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Insight: As Finland reels, Microsoft doubles down with Nokia phone deal

A man uses the camera of a Nokia Lumia 820 smartphone as he poses in this photo illustration taken in the central Bosnian town of Zenica, Se
A man uses the camera of a Nokia Lumia 820 smartphone as he poses in this photo illustration taken in the central Bosnian town of Zenica, Se

By Ritsuko Ando and Bill Rigby

HELSINKI/SEATTLE (Reuters) - In an era when shiny new tech start-ups can be worth tens of billions of dollars, Microsoft's deal to acquire Nokia's mobile handset business for 5.44 billion euros ($7.2 billion) is a modest one from a strictly financial point of view.

Yet the deal is likely to go down as a major turning point in the contemporary technology business, one that marks the end of a Finnish company's unlikely run as world-beating tech icon even as it shapes the future of Microsoft Corp - for better or for worse.

In Finland, politicians and business leaders mourned the fall of Nokia, while pensioners wondered what it all meant for them. In Seattle, the chatter centered on what the deal might say about the race to succeed Microsoft Chief Executive Steve Ballmer, who announced 10 days ago that he would step down within a year.

For the global telecom industry, meanwhile, the deal signals further consolidation, coming just a day after Verizon announced a $130 billion deal to buy Vodafone's stake in its wireless unit. It could also help Microsoft achieve its long-held ambition of becoming a major rival to Apple and Samsung in the global smartphone business, though it will also put even more pressure on the company to show that its massive investments in consumer devices make sense.

The Nokia deal "unequivocally suggests they aren't exiting the business and in fact are doubling down on mobile," said Todd Lowenstein, a portfolio manager at HighMark Capital Management, which holds Microsoft shares.

"They can in all likelihood carve out a decent niche with their scale as a fully integrated player, however investors are questioning the merits," Lowenstein added. "The markets have spoken volumes." Microsoft shares finished down 4.6 percent on Tuesday.

Nokia and Microsoft have been joined at the hip since early 2011, when the Finnish company agreed to adopt Microsoft's Windows Phone software for its smartphones - a big gamble for Nokia, but one that came at a time when the company's market share was already in a freefall and it had few good options.

Since then Nokia has produced a series of Windows-powered phones that were mostly well-reviewed by critics, though largely shunned by customers.

There had been speculation from the start that Microsoft might eventually buy Nokia, but many analysts thought Microsoft had the best of both worlds - a committed hardware partner, but none of the considerable downside risk that might go with owning a phone-maker.

Behind the scenes, though, friction developed, according to a source familiar with the situation, especially after Microsoft launched its Surface tablets last fall.

"Each was trying to spend money on app developers, music stores, all the parts critical to the ecosystem," said the source. "It all came to a head at the end of last year, beginning of this year - was this really the right way to work or are we better as one entity?"

Discussions on an acquisition began in earnest in February, after Ballmer approached Nokia for an "open dialogue." Ballmer and Nokia board chairman Risto Siilasmaa met at the Mobile World Congress in Barcelona. After a few hiccups the negotiations kicked into high gear in July, with almost 50 board meetings on the part of Nokia.

Another source close familiar with the negotiations said the timing of the deal, which was called "Project Gold Medal" at Microsoft, was influenced by Ballmer's announced departure, with Nokia seeking to wrap it up before a new CEO was named. Nokia officials were concerned that if it delayed it could end up with facing a firesale down the road as its cash position worsened, the source said.

For Microsoft, moving ahead with a major strategic acquisition even as it seeks a new CEO reaffirms its commitment to being a broad-based "devices and services" company - a strategy crafted by Ballmer and one which was at the heart of a major reorganization announced just weeks ago.

On Tuesday, Microsoft called the Nokia deal "a huge leap forward on our journey of creating a family of devices and services that delight people and empower businesses of all sizes."

People close to the situation rejected the idea that the transaction meant that Nokia CEO Stephen Elop, a former Microsoft executive who will rejoin the company as head of the devices and services division, would automatically succeed Ballmer. But analysts said the move could make it harder to bring in an outsider CEO who might want to revisit all aspects of the company's strategy.

FINLAND'S NATIONAL CHAMPION

Tuesday's deal marks the breakup of a company almost embedded in Finnish DNA, a once-proud symbol of Nordic entrepreneurial engineering prowess and design. At its peak it accounted for 40 percent of the world's mobile phones, a fifth of Finland's exports and four percent of its GDP, and had a market value of close to $300 billion.

Barely a decade ago, consumers talked about Nokia with the same bated breadth as they do about Apple today, marveling at its sleek but practical designs. But its abrupt fall symbolizes the breakneck speed and unforgiving competition in consumer electronics, where nimble rivals can quickly upset established industry leaders.

Nokia itself has had plenty of experience in reinvention over its 148-year history. From its beginning as a paper manufacturer in 1865, it grew to make everything from rubber boots to televisions, and eventually its brand name was even emblazoned on lavatory tissue.

Its modern incarnation began under Jorma Ollila, who headed the cellphone unit beginning in 1990 and then, as chief executive, transformed the Finnish conglomerate into a global handset leader. Its brand name was often mistaken as Japanese, something that at the time delighted a company whose home country was harder to sell globally.

"It was something Finland hadn't had, this major consumer brand," said Mikko Makipaa, an entrepreneur, recalling his days at the company from 1996 to 2009.

But Ollila was blamed for being late to recognize the threat of Apple's iPhone and the smartphone revolution. A report by the Research Institute of the Finnish Economy said Nokia developed touch-screen phones three years before the iPhone and a tablet as early as 2005, but they never reached the market.

Elop's appointment in 2010 was hailed for bringing Silicon valley zip into the struggling company as rivals led by Apple were gaining market share in high-end smartphones even as Asian competitors were eating away at the cheaper, simpler end of the handset market.

A Canadian with five children and an amateur pilot who had previously headed Microsoft's business division, Elop was the first non-Finn to head Nokia. At his first press conference - broadcast live on Finnish TV - he played up his love for ice hockey, a passion many Canadians share with Finns.

His enthusiasm quickly endeared him to staff, but he was also blunt. In a now-famous 2011 email to staff, he compared Symbian - Nokia's then operating software - with a "burning platform" that needed to be abandoned. It was dropped in favor of a largely untested alternative from Microsoft.

One in three jobs were cut, and one source who was there at the time said the memo was ill-advised because it destroyed sales of Symbian before the Windows phones were ready. Still, it was mostly seen as the sort of bold stroke needed to rescue the flailing company.

Now Elop is viewed in a different light. "A Trojan horse," the widely-read tabloid Ilta-Sanomat declared in a column on Tuesday.

"It sounds like a betrayal to me," said Finnish pensioner Paivi Rengman.

In fact, many in Finland saw the deal as a sign of deeper malaise within the Finnish economy and its celebrated Nordic welfare model.

"For Finland, Nokia is emotional and symbolic. My generation grew up with a Nokia in their pocket. We view the deal in Finland as the end of an era," said Alexander Stubb, Finland's minister for European Affairs and Foreign Trade.

Nokia is not disappearing, and will now concentrate on its networking equipment unit, navigation business and technology patents.

Optimists say it is not the first time Nokia has taken a big bet. In the early 1990s it sold off businesses that accounted for around 70 percent of its sales to focus on telecoms. That followed the collapse of the Soviet Union, which halted a highly profitable cross-border trade.

Finland also remains one of the few countries in the euro zone with a triple-A credit rating. But its reputation as an egalitarian society with top-notch education and health services belies worries about its once-mighty export manufacturers and rapidly ageing population.

"This is a major challenge for Finland," said Tero Kuittinen, an analyst at Alekstra. "Microsoft is unlikely to keep any meaningful handset R&D or production in Finland.

"In 2007, Finland had 60 percent of the global smartphone market. That will now plunge to zero percent - a massive blow for a country that bet so much on mobile technology," Kuittinen added.

To a certain extent, Nokia's decline may have inoculated Finland against a sudden shock. At its peak, Nokia accounted for 4 percent of Finnish GDP and supported myriad suppliers. Today it contributes closer to 1 percent, according to analysts.

Many former Nokia employees have helped to spawn a growing IT industry, symbolized by fast-growing Rovio, maker of the popular Angry Birds game.

Kuittinen said that Rovio's Angry Birds empire has racked up nearly 2 billion downloads while Supercell, another game company, is getting close to $100 million in monthly revenue from its two blockbusters, Hay Day and Clash of Clans.

"The problem is that these two companies combined only have 700 or so employees," Kuittinen said.

But for an upcoming generation, nostalgia about Nokia may have been supplanted by straightforward realism.

"Their share price is all that I'm interested in," said a 28-year-old business student named Aleksi, who declined to give his last name. "I don't understand this crying about national treasure being sold. People seem to think it's the year 2000. Business is business. Nokia is not defining Finland."

For the global tech business, the big question is to what extent Nokia will define Microsoft. Activist shareholders, led by ValueAct Capital, have urged the company to stop spending so heavily on consumer products and instead return money to shareholders.

Microsoft's track record in both consumer devices and major acquisitions does little to inspire confidence. Yet it remains among the very few firms with the muscle to challenge the market leaders in smartphones.

"I continue to believe that there is enough innovation in devices, unlike some of our investors, that it will be a growth opportunity in terms of the financial reward to the bold, to the innovative who pursue it," Ballmer said Tuesday in explaining the deal to analysts.

He also called the phone business "the best opportunity for pursuing users in very, very large numbers." As Nokia learned though, translating opportunity into success is the hard part.

(Additional reporting by Terhi Kinnunen and Jussi Rosendahl in Helsinki, Simon Johnson and Geert de Clercq in Stockholm, Anjuli Davies in London and Poornim Gupta in San Francisco. Writing by Alistair Scrutton and Jonathan Weber; Editing by Tim Dobbyn)

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