X-Box game console. It has so far failed to establish a profitable mobile device business. Its own tablet, the Surface, has thus far had limited success since its launch in 2012. With the limited likelihood other vendors would support its Windows 8 phone system, Microsoft believed it had little choice but to move beyond its software roots increasingly into hardware. In an audacious move, Microsoft announced that it had reached an agreement to acquire Nokia in September 2013. Nokia shareholders approved the $7.4 billion sale of the firm's mobile handset business to Microsoft before the end of the year, eventually closing the deal following receipt of regulatory approval in early 2014. Under the terms of the transaction, Microsoft paid $5.2 billion to buy Nokia's devices and services business plus an additional $2.2 billion to license Nokia's patents and the Nokia name for 10 years. Because Nokia is based in Finland, Microsoft can use a portion of its foreign held cash to pay for the acquisition, enabling it to avoid a hefty tax burden if such funds were repatriated to the United States. Microsoft undertook a similar strategy when it acquired Skype for $8.2 billion, the largest acquisition in its history The acquisition firmly committed Microsoft to a vertical business strategy in which it would own both the hardware and software products. The "Microsoft strategy” is patterned after the Apple model built around iPads, iPhones and the firm's App Store and Google's model built on the Android operating system, Google Plus market place, and Nexus line of tablets. The acquisition also had the added benefit of preventing a Microsoft competitor from acquiring Nokia. After selling its phone business, Nokia is a shadow of its former self. Its remaining businesses include network infrastructure and services; mapping and location services, and a technology development and licensing unit. Microsoft faces an uphill struggle in its effort to transform the firm into a major global mobile technology player. Windows phones accounted for only 3.7% of smartphone shipments in 2013. The Surface tablet, while showing some improvement in sales in early 2014, still lagged far behind industry leader Apple. Nokia has fallen to second place in terms of shipments of mobile phones behind Samsung and is not even in the top five makers of smartphones. Furthermore, integrating with minimal disruption the two disparate Microsoft and Nokia corporate cultures is a daunting task. The takeover of Nokia may prove to be just another battle in the ongoing global smartphone wars. I. THE MERGERS AND ACQUISITIONS ENVIRONMENT 48 1. AN INTRODUCTION TO MERGERS, ACQUISITIONS, AND OTHER RESTRUCTURING ACTIVITIES Discussion Questions 1. Using the motives for M&As described in Chapter 1, which do you think apply to Microsoft's acquisition of Nokia? Discuss the logic underlying each motive you identify. Be specific. 2. Speculate as to why Microsoft and Nokia initially decided to form a partnership rather than have Microsoft simply acquire Nokia? Why was the partnership unsuccessful? 3. Speculate as to why Microsoft used cash rather than some other form of payment to acquire Nokia? Be specific. 4. The Nokia takeover is an example of vertical integration. How does vertical integration differ from horizontal integration? How are the two businesses (software and hardware) the same and how are they different? What are the potential advantages and disadvantages of this vertical integration for Microsoft? Be specific. 5. What are the critical assumptions that Microsoft is making in buying Nokia? Do you believe these assumptions are realistic? Explain your answer. Answers to these questions are found in the Online Instructor's Manual available to instructors using this book. ADDITIONAL CASE STUDY RECOMMENDATIONS (SEARCH HARVARD BUSINESS SCHOOL PUBLISHING SITE BY NAME OF CASE: hbsp.harvard.edu) Hindalco's Acquisition of Novelis: The October 10, 2009, Product Number: Making of a Giant, Aastha Sachdeva, 610020-PDF-ENG. Source: Harvard Madhur Deep, R. Srinivasan, Revision Business School, hbsp.harvard.edu. Date: January 1, 2010, Product Number: Subjects Covered: Takeovers, Mergers IMB303-PDF-ENG, Source: Indian and Acquisitions, Valuation, Business Institute of Management, Bangalore, Strategy, Value Creation, Due Diligence, hbsp.harvard.edu. Integration Planning, Cultural Issues, Subjects Covered: Acquirer and Negotiation Target Motives, Cross-Border Deals, InBev and Anheuser-Busch, Andrew C. Value Creation and Value Destruction, Inkpen, Publication Date: November 16, Aligning Strategic Intents, Cross- 2010, Product Number: TB0251-PDF- Cultural Relations. ENG. Source: Thunderbird School of Big (Double) Deal: Anadarko's Management, hbsp.harvard.edu. Acquisition of Kerr-McGee and Western Subjects Covered: Takeovers, Gas Resources, Clayton Christensen, Synergy, Premiums, Integration. Curtis B. Rising, Publication Date: I. THE MERGERS AND ACQUISITIONS ENVIRONMENT
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