Digging into detail - Microsoft's purchase of Nokia’s handset arm contains intriguing sub-plots
In Change of circumstances, The Value Perspective offered its thoughts on Vodafone’s disposal of its 45% stake in US mobile network operator Verizon wireless for $130bn (£83bn). As if one of the largest deals in corporate history were not enough M&A excitement for one week, however, a day later came the news Microsoft was to buy Nokia’s mobile phone handset business.
What the transaction lacks in size – at least in comparison with the Vodafone deal – it makes up for in interest and not just because of the uneasy partnership the two companies have shared over the last two and a half years producing smartphones based on the Windows operating system. For a start, the €5.4bn (£4.5bn) deal leaves Nokia free to pursue a more interesting business model than it has hitherto been able.
The sale of its entire handset operation to Microsoft leaves Nokia to focus on its mobile networks business – which it recently agreed to take full control of, by buying out its former partner Siemens – but it also has a maps division and a portfolio of patents which it can try to extract value from. Up to now, the company has had to hold back from being too aggressive in monetising its intellectual property because it has needed other people’s patents to build its phones. That is no longer the case.
Another interesting aspect of the deal is that part of Microsoft’s rationale for it seems to be the ability to deploy overseas cash balances. We have discussed before, in articles such as Under scrutiny, how companies – and particularly US ones – can end up with significant amounts of cash trapped abroad because, were they to repatriate it, they would have to pay US tax on it.
Companies will thus often leave their cash earning interest – these days not very much interest – in the country where it originated and so M&A can appear a better option. Certainly it is highly likely to be accretive to earnings per share, which is – incorrectly we believe – what many people look at, but, as Hewlett Packard may attest after buying autonomy, it perhaps should not be seen as a driving reason for making a purchase.
Another intriguing part of the deal was the €1.5bn ‘financing line’, structured as three bonds of €0.5bn each, made available by Microsoft to Nokia and on which the latter had the option to call immediately – irrespective of whether or not the acquisition of the handset business is actually completed.
If it does go through, then Nokia must use some of the €5.4bn proceeds to repay the bonds with interest. However if for any reason the deal does not proceed the funding line remains and is ‘convertible’ in nature so that, should it choose to, Microsoft could ultimately convert debts into Nokia shares, potentially giving it an 8.9% stake in the company.
If this seemed a curious course of action for Microsoft – it is cash-rich so one might reasonably assume the company would prefer a ‘clean break’ sort of deal where it paid its money, acquired its asset and could then wave goodbye to Nokia for ever – it seems more curious still for Nokia which reported having net cash of €4.1bn on its balance sheet at June 2013. Also companies typically dislike issuing new equity unless they really have to.
Things became a bit clearer a few days later when Nokia announced plans to draw down the full €1.5bn from Microsoft to ‘pre-pay’ the finance it had raised to buy out Siemens’ 50% stake in the Nokia Siemens Networks (NSN) joint venture earlier this summer for €1.7bn. Quite why Nokia chose to issue convertible debt to do this, why the funding was needed irrespective of the deal closing given its cash balances and why it was issued to Microsoft rather than the wider markets however all remains unclear.
With most pundits reckoning Nokia got a good price from the Microsoft deal, clearly it has not only been an eventful summer but also a profitable one for the company. It is not unreasonable to infer from the €1.5bn funding line that Nokia may have needed it to be.
This brings us to the last piece of intrigue in the story – for now at least – being that Nokia’s purchase of 50% of NSN for €1.7bn obviously values the whole of NSN at €3.4bn. Yet, at the time of writing barely two months later, the market is valuing Nokia’s equity at over €16bn.
Given we know what the handset business is being sold for, that means the rest of Nokia’s operations – of which NSN is currently by far the biggest part – are being valued at around €11bn by the stockmarket. We simply point out that there seems to be rather a large difference between Siemens view of what NSN was worth and the value currently being placed on it by investors.
Fund Manager, Equity Value
I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.
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