Microsoft Out$18 Billion on Ballmer Nokia Deal: Real M&A

Microsoft Corp.’s $7.2 billion takeover of Nokia Oyj’s handset business cost shareholders more than twice that as it dashed hopes for a fresh start under Steve Ballmer’s successor.

The world’s largest software company lost $18 billion in market value since the purchase of Nokia’s mobile-phone assets was disclosed, erasing all of the gains that followed the announcement last month that Ballmer is retiring, according to data compiled by Bloomberg. The agreement cements the departing chief executive officer’s shift toward the more volatile consumer-device business and leaves little room for his successor to take a different tack, Atlantic Equities LLP said.

Microsoft is chasing growth in a market already dominated by Apple Inc. and Google Inc. with devices that generate lower returns than the company’s business-software division. Nokia CEO Stephen Elop is returning to Microsoft as part of the asset sale, making him Ballmer’s most likely successor and signaling that the company is in smartphones for the long haul, Sanford C. Bernstein & Co. said, even as some shareholders say that strategy is misplaced.

“I can’t say I’m too thrilled about the deal,” Tim Schwartz, a money manager at Bloomfield Hills, Michigan-based Schwartz Investment Counsel Inc., which oversees $1.3 billion and owns Microsoft, said in a phone interview. “The perception is that this is going to be a continuation of the old management and old-school Microsoft mentality.”

Ballmer Exit

Microsoft shares surged 7.3 percent on Aug. 23 after Ballmer, who has been CEO since 2000, said he will retire within 12 months. Some investors were eager for his replacement to be an outsider who might make bold moves to reverse a shrinking market value, such as spinning off consumer-centric units like Xbox and shifting its focus back toward software and services for businesses.

The Nokia purchase instead has fueled speculation that Elop, a former Microsoft executive, is being groomed to take the helm and will continue with Ballmer’s strategy of keeping enterprise and consumer products under one roof. The stock has dropped 6.6 percent since announcing the Nokia deal, sending Microsoft’s market value down to $260 billion yesterday.

Today, Microsoft shares climbed 0.1 percent to $31.23 at 9:50 a.m. New York time.

“There have been a meaningful proportion of investors who had hoped that Microsoft would de-emphasize its consumer businesses and focus on its more profitable, more predictable corporate businesses,” Chris Hickey, a London-based analyst at Atlantic Equities, said in a phone interview. “This acquisition obviously makes that possibility extremely unlikely” and “ties the hands” of the next CEO, he said.

Critical Market

Microsoft said adding Nokia’s handset business will let it make more money from Windows Phones and help the software maker move faster and create better products in a market that is critical to its success. The company sees “significant long-term revenue and profit opportunities” for shareholders, Ballmer said in the press release announcing the deal.

“Phones are the most personal of the personal devices people use today and success in phones is important for success in tablets and PCs,” Brad Smith, Microsoft’s general counsel, said in an interview Sept. 3. “We need to move faster.”

Tony Imperati, a spokesman for Microsoft, declined yesterday to comment further.

The timing of the deal limits activist shareholder ValueAct Holdings LP’s ability to fight the deal, according to Rick Sherlund, a New York-based analyst at Nomura Holdings Inc. ValueAct last week won an agreement that would give it a seat on Microsoft’s board next year and guaranteed regular meetings with “selected Microsoft directors and management.” In return, the investor won’t pursue or participate in a proxy contest.

Response Options

A person with knowledge of the matter has said that ValueAct wants Microsoft to focus on its business software and Internet-based cloud services rather than consumer technology. Representatives for ValueAct didn’t return calls for comment on the Microsoft-Nokia deal.

“Now that ValueAct has entered its standstill agreement, it is not clear what alternatives ValueAct may have to respond to shareholder dissatisfaction with the Nokia deal,” Sherlund wrote in a note Sept. 3.

Much of the dissatisfaction is due to “not the deal itself but what it could mean,” Mark Moerdler, a New York-based analyst at Bernstein, said in a phone interview. “It may not be the end of the investments Microsoft makes in trying to chase after the consumer market, an area that the Street may or may not feel is the best use of Microsoft’s resources.”

More Deals?

Microsoft still needs more applications and services if it wants to fulfill Ballmer’s strategy of integrating its services with its devices, similar to what Apple has done, Jason Maynard, a San Francisco-based analyst at Wells Fargo & Co., wrote in a Sept. 3 report.

BlackBerry Ltd.’s strong presence in the enterprise market could still attract interest from Microsoft, according to people familiar with the matter who asked not to be identified. Shares of the Canadian smartphone maker, which is weighing a sale, have risen 6.2 percent since Microsoft’s Nokia announcement.

Microsoft paid 0.42 times Nokia’s trailing 12-month revenue from devices and services, according to data compiled by Bloomberg that include net debt. That revenue multiple would imply an enterprise value of $4.8 billion for Blackberry. The device maker’s equity and net cash are currently valued at $2.8 billion.

The acquisition will put an even bigger spotlight on the struggles in Microsoft’s consumer-devices business, which are likely to continue as it faces off against stronger rivals Apple and Google, Hickey of Atlantic Equities said.

Declining Asset

The deal doesn’t offer much more to Microsoft than it already had as part of its partnership with Nokia, according to Nandan Amladi, a New York-based analyst at Deutsche Bank AG.

“They already had a partnership in place, so people are wondering why they bought an asset with a declining revenue base and pretty challenging margins,” Amladi said in a phone interview.

Microsoft is paying a much higher premium for the Nokia assets than “even optimistic estimates suggested they were worth,” said Todd Lowenstein, a Los Angeles-based fund manager at HighMark Capital Management Inc., which oversees about $19 billion and owns Microsoft shares.

“The deal handcuffs the next CEO somewhat,” Lowenstein said in an e-mail. “This feeds into the perception Microsoft lacks capital discipline, overpays on deals, and chases growth in areas where they aren’t competitive at their core.”

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