Quick Thoughts: Nokia and Microsoft

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This morning, in an entirely telegraphed but still shockingly radical shift in strategy, new Nokia CEO Stephen Elop announced a comprehensive smartphone partnership with his former employer, Microsoft.  Most observers have been justifiably critical of both erstwhile innovation leaders’ efforts to cope with the iPhone phenomenon to date, and the alliance begins life under a heavy cloud of skepticism.  Earlier in the week, Google engineering VP Vic Gundotra tweeted “Two turkeys do not make an eagle” – a not so veiled shot at the pending team-up that seems to have been taken to heart by investors.  Against the grain, our take is “better late than never”.

The first step on the road to any recovery is admitting that you have a problem.  Elop was appropriately evocative when he likened his company to an oil worker standing on the edge of a blazing drilling platform.  Leaping into the North Sea, or into the arms of Mister Softee, may have unattractive consequences but it is unequivocally better than burning to death standing in place.  Nokia had largely frittered away its pioneer position in smartphones, stubbornly remaining on a path of slow and steady incremental improvement that had allowed it to retake lost market share in the wake of Motorola’s post RAZR self-immolation. This doesn’t work when the competitors are Apple and Google. Four years after its commercial introduction, Nokia still hasn’t delivered a viable response to the iPhone.

This recent legacy of failure is apparent to Elop, and likely drove him to his decision to cut bait with Nokia’s internal smartphone software design ambitions.  Yes, controlling an ecosystem from its core software is the ideal way to create value in the modern smartphone world, but not if your core software is perpetually years behind its competition in an environment of blazing innovation.  Nokia’s old Symbian partners – Sony-Ericsson, Motorola, Samsung, Panasonic, Fujitsu, and others – have long since abandoned the platform in favor of Google’s Android.  MeeGo, the Linux-based Nokia driven iPhone/Android alternative, has missed multiple delivery dates and has generated little enthusiasm amongst potential hardware partners or applications developers.  Better to jump than to burn.

Given that controlling its own destiny was realistically off of the table, Elop looked for partners.  Obviously, Apple was not going to license X-OS.  While we believe that Android will be the predominant standard for smartphones and tablets going forward, Nokia is years behind competitors who have been working with the software standard to tailor it to their own strategies.  In this context, Microsoft is an intriguing partner.  Mobile Windows 7 is an excellent piece of software, with strong technical reviews and clear differentiation vs. the Android/iPhone nexus.  What it lacks are scale, marketing oomph, and distribution channels, things that Nokia can provide.  In this, Nokia and Microsoft need each other, bring substantial resources and assets to a partnership, and likely have forged a mutually beneficial financial relationship that will not render the resulting products uncompetitive under the weight of an untenable royalty structure.

So thus, the former dominant leaders from the PC and cell phone worlds are cast into the role of underdogs in the mobile device market that is superseding the once separate ecosystems.  In this, they have the support of the global carrier community that fears the co-dominance of Apple and Google and their inherent strategies to marginalize them into dumb pipes.  They have Nokia’s global scale and still formidable marketing and distribution into the developing world.  They have Microsoft’s differentiated platform and still formidable position with enterprise IT departments and PC applications ecosystem.  In this, we believe the allied Nokia and Microsoft have a better shot than do Research in Motion or Hewlett Packard, both of which stand alone and neither of which sports the advantages of the Espoo-Redmund connection.

While the fallout from this wrenching course shift will undoubtedly batter Nokia financials for a year or better, and the benefits to both partners are unlikely to be apparent until the real fruits of collaboration hit the market in 2012 and beyond, we believe that it is greatly in the best interest of both companies and their shareholders.  Of course, it will depend on the speed and the quality of execution, factors that have not been evident in either of the parties in the past few years.  Acknowledging that, these are proud organizations with strong managers that we believe can distinguish themselves once freed from bureaucracy and the weight of supporting technology legacies.  We believe that there is a sizeable opportunity to address the slowly emerging enterprise market for portable platforms, to serve the large majority of the market that will never be able to afford an iPhone and to deliver the smartphone experience to more difficult to reach geographies.  Nokia and Microsoft can take leadership if the execution is there.

From a stock perspective, the benefits for the two companies are far enough out that the investment opportunity may not yet be upon us.  We believe that both companies will be survivors through this, and once the pain is fully reflected, suspect that both will be very attractive investments.  This deal also increases our skepticism as to the viability of both Research in Motion and HP in the mobile market.  Meanwhile, the mobile platform revolution continues apace, and whether or not Nokia and Microsoft make this work, Apple and Google can be expected to continue their extraordinary rise in smartphones and tablets, to the detriment of traditional PCs and cell phones

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