After losing ground to Apple and others, the software giant may need an acquisition to avoid losing out in the smartphone market
(Clarifies in first paragraph that Bach spoke to analysts in January.)
Just a few years ago, Microsoft (MSFT) looked like a real contender in the mobile-phone market. Its Windows Mobile operating system ran about a quarter of all smartphones as recently as 2004, and it was gaining ground on leaders like Nokia (NOK). Then Apple (AAPL) and BlackBerry maker Research In Motion (RIMM) left the software giant in the dust. On Feb. 15, at a wireless industry conference in Barcelona, Microsoft will unveil its latest effort to get back into the game. The renamed Windows Phone operating system will "move the bar forward, not in an evolutionary way," Robert J. Bach, president of the company's entertainment and devices division, promised analysts on Jan. 7. Microsoft needs to be a player in the smartphone market. The computing people used to do on personal computers, where Microsoft has a lock, is migrating to mobile devices. Apple's iPhone, RIM's Blackberry, and other phones are becoming the preferred way to read e-mail, check out Facebook, or catch up on the news. Researcher IDC predicts the total shipments of smartphones will more than double between 2009 and 2013, to 391.3 million units. Microsoft's new mobile software "has to be different and convince their customers and partners that they are going to fundamentally change direction," says IDC analyst William Stofega. New, Integrated Software
Microsoft's new software is much improved and has the advantage of easily handling word processing and spreadsheets sent from PCs. It will also be more integrated with the company's Xbox game machine and Zune music player, so users can share music and videos among Microsoft devices. But that won't solve another challenge the company faces in attracting customers. Independent software developers who create new applications for mobile phones have mostly ignored Microsoft and focused instead on the iPhone and Google (GOOG)-backed Android phones. Developers have cooked up more than 140,000 apps for the iPhone, available through Apple's iTunes. There are about 800 available in Microsoft's online mobile store, though the company estimates 20,000 applications will run on its mobile operating system. "They've never really established a brand presence that's meaningful," says analyst Charles S. Golvin of Forrester Research (FORR). Some industry analysts say the Redmond (Wash.)-based company should dramatically change course. It could opt to brand its own phone, like Google did, or strike a strategic partnership with a power player like Nokia. Several think it should make a major acquisition. "The logical thing for them to do would be to buy someone," says Richard Doherty, co-founder of consultancy Envisioneering. The most affordable choice would be Palm (PALM), with a market cap of $1.6 billion. The Sunnyvale (Calif.) maker of the Pre and Pixi phones has received high marks for its easy-to-use operating system. But Microsoft CEO Steve Ballmer has said he's not interested, sources within the company say. "[Palm's] brand equity isn't what it once was," says one Microsoft executive who works on mobile initiatives. Potential RIM Deal
Doherty says another possible target is Waterloo (Ont.)-based RIM, which has a stronghold in the corporate market Microsoft covets. RIM's market cap is now $38.5 billion. In a research report on Feb. 10, analyst Mark McKechnie of Broadpoint AmTech crunched the numbers on a potential RIM deal and suggested Microsoft could pay as much as $56 billion for the company. That would make it by far the most expensive ever by Microsoft, and substantially more than the $44 billion it offered in a failed bid for Yahoo two years ago. There's no guarantee Microsoft could get a RIM deal done or make it work, if completed. RIM executives, who together own more than 11% of the company, have shown no inclination to sell. The deal would also likely face intense regulatory reviews, particularly in Canada, where RIM is considered a national treasure. RIM spokeswoman Tenille Kennedy and Palm spokeswoman Lynn Fox declined to comment. The Microsoft source, who requested anonymity because he is not authorized to speak to the press, says the company is not currently considering a RIM acquisition and is focused on its own internal efforts. The company has begun working more closely with hardware partners, such as HTC and LG, to share engineering resources and better customize its software to their particular phones. It also plans to reduce the number of hardware partners from 58 at the end of 2008 to between a half dozen and a dozen. "We want more control over hardware to make sure the total experience is better," the source says. Microsoft may look like it's caught in a box now, but analysts say not to underestimate its potential. "They have a lot of funding, they have terrific engineering resources," says analyst Alex Spektor of consulting firm Strategy Analytics. "The game is not over."