Microsoft’s purchase of Nokia’s hardware business appears set to sail through, having passed shareholder and regulator approval. The 5.44 billion euro deal will see “substantially all of Nokia’s Devices & Services business” become part of Microsoft, according to the companies.
The deal will allow Microsoft to wrest control of its smartphone platform from a third-party that had increasing hegemony over its end-user experience. Nokia has become the de facto Windows Phone manufacturer, as its rising unit volume met slackening competition due to flagging OEM interest.
What will the financial impacts of the Nokia deal be for Microsoft? Two questions need to be answered: Compared to Microsoft’s revenue, how large is the Nokia purchase in terms of relative top line? Also, what impact can we expect Nokia’s hardware business to have on Microsoft’s earnings per share?
To explore these issues we will source data from both companies, their joint statement, and industry forecasts. We’ll first examine Nokia’s net sales compared to Microsoft revenue, and then weigh their net incomes to determine an expected percentage and dollar decline in Microsoft’s earnings per share using historical data.
Microsoft says it will purchase “substantially all of Nokia’s Devices and Services business,” a statement that is far too generic to use. Happily, it supplied another figure that is quite useful: In 2012, the portion of Nokia that it will purchase generated 14.9 billion euro in net sales.
According to Nokia, the larger Devices and Services group had net sales of 15.686 billion euro in 2012. So, Microsoft is buying assets that drive around 95% of Devices and Services’ net sales.
We can use that figure to estimate calendar 2013 Devices and Services revenue, which we can then compare to Microsoft’s same-period revenue to get a good handle on their relative scale. 2012 data isn’t acceptable, as Nokia has shrunk in the interim while Microsoft has grown, distorting the comparison.
Nokia’s calendar 2013 Q1, Q2, and Q3 net sales totaled 17.209 billion euro. In that three-quarter period, 8.51 billion euro came from the Devices and Services division, or 49.5%. This is a good number, as it jibes with Microsoft’s comment that the Devices and Services net sales from 2012 that is attributable to what it is purchasing was “almost 50 percent of Nokia’s net sales for the full year 2012.”
The market expects Nokia to report 6 billion euros in net sales in calendar Q4 of 2013. Given that half of Nokia revenue is Devices and Services, we can expect that division to generate 3 billion euro in net sales. That added to the extant 8.51 billion net sales tally from the first three-quarters of calendar 2013 implies that Nokia’s Devices and Services division should have net sales of around 11.51 billion euro in the full year.
Converting that to dollars at current exchange rates, we can see that Nokia’s Devices and Services division’s net sales tally for calendar 2013 should be around $15.8 billion. Microsoft’s cut of that total top line is 95%, or $15.01 billion.
So, in 2013 if Microsoft had owned the pieces of Nokia that it will shortly, its revenue tally would have added just over $15 billion in net sales. We’re speaking loosely by comparing Nokia net sales to Microsoft’s revenue figures, but as the comparison is more conservative on the Nokia side, I don’t mind that much.
To compare Nokia’s calendar 2013 we must stack it next to corresponding fiscal quarters from Microsoft, which operates on its own calendar. So, we’ll need to tally revenue from Microsoft’s fiscal Q3 and Q4 of 2013, and its fiscal Q1 and Q2 of 2014. As with Nokia, we’ll use average investor estimates for the current quarter (fiscal Q2 2014 for Microsoft, calendar Q4 2013 for Nokia):
- FQ3 2013: $20.49 billion
- FQ4 2013: $19.90 billion
- FQ1 2014: $18.53 billion
- FQ2 2014: $23.7 billion [Expected]
That totals to $82.62 billion.
We can now compare: Nokia’s Devices and Services net sales tally for calendar 2013 that would be attributable to Microsoft totaled $15.01 billion, including its forecasted fourth quarter. That is 18.17% of Microsoft’s revenue in same-period.
For a slightly more hatcheted comparison, Nokia’s net sales will be between 1/6th and 1/5th of Microsoft’s revenue in the period.
So, Microsoft’s top line will grow by less than 20% after the purchase. The purchase lowers the cost of its shares on a sales multiple basis, reduces its balance sheet value by unloading cash, and, as we’ll see, hurts its earnings per share. Let’s get to that last bit.
Earnings Per Share
For earnings per share, let’s take a look at the most recently reported quarter for each company, and work out what the impact of Nokia’s recent net loss would be on Microsoft’s earnings per share. EPS, of course, is a number closely correlated with a company’s stock price.
We’ll only deal with figures from Nokia’s Devices and Services group as they are the relevant sums.
Microsoft had net income of $5.244 billion, and the Nokia division -$116.97 million (as reported: -85 million euro). However, Microsoft absorbs 95% of that. We’re presuming here that Microsoft’s share of net sales will be equivalent to its share of profits (losses). So, the division’s net loss comes to $111.12 million.
Microsoft had an earnings per share ratio of $8.46 billion:$1 in the quarter. If we deduct the $111.12 million loss that Nokia would have contributed if Microsoft owned its future assets in the most recent quarter, it would have had net income of $5.133 billion.
Using the same ratio, we can see that Microsoft would have had not $0.62 in earnings per share as before, but $0.6067 per share, or just over a penny less per share. So, we can predict that on a quarterly basis, Nokia’s losses will have a minimal impact on Microsoft EPS figure, and therefore, ostensibly, its share price.
You could argue that the impact to Microsoft’s margins will be more material, which is fair, but at a minimum the EPS impact of the Nokia buy — assuming no new material deterioration in the assets in question – will be negligible.
Nokia will bring to Microsoft revenue each year of roughly equivalent size to two quarters of its new Devices and Consumer groups top line. On a revenue basis (or sales multiple basis, if you prefer), Microsoft will become cheaper, assuming its stock price remains static.
However, its gross and operating margins appear set to decline, as will its net profit and earnings per share, even if only in a minor way.
Still, the move by Microsoft to deploy dully performing foreign cash reserves to add nearly 20% to its top line in one move, opening the door to future accelerating profits, is appealing.
The above presumes, of course that Microsoft can in fact wring profits from its shiny new Nokia assets, and employees.
Microsoft wanted to get into hardware business. Welcome!
Top Image Credit: Flickr
For fun, here’s the mental doodles that this post was derived from.