Microsoft and Nokia - a marriage made in hell?

  • Published 10 July 2015
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Microsoft Nokia sign

Microsoft's takeover of Nokia's mobile phone operation is bound to end up as a business school case study. The deal now looks like a disaster for all concerned - many of the 25,000 Nokia employees have seen their jobs disappear and Microsoft has written off just about all the money it spent.

It looks as though the new chief executive Satya Nadella has looked at the strategy of his predecessor Steve Ballmer and decided it was a disaster. It was Ballmer who decided to buy Nokia, and when the deal was announced he told me "together as one company with the devices folks at Nokia, we'll do a phenomenal job".

With hindsight, it looks like a phenomenal error - but was it obvious at the time? Investors were certainly dubious, but even today Microsoft isn't prepared to accept that it was a bad idea. The line from the company is that it was the right decision at the time but that the mobile phone market changes at an incredible pace.

A blogger who writes about Windows argues passionately in support of that view . He argues that having formed the initial partnership with Nokia, making it the flagship Windows Phone builder, Microsoft had little alternative but to go ahead with a full takeover.

"Nokia was already in dire straits, and their board was getting itchy for alternatives," writes Daniel Rubino."Had Nokia decided to jump all-in on Android devices - or worse - sold to a competitor, neither would have been good for Microsoft and their Windows Phone story."

That may be true, but it begs the question of whether Nokia was ever the right partner. For a company that is now going to focus on business customers - always its core strength - it might have been more sensible to tie up with Blackberry. The ailing Canadian firm still has a strong reputation for security, and many professional and enterprise customers remain wistfully nostalgic about its devices. Windows Blackberry could have been a very lucrative niche.

What next then? Microsoft insists that it will still make smartphones, but will focus on its wider "ecosystem". There will be fewer in-house phones, and the aim will be for them to showcase Windows Phone's capabilities for other manufacturers, much as the Surface does for tablets.

But it is hard to see the likes of Samsung and HTC rushing to make Windows Phone handsets, however great their concerns about their reliance on Android. And whatever Microsoft says about developing its own mobile ecosystem, it looks as though selling access to its software on other mobile platforms may prove more lucrative.

The real tragedy here is for Nokia, Finland and Europe. In 2013, Steve Ballmer promised that Finland would become the "hub and the centre for our phone R&D". That at least seemed to promise that the team at what was - only a few years previously - Europe's technology superpower would stay intact, albeit under US ownership. Who knows what would have happened if Nokia had tried to carry on as an independent business - but it could hardly have turned out worse.

This week's edition of Tech Tent looks at what went wrong with Microsoft's mobile strategy - on BBC World Service at 16:05 GMT/17:05 BST

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microsoft nokia merger case study

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  • For Business Negotiators, Patience Can be a Virtue

The story of Microsoft’s Nokia acquisition makes a case for business negotiators staying at the table

By PON Staff — on October 24th, 2023 / BATNA

microsoft nokia merger case study

Business negotiators know that persistence and tenacity can make all the difference between impasse and a game-changing breakthrough. Take the saga behind Microsoft’s 2013 announcement of its pending $7.2 billion acquisition of Finnish mobile phone company Nokia’s handset and services business. The two parties engaged in many months of fruitless talks before either side believed that an agreement was likely—yet a late-stage brainstorming session brought them together. We analyze the negotiations with an eye toward identifying why things suddenly went right after so much had gone wrong.

Nokia builds its BATNA

Microsoft and Nokia had been partners since 2011, when the Finnish firm began installing Microsoft’s Windows Phone operating system (OS) on its smartphones. But the arrangement had been disappointing. Nokia was lagging far behind smartphone manufacturers Samsung and Apple in terms of innovation and market share, and the Windows Phone OS, used primarily on Nokia handsets, was failing to meet expectations as well.

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In January 2013, Microsoft CEO Steven Ballmer made a quick phone call to Risto Siilasmaa, the chairman of Nokia’s board of directors, to raise the possibility of Microsoft buying divisions of Nokia. The following month, the two men sat down at a wireless-industry conference in Barcelona, Spain, to discuss the idea further. The two leaders agreed that inefficiencies existed in their current agreement, including duplicate engineering, marketing, and advertising efforts. Then they brainstormed solutions ranging from minor tweaks to their current deal to more extensive collaborations and business mergers, reports Ina Fried on the technology news website

Nokia narrowed in on two possible options. First, it could sell its underperforming handset business to Microsoft or another company and focus on its telecommunications equipment, mapping, and patent businesses. Second, it could let its deal with Microsoft lapse at the end of 2014 and try to revive its handset business by adapting its smartphones to Google’s Android system. In fact, Nokia informed Microsoft that one of its teams already had Android up and running on Nokia’s Lumia handsets. By cultivating this strong BATNA , or best alternative to a negotiated agreement , Nokia gained the power to walk away from a subpar offer from Microsoft.

Early stumbles between business negotiators

In fact, Nokia executives did just that—turned down a disappointing proposal—immediately after listening to Microsoft’s first formal pitch for an acquisition at an April 2013 meeting in New York. Siilasmaa and his team informed Ballmer and his team that they were too far apart on price and other key issues, such as which company would own Here, Nokia’s mapping service. The Nokia executives believed strongly that they needed to hold on to Here and their ability to sell the software to other companies. Meanwhile, Microsoft felt it couldn’t keep pace with competitors without controlling the mapping technology it was using in its phones, tablets, and PCs and on the web, according to

The next month, a meeting between the two teams in the London office of Microsoft’s law firm also flopped, and not just because Ballmer tripped over a glass coffee table and cut his forehead in the middle of it. (The injury turned out to be minor.) A follow-up meeting at a Nokia-owned mansion in Finland the following month was aborted after four hours because of lack of progress, according to the New York Times .

A deal takes shape

A breakthrough came when Nokia informed Microsoft that it would proceed with formal talks only if Microsoft agreed to abide by certain preconditions, most notably a commitment to set up a financing source for Nokia and the caveat that Here was off the table.

Microsoft agreed. The parties met in early July 2013 in New York, where in the course of discussion they happened upon a solution to the question of who would control the mapping service. Why not share the code, with Nokia retaining intellectual-property rights to Here? Nokia realized that it could grant Microsoft a license to access and customize Here’s source code and own any improvements it made. Nokia would retain ownership of Here and the power to license the service to other companies.

At the end of a weekend of talks, Ballmer and Siilasmaa shook hands on the rough outlines of an agreement, which was filled out over the next two months. As part of the deal, 32,000 Nokia employees, including CEO Stephen Elop, would be hired by Microsoft. A former Microsoft executive, Elop was considered a likely successor to Ballmer, who announced plans to retire within a year.

Lessons learned

The Microsoft-Nokia deal offers several useful takeaways for business negotiators:

■ Don’t jump the gun on price. In its initial presentation, Microsoft lost Nokia’s interest by making a price offer that the Finnish firm considered far too low. Microsoft may have erred by raising the issue of price before it understood key aspects of Nokia’s business and its interests in a potential sale. For this reason and others, it often makes sense to hold off on making concrete price offers until later in a negotiation, after you have engaged in thorough fact-finding. ■ Be open about your BATNA. Nokia not only cultivated a strong alternative to a deal with Microsoft—the capability to jump ship from Windows Phone to Android technology—but also shared this confidential development with Microsoft. A strong BATNA brings with it negotiating power, especially when the other side knows that you could easily walk away. ■ Keep talking. The parties could have gone their separate ways after their first meeting. Instead, each assigned teams to explore issues and tradeoffs they may have overlooked or undervalued. The two sides continued to meet despite a series of deadlocked talks—and eventually reached a point where they could brainstorm creative deal terms .

Setting negotiating conditions: A risky move

Interestingly, it was only after Nokia laid out conditions to future discussions with Microsoft—financing commitments and taking Nokia’s mapping service off the table—that the negotiating teams were able to reach agreement.

Insisting that the other party agree to certain terms as a precondition to negotiation is a common but risky tactic. For example, in the Minnesota Orchestra’s l abor dispute, for example, the players said for many months that they would negotiate with management only after the lockout ended. But management was loath to accept this condition, aware that the players would have little motivation to accept significant salary cuts if they were performing and being paid.

As the failure of this condition illustrates, setting conditions to negotiation is a potentially self-defeating strategy. Remember that your counterpart will weigh the costs and benefits of accepting your conditions against his alternatives away from the table. If you have a strong BATNA, as Nokia appears to have had, then it may make sense to take this risk. But note that even in this case, Microsoft was able to make inroads on the mapping service issue that Nokia had claimed was nonnegotiable. Microsoft may have saved the deal by refusing to assume that Nokia’s conditions to negotiation were nonnegotiable.

In general, the wisest course for business negotiators may be to agree to negotiate rather than stipulating potentially deal-breaking conditions. Then, at the table, seek tradeoffs that will help you gain leverage on the issues you value most, while demonstrating flexibility on your counterpart’s pressing concerns.

What is some advice you’d offer to other business negotiators?

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18 Microsoft’s Acquisition of Nokia

  • Published: June 2022
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In September 2013, US-based computing major, Microsoft Corp. (Microsoft) and Finland-based communications company, Nokia Corporation (Nokia), announced that both the companies would enter into a transaction where Microsoft would acquire Nokia’s devices and services segment, Nokia’s patents and license and use Nokia’s mapping services, for US$ 7.2 billion. Earlier in February 2011, Nokia had entered into a strategic alliance with Microsoft in a bid to combine the traditional strengths of the two companies to create synergies. With the acquisition of Nokia, Microsoft aimed to build on its partnership with the former by accelerating the growth of its share and profit in mobile devices through faster innovation, increased synergies, and unified branding and marketing. The case analyses and highlights the acquisition strategy from the strategic fit perspective as well as the benefits/advantages envisaged by both the companies.

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microsoft nokia merger case study

Microsoft-Nokia culture clash will be tough to overcome

microsoft nokia merger case study

Professor of Organisational Behaviour, Cass Business School, City, University of London

Disclosure statement

Andre Spicer does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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microsoft nokia merger case study

Among Western nations it would be difficult to find two cultures as different as the US and Finland. Americans are stereotypically confident and outgoing; Finns considerably more reserved. This is even reflected in the economies of the two nations: the US is the home of free-market capitalism; Finland is the poster-child of European social democracy.

These are just stereotypes, of course, but they do give you a hint of some of the real challenges that Microsoft is likely to face as it seeks to integrate Nokia’s mobile phone division, which it has purchased for €5.4 billion .

The purchase was announced with great fanfare by both Microsoft and Nokia senior management. For Nokia, the deal is seen as a way to exit from the handset market. Although they once dominated this sector, they are now well behind market leaders Apple and Samsung. For Microsoft, the purchase is a way for them to add a mobile hardware component that will allow them to compete head to head with Apple and Google.

Although the rhetoric around the deal sounds good, the reality is likely to be much messier. The research suggests that most mergers and acquisitions tend to destroy rather than create value.

Indeed, the history of Microsoft during the past decade has served as a remarkable case study of this basic rule. When outgoing CEO, Steve Ballmer, took over in 2000 it was absolutely dominant in its field and its share price was at an all-time high. During Ballmer’s tenure we have seen a stream of acquisitions, uncertain innovation and a stagnation of its shareprice. A New Yorker journalist recently quipped that Ballmer had finally figured out a way to make some money – he quit .

Maybe the acquisition of Nokia should be seen not as a shrewd strategic move, but more like one of the last great acts of the Ballmer regime. Indeed, research suggests that CEOs tend to become addicted to mergers and acquisitions , despite their declining returns.

The hubris of CEOs plays a big role here. Feelings of greatness often lead then to paint a rosy future picture of takeovers. They are also likely to overlook the significant risks that come with any acquisitions. This is all depressing news for Microsoft shareholders – if the research in the area is anything to go by, they are unlikely to see any significant gains from the acquisition of Nokia. In fact, they are actually likely to lose out.

But shareholders are not the only ones who will lose out. The future is likely to be relatively grim for employees in the Nokia phones division. There have already been reports in the Finnish press that many are worried about losing their jobs . This comes on the heels of a stream of layoffs in recent years.

But even for those who hold on to their jobs, life under the Microsoft regime is likely to be difficult. Merging cultures following an acquisition often proves to be difficult, if not impossible. A common outcome is talent staff crucial to the success of the company leave. Those who are left behind are likely to be relatively cynical. This typically leads to companies losing their innovate edge – often precisely what they were purchased for in the first place. This bodes poorly for the Nokia handsets division. Following the Microsoft deal it is likely to become an innovation deadzone, staffed by embittered cynics.

Members of the broader public are the final losers from this deal. Despite all the talk of how competitive the mobile business is, it is actually a market dominated by a few players. The increasing integration of hardware and software has meant a small handful of companies like Apple, Google and now Microsoft are in all our pockets.

This presents big concerns about who owns, controls and watches over our personal data. After all, many of these players are not just funky tech companies, they are also consumer surveillance companies. The purchase of Nokia by Microsoft represents a further step towards the consolidation of this market. But it also may represent a further step towards the consolidation of a few companies’ control over our personal data.

If this deal is likely to create so many losers, why is it going ahead? Well, there are likely to be some big winners as well. For one, Nokia shareholders seem to have benefited significantly with a big jump in share price following the announcement. The senior executives who put the deal together are also likely to do well out of the deal. Research suggests that when CEOs go on buying sprees – even unsuccessful ones - they are likely to get a bump in their reward package as well as a nice ego boost.

A final winner hidden in the wings is the army of advisers and consultants and such like who will gain a significant chunk of the transaction costs involved in trying to knit these two businesses together – and cleaning up the mess afterwards.

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Microsoft Corporation’s Acquisition of Nokia Case Study

The Microsoft Corporation purchased the Nokia phone business in 2014 for approximately $7.2 billion. Although Nokia could be labeled as a profitable business during that time, it was a downstream customer for Microsoft. Thus, it was unclear whether the deal was beneficial for Microsoft since Nokia was not even a leader in the mobile phone industry.

The issue that Microsoft had to resolve was the negotiation process between the companies as the negotiators were from different cultural origins: Microsoft is an American company, while Nokia is a European (Finnish) one. What is more, the strategies and aims of both companies were different: while Microsoft was trying to become present in the mobile phone market, Nokia wanted to be provided with a serious capital that could help it deal with expensive operations and productions. However, it should be noted that negotiations between the two companies took place before Microsoft acquired Nokia: in 2011, the Windows 7 Platform was presented on Nokia phones. At first, the companies only cooperated to develop new devices and products. Only three years after the first cooperation Nokia was purchased by Microsoft. This decision implies that this type of partnership was profitable for both companies at first.

Another problem of these negotiations is the fact that companies often do not see their counterparts as individuals; thus, one of the companies (Nokia) had to abandon its identity to receive benefits from the synergetic deal. However, as it can be seen from the case study, Windows phones were not as popular as it was expected and did not bring Microsoft visible presence and recognition in the mobile phone market, where Apple and Android were the main leaders.

While the deal might appear as unprofitable at first, it may present some benefits in the long run. Nevertheless, Microsoft is not the first company that chose to purchase a “downstream customer” in order to target a new market where the corporation was not present. Acquiring a company that is not a leader anymore can be a risky decision, and, in Microsoft’s case, it led to a reduction in the value of the company. Moreover, it also brought little benefit to Nokia, although the Finnish company had expected other outcomes. While Microsoft tried to resurrect the former leader in the mobile phone market, Nokia experienced losses and thousands of job cuts due to Microsoft’s workforce management policy in 2014. Thus, the deal was not as profitable as both companies had expected.

One question remains to be answered: why did Microsoft decide to involve in this deal if it was clear that the deal was not profitable? On the one hand, this deal was unlikely to harm Microsoft’s core business. On the other hand, the corporation tried to present a new product (Windows Phone) by purchasing a (once stable) company in decline – not an entirely new approach. It can work if the odds are in your favor. However, as it can be seen, Windows Phone cannot compete with iPhones and Android devices, and Microsoft’s presence in the smartphone market is still relatively small. Android is capable of expanding because this operating system can be installed on multiple devices from various manufacturers (Samsung, LG, Lenovo, Huawei, etc.). Windows 7 and 8 for mobile phones are mostly used on Nokia smartphones that cannot compete with Samsung, not to mention other companies. Thus, Microsoft’s acquisition of Nokia was unprofitable. It is possible to assume that this deal will bring more additional losses in the future.

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IvyPanda. (2021, August 2). Microsoft Corporation's Acquisition of Nokia.

"Microsoft Corporation's Acquisition of Nokia." IvyPanda , 2 Aug. 2021,

IvyPanda . (2021) 'Microsoft Corporation's Acquisition of Nokia'. 2 August.

IvyPanda . 2021. "Microsoft Corporation's Acquisition of Nokia." August 2, 2021.

1. IvyPanda . "Microsoft Corporation's Acquisition of Nokia." August 2, 2021.


IvyPanda . "Microsoft Corporation's Acquisition of Nokia." August 2, 2021.

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Microsoft Acquisition of Nokia: An Analysis from Strategic and Financial Perspective*

Case Preview

Case Preview

Microsoft acquisition of nokia: an analysis from strategic and financial perspective.

”We are excited and honored to be bringing Nokia’s incredible people, technologies and assets into our Microsoft family. Given our long partnership with Nokia and the many key Nokia leaders that are joining Microsoft, we anticipate a smooth transition and great execution. With ongoing share growth and the synergies across marketing, branding and advertising, we expect this acquisition to be accretive to our adjusted earnings per share starting in FY15, and we see significant long-term revenue and profit opportunities for our shareholders.”

– Steve Ballmer, Microsoft’s CEO

“Building on our successful partnership, we can now bring together the best of Microsoft’s software engineering with the best of Nokia’s product engineering, award-winning design, and global sales, marketing and manufacturing, with this combination of talented people, we have the opportunity to accelerate the current momentum and cutting-edge innovation of both our smart devices and mobile phone products.”

– Stephen Elop, Nokia’s CEO

“Microsoft will record a charge in the fourth quarter of fiscal 2015 for the impairment of assets and goodwill in its Phone Hardware segment, related to the Nokia Devices and Service business.”

On 3 rd September 2013, Microsoft Corporation (NASDAQ:MSFT) and Nokia Corporation (HEL:NOKIA) entered into a joint venture (JV), whereby Microsoft Corporation (Microsoft) acquired all of the Device and Service business of Nokia Corporation (Nokia) through an all-cash deal. The Microsoft-Nokia JV was the 2 nd largest merger in the history of Microsoft after the acquisition of Skype Technologies, the VOIP innovators, for $9.2 billion...................

An Overview of Nokia

The Finnish company “Nokia” began its operation in 1865 as a single paper mill at Tammerkoski Rapids in south-western Finland. Over the years, Nokia has nurtured success in several sectors including paper products, rubber boots and tiers, cable, mobile devices and telecommunications infrastructure equipment. Nokia entered the Device and Telecommunication industry with the motto of “connecting people” through its cutting edge technology. As early as 1980, Nokia became a household name around the world with the launch of Nordic Mobile Telephone (NMT), world’s first international cellular network with international roaming supported. The Nokia brand emerged as an undisputed leader in the mobile phone industry due the reliability, easy usage, higher resale value and durability of the devices.............

Insights into Nokia

Nokia was one of the largest manufacturers of mobile phones with world-acclaimed strategy and brand name. Nokia invested almost 14% of its revenue in Research and Development as a fundamental component of competitive advantage and sustainability. However, the company’s landscape began to change gradually post-2008. Nokia’s premier product lines were based on “Symbian”, an Operating System (OS) which was considered obsolete as compared to the modern counterparts such as iPhone OS (iOS) and Android. Apart from the technical limitations, Symbian OS prevented people or companies unrelated to the mobile manufacturing...........

An Overview of Microsoft

Microsoft is the world’s leading producer of computer software and is considered to be one of the most valuable brands in the world by Forbes magazine. Microsoft was incorporated in 1981, but it came into existence in 1975 when founder Bill Gates and Paul Allen saw an opportunity in operating system after the launch of Altair 8800 (microcomputer) by an American electronics company known as Micro Instrumentation Telemetry Systems (MITS)..............

Insight into Microsoft

Microsoft is a unicorn in the office productivity software and desktop operating system. The Windows OS itself has a total market share of about 88%, which includes Windows XP/Vista/7/8 and 10. This shows how predominant Microsoft is. Microsoft has become a household name across nations. Its brand awareness is extremely high..............

Global Smartphone Market

According to Gartner, the year 2013 saw a record sale of smartphones, 968 million units were sold, a whopping 42.3% increase from 2012 (Exhibit II). The smartphone market was rising exponentially and every player wanted a piece of this cake. Many new Chinese players emerged in the market..........

Rationale of the deal

Microsoft acquisition of a part of Nokia’s business was a strategic alliance where both the companies would work strategically to achieve common goals. Microsoft had nil to limited experience in manufacturing physical smartphone and needed strong.........

Strategic expectations of Microsoft

What was the rationale behind Microsoft buying out Nokia’s handset and service division?

• Improving market share: Microsoft believed that the acquisition will help them accelerate its market share and profits in the phone market as millions of new users were waiting to buy a new smartphone. Before the acquisition, Nokia and Windows phone had more than 10% share in 9 markets and it was outselling Blackberry (then, a very popular company) in 34 different markets. Lumia phones had started gaining popularity and it believed that the imaging capabilities of Nokia could drive more success to them.......... • .............

Financial Expectations of Microsoft

• A much better profit per unit: Under the previous partnership, Microsoft was earning less than $10 per unit and this earning had to support the entire marketing investment and platform payment support. But after the acquisition, a gross margin of more than $40 was expected with a breakeven in 50 million smart devices. • ..................

Strategic Expectations of Nokia

Smartphone business reached a phase where the big players (Google and Apple) dominated the market with their strong ecosystems while the rest were either making losses or breaking even at best 26. At this juncture, Nokia had partnered with Microsoft. Leading business experts analyzed the rationale behind the deal from Nokia’s perspective.............

Financial Expectations of Nokia

• The ultimate objective of Nokia was to increase the revenue generation from Nokia’s mobile devices segment besides an increased market share under the global smartphone market. • .............

Reflections of the Acquisition

It is evident from Exhibit VI that Microsoft financials showed a steep decline. A write-off of $7.5 billion of goodwill and asset impairment charges related to phone hardware and $2.5 billion of integration and restructuring expenses, primarily costs associated with Microsoft’s restructuring plans, which affected the overall business of Microsoft...........

The Way Forward

The recent 18,000 job cuts (12,500 from Nokia), restructuring charges of $960 million and impairment charges of $7.6 billion to Nokia Device segment by Microsoft gives a clear indication that the Microsoft acquisition of Nokia was a clear blunder. The prime reason behind such strategic collaboration is for the shared synergistic benefits derived by participating organizations.................

Exhibit I: Operating Systems and their Market Shares in 2009 and 2010

Exhibit II: Worldwide Smartphone Sales to End Users by Vendor in 2013 (Thousands of Units)

Exhibit III: Worldwide Smartphone Sales to End Users by Operating System in 2013 (Thousands of Units)

Exhibit IV: Smartphones Revenue Predictions/Opportunity

Exhibit V: NPV Predictions by Microsoft

Exhibit VI: Comparative Analysis of Financial Parameters

Teaching Note Preview

The case set in 2014, depicts the dynamics of multinational business ecosystem with US tech giant Microsoft Corporation (MSFT), aspiring to be the leader in the Services and Devices industry, by acquiring the handset business of Nokia Corporation (HEL: NOKIA). The case study, through minute detailing and multi-dimensional market analysis, will help the students understand the implications of the deal from the strategic and financial perspective.

The Global Smartphone Industry is highly competitive with ever-changing technological landscape. The business strategies of the companies are evolving to cater the emerging global smartphone market. Multiple companies globally consider merger and acquisitions as the best strategic tool for effective growth and shareholder’s wealth maximization. The analysis of the case using tools and techniques such as SWOT, PESTEL, Porter’s Five Forces Model, etc. will provide analytical reasoning for strategic intent of the acquisition. To understand the financial impact, the comparative analysis of the financial parameters such as Return on Total Assets, Return on Capital Employed, Return on Equity, Gross Profit Margin, Net Profit Margin, Debt to Equity Ratio and value of the companies pre- and post-merger can be adopted and the impact of the financial ratios on the balance sheet and visa-versa can be discussed. The case can be used to analyze and highlight the acquisition strategy form the strategic fit perspective, the benefits/advantages envisaged by both the companies.

In order to enrich the understanding of the students and develop logical approach for solving complex case studies, mergers & acquisition of other companies in the same decade could be studied and inferences could be drawn for case comparison. The students can come up with their own version of strategies and their financial impact under such scenarios...............

US tech giant Microsoft Corporation (NASDAQ:MSFT), in 2014 announced its acquisition of the Finnish communication company – Nokia Corporation’s (HEL: NOKIA) handset division for $7.2 billion. Microsoft Corporation (Microsoft) aspired to be the leader in the services and devices industry. However, by July 2015, the profitability ratios for Microsoft such as Return on Assets (ROA), Return on Equity (ROE), Return on Invested Capital (ROIC), Gross Profit Margin (GPM), Net Profit Margin (NPM) have shown a decline from 2014 to 2015. Besides, EPS figure has also declined from 2014 to 2015.

The objective of this case study is to understand the implications of the deal from the Strategic and Financial perspective. To highlight the financial impact, the case presents a comparative analysis of the financial parameters such as ROA, ROCE, ROE, GPM, NPM, Debt to Equity (D/E) Ratio, pre and post-merger valuations of the companies, etc. The case analyzes and highlights the acquisition strategy from the strategic fit perspective as well as the benefits/advantages envisaged by both the companies.

Pedagogical Objectives

  • To understand the concept of M&A and its implications on strategy, technology, marketing, and financial intents, IP acquisition and licenses
  • To understand the role of PESTEL factors and SWOT analysis in strategic decision making
  • To understand financial implications of the strategy on a business by discussing financial parameters such as ROA, ROCE, ROE, GPM, NPM, D/E, EPS etc.

Case Positing and Setting MBA Program – Mergers and Acquisitions course – To understand certain concepts of Finance and Strategy


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Microsoft writes off $7.6B, admits failure of Nokia acquisition

'monumental mistake' by former ceo steve ballmer comes home to roost.

Gregg Keizer

Senior Reporter, Computerworld |

Ballmer at Nokia event

Microsoft today wrote off billions of dollars related to its Nokia acquisition, saying it's taking an "impairment charge" of $7.6 billion, or nearly the full amount it paid for the Finnish firm's smartphone business and patents last year.

The announcement slapped the failure sticker on the last major move made by former CEO Steve Ballmer, who pushed for the Nokia deal in his final months in office against objections by, among others, Satya Nadella before he was elevated to the chief executive's chair.

"It was a mistake to begin with," said Jack Gold, principal analyst at J. Gold Associates. "A monumental mistake. Microsoft had no business being in the cut-throat, low-margin phone business. Who's making money in phones besides Apple?"

Microsoft announced the purchase of Nokia's phone assets in September 2013 -- just weeks after Ballmer said he would step down -- and finalized the deal in April 2014. The total purchase price ended up as approximately $7.9 billion, according to an April 2015 filing with the U.S. Securities and Exchange Commission (SEC).

"Microsoft will record a charge in the fourth quarter of fiscal 2015 for the impairment of assets and goodwill in its Phone Hardware segment, related to the NDS business," Microsoft said in a statement Wednesday, referring to the Nokia Devices and Services division it acquired.

"Impairment" is a term used to describe the situation when the market value of a business is less than what's carried on the books. In such scenarios, corporations are required to balance accounts by taking a non-cash charge to the tune of the difference. No cash is transferred, although the write-down will impact Microsoft's June quarter earnings and its fiscal-year numbers. The money was already spent, Gold pointed out.

Previously, Microsoft had carried $5.5 billion in "goodwill" from the Nokia acquisition, and another $4.5 billion in intangible assets, the bulk of the latter representing the patents it bought from the Finnish firm. Because "goodwill" is the difference between purchase price and actual assets, tangible or otherwise, writing off the entire amount, as Microsoft just did, signals that the company grossly overpaid.

Today's write-off was Microsoft's largest ever, exceeding by 23% the $6.2 billion charge it took in 2012 to account for the failure of its 2007 purchase of online marketing and advertising company aQuantive.

"Give Nadella a lot of credit for stepping up here," said Gold, referring to the CEO's decision to write down the deal and move on.

Jan Dawson, chief analyst with Jackdaw Research, echoed that in an analysis he posted shortly after Microsoft's announcement. "The key point is that Microsoft has at this point basically unburdened itself of the value of the acquisition, such that if it does have to wind the business down it likely won't have to take another significant impairment charge," Dawson wrote.

Along with the write-off, Microsoft announced it would lay off about 7,800 employees, most of them working in its device division, specifically the phone group. Those layoffs, as well as other restructuring charges, will cost the company another $750 million to $850 million, Microsoft said. The layoffs will be in addition to the 18,000 workers Microsoft cut loose last year, the company's largest-ever reduction.

When the layoffs wrap up, Microsoft will have retained just one out of every five former Nokia employees it inherited, Dawson calculated.

Nadella tried to explain the decision in his email to the troops .

"We are moving from a strategy to grow a standalone phone business to a strategy to grow and create a vibrant Windows ecosystem including our first-party device family," Nadella said. "In the near-term, we'll run a more effective and focused phone portfolio while retaining capability for long-term reinvention in mobility."

Gold interpreted that as a vastly scaled-back smartphone business, with fewer models, that would likely resemble the niche strategy Microsoft has pursued with its Surface line of tablets-cum-notebooks, especially the Surface Pro 3. "If Microsoft wants to do something unique for business, that's fine, that's what he's pointing at," said Gold.

Dawson agreed that Microsoft will probably reduce the number of different Lumia models, but read Nadella's comment differently. "I would expect them to pare the number of devices, but it doesn't sound like they're abandoning its strategy of trying to appeal to a broad swath of consumers. They'll have a high-end [model], low-end [models]," he said.

Nor did he see any logic to focusing, if that's what Microsoft did, on business customers, although years ago many analysts believed the firm would, in fact, cater to its best customers, enterprises, with its smartphones. "The fact is that business users are just the same as anyone else," Dawson said. "They want phones they like to use, that allow them to do not just work but personal stuff, too."

Microsoft said that the layoffs and restructuring, including the incurred costs, would be substantially completed by the end of the year, and wrapped up by the end of Microsoft's fiscal year, or by June 30, 2016.

The company will release more information about the write-off and the restructuring charges when it files its end-of-fiscal-year report with the SEC later this month. Nadella and CFO Amy Hood will undoubtedly face questions from Wall Street on the moves during the next earnings call, slated for July 21.

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<strong>Mergers</strong> & <strong>Acquisitions</strong>:<br />

<strong>The</strong> <strong>Case</strong> <strong>of</strong> Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong><br />

Luís Franco Hilário<br />

Advisor: Peter Tsvetkov<br />

Dissertation submitted in partial fulfillment <strong>of</strong> requirements for the degrees <strong>of</strong> MSc in<br />

Business Administration, at the Universidade Católica Portuguesa<br />

SEPTEMBER 2011<br />

Abstract<br />

Due to the financial downturn <strong>and</strong> the emergence <strong>of</strong> new devices in the global h<strong>and</strong>set<br />

market has led companies to change their business strategies. Indeed, <strong>Mergers</strong> <strong>and</strong><br />

Acquisition are considered one <strong>of</strong> the best strategies to increase shareholder value<br />

despite its hardship to be well-implemented. For this reason, a consolidation between<br />

Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> may create new opportunities to challenge the market. <strong>The</strong>reby,<br />

the focus <strong>of</strong> this dissertation will be the calculation <strong>of</strong> the additional value created by<br />

combining both firms bearing in mind the companies’ financial situations. All this<br />

considered, <strong>Nokia</strong>’s average share price during the last year is considered to have a<br />

0.14% upside potential <strong>and</strong> synergies are estimated around 13% <strong>of</strong> <strong>Nokia</strong>’s average<br />

market capitalization. As a result, an <strong>of</strong>fer at 19.4% premium over <strong>Nokia</strong>’s average<br />

market capitalization will be suggested with 100% in cash.<br />

Acnowledgments<br />

<strong>The</strong> author would like to thank: Pr<strong>of</strong>essor Peter Tsvetkov, the Dissertation Advisor,<br />

who has provided several thoughtful comments <strong>and</strong> an immeasurable help throughout<br />

the thesis. ; his friends, who provided assistance <strong>and</strong> feedback by detecting <strong>and</strong><br />

reporting errors; finally to his family for their forbearance <strong>and</strong> support.<br />

Table <strong>of</strong> Contents<br />

1. INTRODUCTION ............................................................................................................. 7<br />

2. LITERATURE REVIEW .................................................................................................. 8<br />

2.1 Valuation Methodologies ................................................................................................................. 8<br />

2.1.1. Cash-Flow Approaches ............................................................................................................ 10<br /> <strong>The</strong> Cost <strong>of</strong> Capital ........................................................................................................... 11<br /> Risk-Free Rate ( ) ................................................................................................... 13<br /> Beta (β) .................................................................................................................... 13<br /> Market Risk Premium ( ) ............................................................................. 15<br /> Free Cash Flow to the Firm Model .................................................................................... 15<br /> Terminal Value ......................................................................................................... 16<br /> Expected Growth Rate .............................................................................................. 17<br /> Adjusted Present Value (APV) .......................................................................................... 17<br />

2.1.2. Relative Valuation ................................................................................................................... 20<br />

2.2. M&A related issues ....................................................................................................................... 22<br />

2.2.1. Main types <strong>of</strong> M&A ................................................................................................................. 22<br />

2.2.2. Synergies - “<strong>The</strong> creation <strong>of</strong> value”.......................................................................................... 24<br />

2.2.3. Cross-Border M&A <strong>and</strong> Emerging Markets .............................................................................. 25<br />

2.2.4. Methods <strong>of</strong> Payment .............................................................................................................. 27<br />

2.2.5. Post-acquisition Returns ......................................................................................................... 28<br />

2.3. Conclusion..................................................................................................................................... 30<br />

3. INDUSTRY AND COMPANY ANALYSIS .................................................................... 31<br />

3.1. Overview <strong>of</strong> the Global Mobile Industry ....................................................................................... 31<br />

3.1.1. Current Market Trend – “<strong>The</strong> emergence <strong>of</strong> the tablets” ......................................................... 37<br />

3.1.2. Technology market growth opportunities in Asian economies ................................................. 38<br />

3.2 Micros<strong>of</strong>t Corporation.................................................................................................................... 39<br />

3.2.1. Windows <strong>and</strong> Windows Live Division ...................................................................................... 42<br />

3.2.2. Server <strong>and</strong> Tools ..................................................................................................................... 43<br />

3.2.3. Online Services Division .......................................................................................................... 45<br />

3.2.4. Micros<strong>of</strong>t Business Division ..................................................................................................... 46<br />

3.2.5. Entertainment <strong>and</strong> Devices Division ........................................................................................ 47<br />

3.3. <strong>Nokia</strong> Corporation ......................................................................................................................... 49<br />

3.3.1. Devices & Services .................................................................................................................. 52<br />

3.3.2. NAVTEQ .................................................................................................................................. 53<br />

3.3.3. <strong>Nokia</strong> Siemens Networks ........................................................................................................ 54<br />



6. PERFORMANCE FORECAST ....................................................................................... 60<br />

6.1. Micros<strong>of</strong>t’s St<strong>and</strong>alone Valuation – Base case scenario ................................................................ 60<br />

6.1.1. Revenues ................................................................................................................................ 61<br /> Windows & Windows Live Division ................................................................................... 61<br /> Micros<strong>of</strong>t Business Division .............................................................................................. 62<br /> Server <strong>and</strong> Tools .............................................................................................................. 62<br /> Online Services Division ................................................................................................... 62<br /> Entertainment <strong>and</strong> Devices Division ................................................................................. 63<br />

6.1.2. Operating Expenses ................................................................................................................ 63<br />

6.1.3. Assets, Liabilities <strong>and</strong> Equity.................................................................................................... 65<br />

6.1.4. Net Working Capital ................................................................................................................ 65<br />

6.1.5. Capital Expenditures ............................................................................................................... 65<br />

6.1.6. Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital ..................................................................................... 66<br />

6.1.7. Sensitivity Analysis .................................................................................................................. 68<br />

6.1.8. Multiples Valuation ................................................................................................................. 68<br />

6.2. <strong>Nokia</strong>’s St<strong>and</strong>alone Valuation – Base <strong>Case</strong> Scenario ...................................................................... 69<br />

6.2.1. Revenues ................................................................................................................................ 70<br /> Devices <strong>and</strong> Services ........................................................................................................ 70<br /> NAVTEQ ........................................................................................................................... 71<br /> <strong>Nokia</strong> Siemens Networks ................................................................................................. 71<br />

6.2.2. Operating Expenses ................................................................................................................ 71<br />

6.2.3. Assets, Liabilities <strong>and</strong> Equity.................................................................................................... 72<br />

6.2.4. Net Working Capital ................................................................................................................ 73<br />

6.2.5. Capital Expenditures ............................................................................................................... 73<br />

6.2.6. Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital ..................................................................................... 74<br />

6.2.7. Sensitivity Analysis .................................................................................................................. 74<br />

6.2.8. Multiples Valuation ................................................................................................................. 75<br />

7. VALUATION OF THE MERGED ENTITY .................................................................. 76<br />

7.1. Valuation <strong>of</strong> the Merged Entity without Synergies ........................................................................ 76<br />

7.1.1. Revenues ................................................................................................................................ 76<br />

7.1.2. Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital ..................................................................................... 77<br />

7.2. Synergies ....................................................................................................................................... 77<br />

7.2.1 Cost Synergies ......................................................................................................................... 78<br /> Cost <strong>of</strong> Revenues ............................................................................................................. 78<br /> Sales & Marketing, General & Administrative <strong>and</strong> R&D .................................................... 79<br /> Employee Severance ........................................................................................................ 79<br /> CAPEX .............................................................................................................................. 79<br />

7.2.2. Revenue Synergies .................................................................................................................. 80<br /> Windows <strong>and</strong> Windows Live Division <strong>and</strong> <strong>Nokia</strong> Siemens Networks ................................... 80<br />

7.2.3. Integration Costs .................................................................................................................... 80<br />

7.3. Valuation <strong>of</strong> the Merged Entity with Synergies ............................................................................. 81<br />

7.3.1. Value <strong>of</strong> Synergies .................................................................................................................. 81<br />

8. THE ACQUISITION PROCESS ..................................................................................... 83<br />

8.1.Type <strong>of</strong> Acquisition ........................................................................................................................ 83<br />

8.2. Synergy Benefits ........................................................................................................................... 83<br />

8.3. Premium Offered .......................................................................................................................... 84<br />

8.4. Method <strong>of</strong> Payment ...................................................................................................................... 84<br />

8.5. <strong>The</strong> Proposal ................................................................................................................................. 85<br />

9. CONCLUSION ................................................................................................................. 86<br />

10. APPENDIXES ............................................................................................................... 87<br />

11. BIBLIOGRAPHY ...................................................................................................... 109<br />

1. Introduction<br />

<strong>The</strong> aim <strong>of</strong> this dissertation is on <strong>Mergers</strong> & <strong>Acquisitions</strong> processes where two firms<br />

will be presented <strong>and</strong> analyzed exhaustively, demonstrating at the end, the main reasons<br />

justifying the consolidation between them. Further, these two companies are Micros<strong>of</strong>t<br />

<strong>and</strong> <strong>Nokia</strong>, two well-known <strong>and</strong> recognized technology enterprises operating in the<br />

Mobile Industry.<br />

This dissertation provides a deep theoretical analysis, followed by a practical analysis<br />

taking into account the companies’ historical st<strong>and</strong>alone situation. <strong>The</strong>reby, the<br />

Literature Review will contemplate the existing academic literature about the M&A<br />

topics.<br />

Furthermore, an Industry <strong>and</strong> Company analysis will be provided, describing the<br />

historical background <strong>of</strong> the industry <strong>and</strong> current trends. Additionally, each one <strong>of</strong> the<br />

companies will be described: their main segments, financial indicators <strong>and</strong> performance<br />

in the stock market.<br />

Afterwards, a performance forecast <strong>of</strong> both firms will be computed, translating the<br />

Micros<strong>of</strong>t’s <strong>and</strong> <strong>Nokia</strong>’s information into numbers. <strong>The</strong> following section will focus on<br />

the valuation <strong>of</strong> the merged entity, defining the main sectors where an additional value<br />

is expected to arise.<br />

Lastly, after the consolidation benefits calculation, an acquisition <strong>of</strong>fer will be<br />

proposed. Indeed, it is in this section that a proposal will be defined with the main goal<br />

<strong>of</strong> being positively well-perceived by the markets.<br />

2. Literature Review<br />

Being the main goal <strong>of</strong> a company which starts negotiating in a market is the creation <strong>of</strong><br />

value to the shareholders, has led organizations to start looking at different forms <strong>of</strong><br />

creating <strong>and</strong> at the same time, increasing the value. Among a set <strong>of</strong> strategies, <strong>Mergers</strong><br />

<strong>and</strong> <strong>Acquisitions</strong> were considered as a coherent <strong>and</strong> sophisticated strategy, allowing<br />

creating value not only for the acquiring company, but also for the target company.<br />

Nevertheless, the positive consequences resulting from those corporate mergers are far<br />

from clear. <strong>The</strong> players on the takeover project usually underestimate the potential<br />

benefits from M&A, <strong>and</strong> therefore the additional value originated by the combined<br />

entity is usually scarce since it is incorrectly estimated (Damodaran, 2005), destroying<br />

consequently shareholder value rather than increasing it.<br />

Damodaran (2005) defines synergy as the additional value generated by combining two<br />

entities, which create opportunities impossible to achieve operating each one<br />

independently. Moreover, problems <strong>and</strong> errors on the value estimation affect directly<br />

the firms’ resources allocation which is a key driver <strong>of</strong> an organization performance<br />

(Luehrman, 1997). Thus, the best form to minimize those biases is firstly, value both<br />

companies independently, then values the combined organization, as the sum <strong>of</strong> the<br />

values computed initially, <strong>and</strong> finally values the combined firm with the synergies that<br />

will be created due to the takeover.<br />

<strong>The</strong> following describes the organization <strong>of</strong> this Literature Review: the first section is<br />

composed by the Valuation methods, which describes the Cash-flow approaches <strong>and</strong> the<br />

method <strong>of</strong> “comparables” (Relative Valuation); the second section includes M&A<br />

topics <strong>and</strong> related issues, as Synergies, types <strong>of</strong> M&A, Cross-border M&A <strong>and</strong><br />

Emerging Markets, Methods <strong>of</strong> Payment <strong>and</strong> Post-acquisition returns.<br />

2.1 Valuation Methodologies<br />

According to Copel<strong>and</strong>, T. et al (1990), “financial valuation is indeed central to setting<br />

business strategy”. In fact, the firm’s value estimation is for general managers <strong>and</strong><br />

financial experts an important step to determine how well their firms allocate resources<br />

<strong>and</strong> take strategic decisions based on those values (Luehrman, 1997), in a word,<br />

valuation knowledge is basically a requisite for a participation in a firm’s resource<br />

allocation choices (Myers, 1974). Based on the sizeable “portfolio” <strong>of</strong> existing valuation<br />

approaches, each organization should adopt the valuation method that better matches its<br />

current situation, information available <strong>and</strong> its future perspectives <strong>of</strong> growth. Albeit, it<br />

is also important to highlight the fact that some valuation approaches create the same<br />

results under certain assumptions as it is the case reported by Oded, J. (2007) on which,<br />

the four discount cash flows approaches lead to the same value for companies that<br />

rebalance their debt. Welch (2004) considers the coherent <strong>and</strong> unbiased analysis <strong>of</strong> the<br />

company capital structure <strong>and</strong> capital structure changes a way to increase the likelihood<br />

<strong>of</strong> adopting the correct valuation method.<br />

As a consequence, under the Financial Literature is unanimous the existence <strong>of</strong> two<br />

large groups <strong>of</strong> methods to estimate value: the Discounted Cash-Flow approaches<br />

(DCF), as the most accurate <strong>and</strong> flexible method for valuing organizations (Goedhart,<br />

M. et al, 2005) <strong>and</strong> the Valuation by Multiples (Relative Valuation) which can generate<br />

insights into specific drivers creating value in the industry (Lie <strong>and</strong> Lie, 2002). Jointly,<br />

Young, M. et al (1999) go further <strong>and</strong> distinguish those approaches in terms <strong>of</strong><br />

spotlight: focus on Equity Values <strong>and</strong> focus on Enterprise Values. <strong>The</strong> distinction<br />

between them it is easy to highlight. While the first method focus on Equity Values<br />

computes only the value <strong>of</strong> Equity, on the other h<strong>and</strong>, methods focus on Enterprise<br />

Values compute the value <strong>of</strong> Equity plus the value <strong>of</strong> Debt.<br />

Besides this distinction, it is primordial to analyze <strong>and</strong> distinguish each Valuation<br />

Method mentioned above. Starting with the Discounted Cash-Flow methodologies,<br />

these approaches imply forecasting future cash-flows <strong>and</strong> discounting them to their<br />

present value at a specific <strong>and</strong> proper rate which reflects their level <strong>of</strong> risk (Luehrman,<br />

1997). At the same time, the most common DCF approach is to discount the future<br />

cash-flows by the weighted average cost <strong>of</strong> capital –WACC- (Kaplan <strong>and</strong> Ruback,<br />

1996). According to Oded, J. (2007), there are four cash-flow methods to value a<br />

company: Adjusted Present Value (APV), Capital Cash Flows (CCF), Cash Flows to<br />

Equity (CFE) <strong>and</strong> Free Cash Flows to the Firm (FCFF). <strong>The</strong> only three differences<br />

between them are: which cash flows are discounted <strong>and</strong>; at which discount rate <strong>and</strong> how<br />

the interest tax shields associated with the debt financing are valued. Some authors as<br />

Goedhart, M. et al, (2005) claim DCF analysis delivers the best valuation results.<br />

In turn, the Valuation by Multiples requires the computation <strong>of</strong> specific multiples for a<br />

set <strong>of</strong> benchmark <strong>and</strong> similar companies <strong>and</strong> therefore finding the company’s assets<br />

value based on these benchmark multiples (Lie <strong>and</strong> Lie, 2002). <strong>The</strong> point in this<br />

approach is the choice <strong>and</strong> application <strong>of</strong> the correct <strong>and</strong> accurate multiple (Goedhart,<br />

M. et al, 2005).<br />

However, Kaplan <strong>and</strong> Ruback (1995) conclude that “there is no obvious method to<br />

determine which measure <strong>of</strong> performance…is the most appropriate for comparison”. In<br />

response to the accurately estimation <strong>of</strong> the firm’s cash flows through DCF<br />

methodologies, Lie <strong>and</strong> Lie (2002) affirm that DCF analysis is frequently left behind in<br />

favor <strong>of</strong> Relative Valuation, <strong>and</strong> the Valuation by Multiples provides the lowest<br />

valuation error (Koeplin, Sarin <strong>and</strong> Shapiro, 2000). <strong>The</strong>re is also another valuation<br />

method which will not be approached here – Return-Based method – on which the value<br />

<strong>of</strong> an asset is the differential between return <strong>and</strong> cost <strong>of</strong> capital (Damodaran, 2002), as it<br />

is the case <strong>of</strong> Return on Equity <strong>and</strong> the Economic Value Added (EVA).<br />

Besides this distinction, Luehrman (1997) also refers to a tool for valuing opportunities<br />

– Option Pricing <strong>The</strong>ory – considering an “opportunity is analogous to an option, where<br />

you have the right to buy or sell at a certain price” <strong>and</strong> on which the asset’s value<br />

depends on a future event. Thus, it should be viewed as a supplement to the DCF<br />

methods <strong>and</strong> not as a replacement. Taking into account the strengths <strong>and</strong> weaknesses <strong>of</strong><br />

each method, which will be deepened farther more in detail, even though it is essential<br />

to refer the most reliable value estimations are the result <strong>of</strong> combining both methods<br />

together (Kaplan <strong>and</strong> Ruback, 1996). <strong>The</strong>reby, the present analysis will be focused on<br />

FCFF, APV <strong>and</strong> Multiple methodologies.<br />

2.1.1. Cash-Flow Approaches<br />

A valuation based on discounted cash flows starts with the estimation <strong>of</strong> the nominal<br />

<strong>and</strong> real future cash flows (Luehrman, 1997), <strong>and</strong> it is also in this initial phase where the<br />

valuation errors usually appear (Damodaran, 2002) due to the expectations about the<br />

growth rates, return on invested capital <strong>and</strong> growth periods, which may be scattered. In<br />

many cases as Damodaran (2002) shows, for purposes <strong>of</strong> simplicity the cash-flows are<br />

forecasted for a limited period <strong>of</strong> time <strong>and</strong> expected to grow at a constant nominal rate<br />

in perpetuity. This assumption is quiet important, seeing that every increase in the<br />

horizon <strong>of</strong> the valuation reduces the valuation errors allowing consequently to a better<br />

corporate performance (Ohlson <strong>and</strong> Zhang, 1999).<br />

<strong>The</strong> second step <strong>of</strong> this methodology refers to determine the proper rate on which cash<br />

flows will be discounted. Since each cash flow has a level <strong>of</strong> risk which directly implies<br />

the use <strong>of</strong> a distinct discount rate, we must do assumptions to estimate the correct cost<br />

<strong>of</strong> capital, which is usually, computed using the Capital Asset Pricing Model (Kaplan &<br />

Ruback, 1996).<br /> <strong>The</strong> Cost <strong>of</strong> Capital<br />

<strong>The</strong> process <strong>of</strong> estimation the cost <strong>of</strong> capital is one <strong>of</strong> the most critical inputs in many<br />

corporations as many companies operate in several industries (Kaplan & Peterson,<br />

1998). Copel<strong>and</strong>, T. et al (1990) consider it as the opportunity cost <strong>of</strong> investing in a<br />

similar risk-project. Moreover, the cost <strong>of</strong> capital can be provided by specific financial<br />

tools (debtholders) as bonds, securitization, hybrids, bank debt <strong>and</strong> convertibles<br />

(Shivdasani & Zak, 2007). In order to compute the correct cost <strong>of</strong> debt capital, this is a<br />

result <strong>of</strong> the risk-free rate plus a default-risk spread depending on the firm’s probability<br />

<strong>of</strong> default. On the other h<strong>and</strong>, it can also be provided by equityholders, in spite <strong>of</strong> the<br />

approaches to compute the correct costs <strong>of</strong> equity capital being less consensual. Indeed,<br />

among the various existing theories about the estimation <strong>of</strong> the cost <strong>of</strong> equity, the most<br />

commonly-used is the Capital Asset Pricing Model (CAPM). According to Kaplan <strong>and</strong><br />

Peterson (1998), the CAPM defines linear relationship between the cost <strong>of</strong> equity <strong>and</strong><br />

the slope coefficient (beta) in a regression <strong>of</strong> the company’s equity returns, in other<br />

words, the CAPM embodied by Sharpe (1964), Lintner (1965) <strong>and</strong> Black (1972)<br />

conclude that the return <strong>of</strong> an asset is the sum <strong>of</strong> the risk-free rate <strong>and</strong> the risk-premium,<br />

which depends on beta. However, the use <strong>and</strong> adequacy <strong>of</strong> the CAPM in practice has<br />

been questionable by some authors. For instance, Fama <strong>and</strong> French (1996) argue that<br />

the main implication in market equilibrium <strong>of</strong> this method is that, the “value-weight<br />

market portfolio is mean-variance-efficient”, in a word, beta explains the expected<br />

return <strong>and</strong> for a beta risk there is a positive expected premium. Ferson <strong>and</strong> Locke (1998)<br />

claim that improving the procedures on the estimation <strong>of</strong> market risk premiums would<br />

allow a superior cost <strong>of</strong> equity estimation rather than using the CAPM.<br />

Despite the distinction mentioned above, firms prefer debt instead <strong>of</strong> equity when<br />

receiving returns because a rise on the debt ratios reduce the probability <strong>of</strong> its<br />

shareholders being compensated in a potential situation <strong>of</strong> financial depression. As a<br />

consequence, the cost <strong>of</strong> unlevered equity must be lower than the cost <strong>of</strong> levered equity.<br />

<strong>The</strong> expected returns implied by the CAPM for the Unlevered <strong>and</strong> Levered firm are<br />

described below:<br />

where is the risk free rate, is the firm’s unlevered beta or systematic risk, is the<br />

firm’s levered beta, <strong>and</strong> is the risk premium required by investors to invest in a<br />

firm with the same level <strong>of</strong> β as the stock market, or market risk premium.<br />

As we have mentioned above, one <strong>of</strong> the commonly-used discount rate in cash flow<br />

calculation approaches is the tax-adjusted discount rate or weighted average cost <strong>of</strong><br />

capital (Kaplan & Ruback, 1996). According to this “method”, WACC represents a<br />

weighted average <strong>of</strong> the after-tax costs <strong>of</strong> different sources <strong>of</strong> capital (equity <strong>and</strong> debt),<br />

in which each one is weighted by the fraction <strong>of</strong> the capital structure it represents<br />

(Luehrman, 1997). Albeit, this approach has been questioned by several authors; for<br />

instance, Kaplan <strong>and</strong> Ruback (1996) argue that a correct WACC practice is hard to<br />

achieve due to the cost <strong>of</strong> capital being recomputed each period as a result <strong>of</strong> changing<br />

leverage over time, making this approach too exhaustive. In turn, the use <strong>of</strong> this model<br />

in a constant growth context implies certain assumptions with regard to the discount<br />

rates to be used in computing the tax shields (Massari, M. et al, 2007).<br />

In fact, the WACC methodology considers that capital structure is rebalanced which<br />

implies that when future asset values are uncertain, the value <strong>of</strong> future debt tax shields<br />

will be also uncertain (Miles & Ezzell, 1980). On the other h<strong>and</strong>, the more complex a<br />

company’s capital structure <strong>and</strong> tax position is, the more likely it is that errors in<br />

estimation will occur (Luehrman, 1997). For example, Welch (2004) argues that the<br />

main determinant <strong>of</strong> capital structure is the stock returns. Moreover, there is also a<br />

tendency to use book values rather than market values in the estimation <strong>of</strong> the capital<br />

structure, which becomes WACC an old fashioned measure (Luehrman, 1997).<br />

Below it is presented the WACC formula:<br />

where is the cost <strong>of</strong> equity <strong>and</strong> is the cost <strong>of</strong> debt, E is the equity <strong>and</strong> D the debt,<br />

<strong>and</strong> is the corporate tax rate.<br />

Indeed, WACC’s main advantage is that it bundles the two sources <strong>of</strong> capital together in<br />

order to discount them only once (Myers, 1974), but given the set <strong>of</strong> complexity<br />

presented on the capital structure <strong>of</strong> firms today, WACC has been increasingly replaced<br />

by other methods (Massari, M. et al, 2007).<br /> Risk-Free Rate ( )<br />

Oded, J (2007) defines the first element <strong>of</strong> the CAPM Model as the expected return on<br />

investment without default risk, which is the same <strong>of</strong> saying when β is zero, the cost <strong>of</strong><br />

equity (either levered or unlevered) is equal to the risk-free rate. Moreover, Copel<strong>and</strong>,<br />

T. et al (1996) conclude that the application <strong>of</strong> the long-term Treasury bond yield in<br />

terms <strong>of</strong> maturity for the computation <strong>of</strong> the risk-free rate in the cost <strong>of</strong> capital<br />

calculations permits a consistent <strong>and</strong> correct valuation on which risk-free rate is<br />

somewhat less dependent on inflation.<br /> Beta (β)<br />

<strong>The</strong> second element <strong>of</strong> the CAPM Model is according to Damodaran (2002) a measure<br />

<strong>of</strong> exposure to the systematic risk <strong>of</strong> the stock. Kothari, S. et al (1995) concluded that<br />

the higher is β, the more negative effects market shocks will create. Firstly, as a way to<br />

increase precision, it is common to estimate the beta <strong>of</strong> a group <strong>of</strong> firms operating solely<br />

in the same industry as the firm who is being valued. Nevertheless, betas may also differ<br />

across firms within an industry (Kaplan & Peterson, 1998). Consequently, several<br />

approaches have appeared for the estimation <strong>of</strong> the systematic risk.<br />

Kaplan <strong>and</strong> Ruback (1996) propose valuations using three measures <strong>of</strong> betas: a firm-<br />

based measure, an industry-based measure <strong>and</strong> a market-based measure; the latter<br />

basically assumes the systematic risk for all the firms analyzed equals the risk <strong>of</strong> the<br />

market assets. Meanwhile, Kaplan <strong>and</strong> Peterson (1998) propose an average beta for the<br />

industry (industry-based measure) in order to avoid errors. <strong>The</strong> methodology that will<br />

be approached will be thereby an industry-based measure, on which will be only<br />

accounted corporations with the same growth, size, cyclicity, gains <strong>and</strong> leverage levels.<br />

According to Kaplan & Peterson (1998), the first step should be the calculation <strong>of</strong> the<br />

firms’ betas operating in the same industry followed by the computation <strong>of</strong> the weighted<br />

average <strong>of</strong> all values (called “Industry betas” by Kaplan & Peterson, 1998). Afterwards,<br />

a cross-sectional regression <strong>of</strong> betas against the industry percentages is computed <strong>and</strong> a<br />

“Market-capitalization-weighted industry betas” is achieved. According to Berk (1995),<br />

it is also extremely important to come up with a relation between beta <strong>and</strong> market<br />

capitalization. Indeed, Berk (1995) concludes that firms with higher risk have smaller<br />

market capitalizations due to the extra risk premium incorporated on the discount rate <strong>of</strong><br />

those firms.<br />

Below it is presented the firm’s levered beta:<br />

Furthermore, as Kaplan & Peterson stated, the betas <strong>of</strong> individual business units cannot<br />

be calculated using historical return information <strong>and</strong> additionally, firms are constantly<br />

changing its capital structures, thus beta is m<strong>and</strong>atorily changing too. In order to<br />

overcome that limitation, betas should be calculated on the basis <strong>of</strong> published estimates<br />

<strong>of</strong> the firm’s unlevered beta for the industry in question (Copel<strong>and</strong>, T et al, 1990).<br /> Market Risk Premium ( )<br />

<strong>The</strong> last parameter that remains to be estimated in the CAPM model is the market risk<br />

premium which represents the difference between the expected return on the market<br />

(Rm) <strong>and</strong> the risk free rate (Rf) mentioned above (Oded, J., 2007). It depends on the<br />

levels <strong>of</strong> liquidity, information availability <strong>and</strong> the economic environment (Damodaran,<br />

2002). Moreover, the computation <strong>of</strong> the market risk premium should use the arithmetic<br />

average historical risk premium (Kaplan & Ruback, 1996). Additionally, Koller, T. et al<br />

(2005) consider that the historical risk premium for a mature equity market is nearly 4,5<br />

percent.<br />

In fact, the importance <strong>of</strong> the expected market returns leads to the use <strong>of</strong> the most<br />

representative equity market due to the inability to compute the market portfolio.<br />

According to Damodaran (2002), a good index is the one which includes the highest<br />

number <strong>of</strong> securities (seen the wide equity market), assuming they are market weighted.<br />

As Fama <strong>and</strong> French (1996) refer, one <strong>of</strong> the main limitations <strong>of</strong> CAPM is mainly due<br />

to miscalculations <strong>of</strong> market portfolio. <strong>The</strong>refore, a good approach to avoid such errors<br />

is the one mentioned by Damodaran (2002), on which, the default spread affiliated with<br />

the country rating has to be multiplied by the average <strong>of</strong> equity to bond market volatility<br />

<strong>and</strong> then added to the historical risk premium.<br /> Free Cash Flow to the Firm Model<br />

According to Kaplan & Ruback (1996), the Free Cash-Flow to the Firm Model (FCFF)<br />

is “the most commonly-used DCF approach, on which the value <strong>of</strong> a leveraged firm can<br />

be calculated by discounting the unleveraged cash flows to the firm at the firm weighted<br />

average cost <strong>of</strong> capital (WACC).<br />

Thus:<br />

Firm Value =<br />

Indeed, this formula is composed by two stages: the first is computed the present value<br />

<strong>of</strong> cash-flows up to some preselected horizon date (n), which according to Ohlson &<br />

Zhang (1999) is rarely superior to 15 years; <strong>and</strong> the second is calculated to the present<br />

value <strong>of</strong> cash-flows beyond the horizon date referred as the terminal value (TGR<br />

represents the terminal growth rate).<br />

Moreover, other authors such as Damodaran (2005) values the FCFF model as the<br />

amount <strong>of</strong> cash earned by a company after paying all taxes, expenses <strong>and</strong> reinvestment<br />

needs, but before dividends <strong>and</strong> interests to debtholders or equityholders.<br />

Below is presented the FCFF model according to Damodaran (2005):<br />

FCFF = EBIT (1-T) – Capital Expenditures + Depreciation – ΔNWC ± other Non cash items<br />

Once again, it is essential to refer that these cash-flows must be discounted at the firm<br />

WACC (Massari, M. et al, 2007), which is the discount rate that adjusts for the tax<br />

effect. Next, it will be analyzed the following two FCFF parameters: the Terminal<br />

Value <strong>and</strong> the Expected Growth Rate.<br /> Terminal Value<br />

After the computation <strong>of</strong> the operating cash-flow plus <strong>and</strong>/or minus the investment<br />

effects up to a certain point in the future (Luehrman, 1997), it is required to execute the<br />

second stage <strong>of</strong> this methodology: the present value <strong>of</strong> cash-flows beyond the horizon<br />

date (Terminal value). <strong>The</strong> terminal value is thereby, the capital cash-flow in the last<br />

forecast year (terminal year) <strong>and</strong> then adjusting it for the difference between cost <strong>of</strong><br />

capital <strong>and</strong> expected growth rate (Damodaran, 2005).<br />

Thus,<br />

Terminal Value =<br />

In fact as formula shows, the Terminal Value is very delicate to possible changes in the<br />

expected growth rate <strong>and</strong> in the cost <strong>of</strong> capital (Oded, J., 2007).<br /> Expected Growth Rate<br />

While Kaplan & Ruback (1996) argue that terminal cash-flow grow at a constant<br />

nominal rate in perpetuity, assuming that Depreciation is equal to Capital Expenditures<br />

in the capital cash-flow in the terminal year, Copel<strong>and</strong>, T. et al (1990) claim the<br />

importance <strong>of</strong> the growth factor in obtaining the enterprise value, <strong>and</strong> m<strong>and</strong>atorily in the<br />

WACC. Hence, the Expected Growth rate is the product <strong>of</strong> the Reinvestment rate (RR)<br />

multiplied by the after-tax return on capital (ROC) (Damodaran, 2005).<br />

ROC =<br />

RR =<br />

Concerning to the Terminal Growth rate (TGR) stated above on the firm’s value<br />

formula, Damodaran (2005) also argues that no organization can grow faster than its<br />

current economy in the long-term period. Consequently, TGR at a constant rate shall be<br />

computed as the real or nominal expected growth rate <strong>of</strong> the economy’s GDP depending<br />

on whether the cash-flows will be included or not on the inflation parameter on its<br />

computation.<br /> Adjusted Present Value (APV)<br />

<strong>The</strong> APV approach, <strong>of</strong>ten called “valuation in parts” suggested by Myers (1974),<br />

besides being less susceptible to valuation errors than the traditional WACC, it also<br />

computes how much a firm asset is worth <strong>and</strong> where this value comes from (Luehrman,<br />

1997). Indeed, Myers (1974) argues that the valuation <strong>of</strong> a firm’s assets is the sum <strong>of</strong><br />

two categories <strong>of</strong> cash-flows: the real cash-flows (revenues, cash operating costs, capital<br />

expenditures) related to the business operation; <strong>and</strong> the “side effects” associated with<br />

the financing program (interest tax shields, cost <strong>of</strong> financial distress, subsidies, hedges,<br />

issue costs <strong>and</strong> agency costs). In a word, the first part <strong>of</strong> this technique can be<br />

considered as the value <strong>of</strong> an all-equity firm, while the second piece can be considered<br />

as the value added by a firm’s choice <strong>of</strong> capital structure (Kaplan & Ruback, 1996).<br />

Nevertheless, it is also important to highlight that the value <strong>of</strong> all financing side effects<br />

might introduce excessive complexity to this method <strong>and</strong> for this reason, because <strong>of</strong>ten<br />

mostly are disregarded, paying attention only to the interest tax shields (Damodaran,<br />

2005).<br />

<strong>The</strong>refore, the first task on the APV model consists <strong>of</strong> the firm business valuation as if it<br />

was financed entirely with equity (unlevered firm). Thus:<br />

Value <strong>of</strong> the Unlevered Firm (Vu) =<br />

As it is shown, the procedure is precisely the same as the FCFF model; the only<br />

difference reports to the applied discount rate: in this case, it is used the unlevered cost<br />

<strong>of</strong> equity ( ) rather than the WACC.<br />

<strong>The</strong> second task on the APV approach is related to the value associated with the<br />

financing program that firm expects to use. According to Luehrman (1997), the net<br />

effect <strong>of</strong> the financing program value should be positive, otherwise, the company would<br />

use solely equity financing. As a result <strong>of</strong> a company will hardly be financed entirely<br />

with equity, so the Value <strong>of</strong> the Tax Shields (VTS) is described below:<br />

Value <strong>of</strong> Tax Shields =<br />

where represents the net debt, represents the levered cost <strong>of</strong> equity, represents<br />

the corporate tax rate, <strong>and</strong> g represents the perpetual tax shield growth.<br />

Luehrman (1997) highlights that interest tax shield normally appear as a consequence <strong>of</strong><br />

interest payments which are deductible on the corporate tax return. Moreover, the same<br />

author pays attention to the fact that in the long-term period as the indebtedness grows<br />

at the same rate as the firm, thus, g will be equal to TGR (terminal growth rate).<br />

Regarding the discount rate used in the model, Myers (1974) <strong>and</strong> Luehrman (1997)<br />

argues that tax shields should be discounted using the cost <strong>of</strong> debt as a discount rate<br />

because firms almost defaulting are unable to use tax shields in spite <strong>of</strong> their ability to<br />

pay interest. However, Milles & Ezzel (1980) have an opposite point <strong>of</strong> view, giving<br />

relevance <strong>of</strong> using the cost <strong>of</strong> equity as the appropriate discount rate.<br />

As a result <strong>of</strong> those two assessments, it is plausible to add the probability <strong>of</strong> firm default<br />

to the cost <strong>of</strong> debt in order to reach a rate that reflects riskiness, as from Luehrman’s<br />

point <strong>of</strong> view (1997), tax shields are more risky than debt itself.<br />

Besides the value <strong>of</strong> interest tax shields, there are other important side effects which can<br />

also be added or subtracted to the all-equity firm value, namely the value <strong>of</strong> a firm in<br />

case <strong>of</strong> distress (CFD). Thus:<br />

Cost <strong>of</strong> Financial Distress =<br />

In practice, CFD represents the product between the values <strong>of</strong> <strong>and</strong> unlevered firm ( )<br />

<strong>and</strong> the percentage <strong>of</strong> loss in a company’s value (Damodaran, 2005). Meanwhile, this<br />

percentage is highly variable across industries, that Andrade & Kaplan (1998) argue to<br />

be on average a value between 10% <strong>and</strong> 20%.<br />

<strong>The</strong>reby, as Myers (1974) claimed, the final task refers to add all the parts together <strong>and</strong><br />

then, we get an estimate <strong>of</strong> the APV methodology.<br />

Firm Value = + [1 - P(D)] VTS – [P(D) CFD]<br />

Once again, the VTS must be multiplied by the probability <strong>of</strong> no default inasmuch VTS<br />

only exists while a firm is operating, <strong>and</strong> similarly, the CFD has to be multiplied by the<br />

probability <strong>of</strong> default.<br />

According to Luehrman (1997), APV is highly helpful in the valuation <strong>of</strong> cross-border<br />

takeovers, although the use <strong>of</strong> the correct valuation approach depends on the nature <strong>of</strong> a<br />

firm’s capital structure (Kaplan & Ruback, 1996). Indeed, the APV represents a model<br />

which can incorporate easily the impact <strong>of</strong> dividend policy, or even transaction costs in<br />

financing, <strong>and</strong> is extraordinarily transparent concerning in adjustments to the discount<br />

rate (Myers, 1974).<br />

Notwithst<strong>and</strong>ing, the APV concept presents certain h<strong>and</strong>icaps: first <strong>of</strong> all, the income<br />

from stocks can be taxed in a different way, when the investor files a personal tax<br />

return; in addition, analysts usually ignore the use <strong>of</strong> other financing side effects in<br />

order to avoid complexity in getting the APV estimation (Luehrman, 1997). For this<br />

reason, Kaplan & Ruback (1996) proposed a new APV technique called “Compressed<br />

APV” as an upgrade <strong>of</strong> the traditional APV method, in which the all-equity discount<br />

rate is applied to the whole firm’s expected capital cash-flows, either the real cash-<br />

flows, or the side effects.<br />

2.1.2. Relative Valuation<br />

Even though the DCF methodologies computed the most reliable estimations, the use <strong>of</strong><br />

multiples provided the smallest valuation errors (Kaplan & Ruback, 1996). To this<br />

extent, it becomes essential to analyze the use <strong>of</strong> Multiples valuation in the estimation<br />

<strong>of</strong> the corporate value. Relative Valuation focus on what the market expects a firm’s<br />

ability to create pr<strong>of</strong>it to be based on its position against similar firms operating on the<br />

same industry around the same time (Koeplin, Sarin, Shapiro, 2000). In practical terms,<br />

enterprise value estimation starts by finding a set <strong>of</strong> comparable transactions <strong>and</strong> then<br />

calculate such transaction multiples <strong>of</strong> several relevant financial parameters, such sales<br />

or earnings. Finally, the estimated multiple is applied to the values <strong>of</strong> those parameters<br />

for the firm which is being valued (Kaplan & Ruback, 1996). Nevertheless, the success<br />

<strong>of</strong> such method is inherent to the ability in identifying transactions that shows specific<br />

characteristics such as, risk, growth rate, capital structure, size <strong>and</strong> liquidity, which are<br />

closely related to those <strong>of</strong> the firm which is being valued. Thus, the correct choice <strong>of</strong><br />

comparable companies <strong>and</strong> the use <strong>of</strong> the right set <strong>of</strong> multiples are essential to prevent<br />

misunderst<strong>and</strong>ings (Goedhart, M. et al, 2005).<br />

According to Koeplin, J. et al (2000) <strong>and</strong> matching with Goedhart, M. et al (2005) main<br />

findings, a firm with similar size <strong>and</strong> timing <strong>of</strong> cash-flows, as well as, growth, leverage<br />

<strong>and</strong> risk levels is considered a suitable comparable firm.<br />

Notwithst<strong>and</strong>ing, such comparable firm is only possible to meet in the same industry or<br />

business segment (Lie & Lie, 2002). Hereupon <strong>and</strong> according to Alford (1992), the first<br />

task should be the definition <strong>of</strong> a firm’s business segment through a four-digit SIC code<br />

(St<strong>and</strong>ard Industrial Classification), which identifies in what industry a certain company<br />

belongs to. Furthermore, from the portfolio <strong>of</strong> companies selected, it is essential to<br />

focus on those with similar ROC <strong>and</strong> growth expectations (Goedhart, M. et al, 2005).<br />

<strong>The</strong> second half <strong>of</strong> this methodology concerns to the selection <strong>of</strong> the correct set <strong>of</strong><br />

multiples. Indeed, a good multiple is the one which is difficult to manipulate through<br />

leverage <strong>and</strong> which describes the firm’s capacity to create pr<strong>of</strong>its as well (Goedhart, M.<br />

et al, 2005). At the same time, the superiority <strong>of</strong> enterprise-value multiples (as<br />

enterprise-value-to-EBITDA multiples) over equity-value multiples (as Price-earnings<br />

multiples) is evident, since the latter is directly affected by changes in the capital<br />

structure, while the former is not affected by depreciation effects, although some<br />

analysts have used both (Kaplan & Ruback, 1996). Moreover, enterprise-value<br />

multiples should also be adjusted for non-operating items, like excess cash, employee<br />

stock options, operating leases <strong>and</strong> pensions (Goedhart, M. et al, 2005). In addition,<br />

another recommendation presented by the same author is the following: multiples<br />

should also be based on forecasted information if available, or on the latest information<br />

released.<br />

Koeplin, J. et al (2000) consider four types <strong>of</strong> multiples valuation ratios based on EBIT,<br />

EBITDA, sales <strong>and</strong> book value, <strong>and</strong> in fact, the ratio results for public transactions were<br />

higher than for private transactions. <strong>The</strong>refore, private firms sell at a discount relatively<br />

to similar public firms. Meanwhile, Lie & Lie (2002) reported that EBITDA multiples<br />

generated better estimates than EBIT multiples. According to Alford (1992) <strong>and</strong> Lie &<br />

Lie (2002), the accuracy <strong>and</strong> performance <strong>of</strong> estimates vary by firm size, pr<strong>of</strong>itability<br />

<strong>and</strong> the value <strong>of</strong> intangible assets in the firm, emphasizing that valuation by multiples<br />

are more accurate for large (Alford, 1992) <strong>and</strong> financial (Lie & Lie, 2002) companies<br />

than for nonfinancial companies.<br />

As it was referred above, companies with high intangible assets, as “Dot-com”<br />

enterprises, which have been recently created, with a lower sales percentage <strong>and</strong><br />

negative pr<strong>of</strong>its, the use <strong>of</strong> nonfinancial multiples, such as website visitors or<br />

subscribers, on its own valuation may deliver better results (Goedhart, M. et al, 2005).<br />

Of the presented multiples, there is no consensus as to which multiple performs the best<br />

results, even though they should be taken into account in any valuation process<br />

(Koeplin, J, et al, 2000).<br />

2.2. M&A related issues<br />

Despite the large wave <strong>of</strong> acquisitions since the late <strong>of</strong> 1990’s, according to Lajoux<br />

(1998) on average, takeovers have failed to generate value for those who invested <strong>and</strong><br />

live up to the financial expectations <strong>of</strong> those transacting them. Indeed, an acquisition<br />

process, either domestic or cross-border deal requires a sequence <strong>of</strong> activities which are<br />

difficult to accomplish due to limited information <strong>and</strong> time, as well as, poor<br />

management <strong>of</strong> the whole process by the intervening companies (Jemison & Sitkin,<br />

1986). <strong>The</strong>reby, according to Very & Schweiger (2001), an acquisition process requires<br />

firstly, the identification <strong>and</strong> evaluation <strong>of</strong> potential target firms, followed by the<br />

election <strong>of</strong> the best targetable company <strong>and</strong> consequently starting the negotiation stage<br />

with their owners, managers <strong>and</strong> other stakeholders. Finally, the last step is related to<br />

invest in post-acquisition integration. Hence, this section will address the main types <strong>of</strong><br />

M&A, the resulting Synergies, then it will focus on the aspect <strong>of</strong> cross-border deals <strong>and</strong><br />

emerging markets <strong>and</strong> to conclude, how synergy benefits are shared among two<br />

companies.<br />

2.2.1. Main types <strong>of</strong> M&A<br />

According to Damodaran (2002), a firm can be acquired by another company or by<br />

outside investors <strong>and</strong> its own managers. In fact, the form as M&A is driven; it will<br />

affect directly the method <strong>of</strong> payment <strong>and</strong> the post-acquisition outcome (Loughran &<br />

Vijh, 1997).<br />

By that means, an acquisition by another company can also be classified as: merger,<br />

tender <strong>of</strong>fer, consolidation <strong>and</strong> acquisition <strong>of</strong> assets. In mergers, the target company is<br />

integrated into the acquiring company, so both shareholders intervene on the acquisition<br />

process. On the other h<strong>and</strong>, in tender <strong>of</strong>fers, the integration depends on the approval or<br />

not by the target shareholders; for instance, if target shareholders accept the tender, this<br />

will result into a merger in which the acquiring firm gains control. In a consolidation<br />

process, a new firm is created by both intervening companies, so it requires the<br />

participation <strong>of</strong> both shareholders. <strong>The</strong> last form concerns to the purchase <strong>of</strong> assets by<br />

the acquirer, thus it only requires a target shareholder approval. On the other h<strong>and</strong>, in<br />

the case <strong>of</strong> a company being acquired by its own managers (Management Buyout) or<br />

external investors (Leveraged Buyout), these acquisition processes normally take the<br />

form <strong>of</strong> tender <strong>of</strong>fers where the target company becomes a private business (Wruck,<br />

2008).<br />

Meanwhile <strong>and</strong> according to the same author, it is essential to highlight that Leveraged<br />

buyout (Private Equity) markets are leaning to boom <strong>and</strong> bust cycles due mainly to<br />

hostile deal pricing <strong>and</strong> the laid-back credit market conditions. As such acquisitions are<br />

executed through raising debt, who holds the debt is the main question mark. Not only<br />

banks, but also private hedge funds have increased its importance in private-equity<br />

transactions, creating information problems for those who funded the Leverage buyout<br />

debt (Acharya, V. et al, 2007). <strong>The</strong>refore, capital requirement modifications <strong>and</strong> more<br />

information provision about risk exposure are required measures to avoid such cycles<br />

<strong>and</strong> the related debt problems.<br />

Besides this differentiation, Loughran & Vijh (1997) also advocate a distinction<br />

between aggressive <strong>and</strong> friendly takeovers, referring that mergers are usually friendly,<br />

while tender <strong>of</strong>fers use a hostile tone during the whole acquisition process. At the same<br />

time, Stahl & Voigt (2005) argue for the speed <strong>of</strong> integration, highlighting that a faster<br />

acquisition leads to a simpler culture assimilation process. Last but not least, a M&A<br />

etween firms competing on the same industry or business segment tends to increase the<br />

probability <strong>of</strong> success compared to those operating in different industries, without the<br />

required know-how to interfere on the target’s core business (Barkema & Vermeulen,<br />

1998).<br />

2.2.2. Synergies - “<strong>The</strong> creation <strong>of</strong> value”<br />

According to Damodaran (2005), synergy is defined as the increase in value that comes<br />

from the combination <strong>of</strong> two enterprises to create a more valuable company. On the<br />

other h<strong>and</strong> <strong>and</strong> also mentioned by the same author, valuing control consists <strong>of</strong> revaluing<br />

only the target company with a different <strong>and</strong> presumably better management in place<br />

<strong>and</strong> compare this value to the one obtained with the existing management in place. This<br />

distinction must be essentially <strong>and</strong> separately done in order to avoid double counting<br />

<strong>and</strong> to distinguish between control value-oriented acquisitions <strong>and</strong> synergy value-<br />

oriented purchases.<br />

As the spotlight <strong>of</strong> this analysis is the synergies created by M&A, it becomes crucial to<br />

address about the synergies achievement. Synergies can be reached through cost<br />

reductions, or revenue enhancements, or even through both simultaneously (Sirower &<br />

Sahni, 2006). In other words, the increase in value can be a result <strong>of</strong> reduction in the<br />

cost <strong>of</strong> capital or an increase in the expected cash-flows (Damodaran, 2005), albeit<br />

companies are normally more triumphant in reducing costs than in increasing revenues<br />

(Sirower & Sahni, 2006). Moreover, for a synergy to create value, there must be a<br />

further growth in the return on capital to the combined firm.<br />

Furthermore, synergies can be grouped into three groups: Operating Synergies,<br />

Financial Synergies <strong>and</strong> Dubious Synergies (Damodaran, 2005). Operating Synergies<br />

refer to a better development <strong>of</strong> the existing assets resulting into higher growth<br />

potential, increasing pricing power, economies <strong>of</strong> scale <strong>and</strong> scope <strong>and</strong> combination <strong>of</strong><br />

distinct skills. On the other h<strong>and</strong>, Financial Synergies refer to tax benefits through tax<br />

deductions or accumulated losses, increasing debt capacity through a lower earnings<br />

variance, the use <strong>of</strong> excess cash in new opportunities - Cash-slack – <strong>and</strong> finally,<br />

Diversification which depends on a firm’s size <strong>and</strong> its corporate governance <strong>and</strong> its<br />

effects are far from clear, varying across industries. In fact, the same authors quoted that<br />

markets do not recognize the success <strong>of</strong> diversification to generate value. Ultimately,<br />

Dubious Synergies in which markets react positively to its announcements, can take the<br />

form <strong>of</strong> accretive purchases (higher EPS post-acquisition) <strong>and</strong> fast-growing enterprises.<br />

In turn, the valuation <strong>of</strong> such synergies is unanimous among analysts (Damodaran,<br />

2005), using the DCF methodologies to compute the additional value created, but its<br />

evidence is difficult to evaluate though. In spite <strong>of</strong> the synergy potential at the time <strong>of</strong><br />

the takeover, only a small percentage <strong>of</strong> mergers deliver additional value due to the<br />

excessive price paid by acquiring firms <strong>and</strong> the operations <strong>of</strong> both intervening firms did<br />

not fit (Kaplan & Weisbach, 1992). Moreover, markets perceive M&A takeovers as a<br />

surprise; regardless prices adjust quickly (Kiymaz & Kilic, 2004). <strong>The</strong>reby <strong>and</strong> based<br />

on historical evidence, Damodaran (2005) mentions three facts which might help to<br />

increase the probability <strong>of</strong> M&A success in creating synergies: firms with similar size<br />

have a higher likelihood <strong>of</strong> failure than small/large firm combinations; cost reduction<br />

takeovers have a higher probability <strong>of</strong> delivering on synergy than takeovers based on<br />

growth synergy; lastly, the acquisition <strong>of</strong> private businesses has a greater probability <strong>of</strong><br />

success than acquisition <strong>of</strong> publicly traded firms (Shivdasani & Zak, 2007).<br />

2.2.3. Cross-Border M&A <strong>and</strong> Emerging Markets<br />

<strong>The</strong> partnerships or takeovers between companies headquartered in different countries<br />

usually raise certain interrogations about how to value such M&A, the entry process <strong>and</strong><br />

the future perspectives <strong>of</strong> success (Very & Schweiger, 2001). In fact, the increasing<br />

Globalization <strong>of</strong> markets for goods, services, labor <strong>and</strong> capital has led companies to<br />

start searching for new opportunities abroad <strong>and</strong> in emerging markets, in order to<br />

exp<strong>and</strong> its operations overseas (Zenner, M. et al, 2008). Thus, on the last decade, the<br />

markets witnessed a growth <strong>of</strong> Cross-border transactions, representing one-fourth <strong>of</strong> the<br />

total value <strong>of</strong> the M&A market (Very & Schweiger, 2001).<br />

Zenner, M. et al (2008) report the main reasons for this growth in cross-border<br />

takeovers: Globalization, Geographic diversification, in which emerging market<br />

companies increasingly seek cross-border transactions, <strong>and</strong> tax benefits. Additionally,<br />

short-term factors can also live on over time, like: high-relative valuations (increasing<br />

purchase power when stock prices are great), currency changes (for instance, a cheap<br />

U.S. dollar), Sovereign wealth funds behaving as reserve future funds, <strong>and</strong> finally<br />

decreasing domestic competition given in theory, foreign acquirers seem to pay more<br />

than domestic acquirers in cross-border transactions (Bruner, 2004).<br />

However, cross-border M&A present several implications that we must take into<br />

account in terms <strong>of</strong> valuation in order to avoid misjudgments. Differences in terms <strong>of</strong><br />

currency in which to execute the valuation (normally, using the currency <strong>of</strong> the target’s<br />

cash-flows), taxation (foreign or domestic tax rates), cost <strong>of</strong> capital, risk assessment<br />

among jurisdictions, inflation <strong>and</strong> cash-flow valuation approaches are crucial to<br />

compute (Koller, T. et al, 2005). As a consequence <strong>of</strong> foreign exchange risk as political<br />

risk as well, it is also fundamental to adjust expected cash-flows through a probability<br />

weighted scenario method (James & Koller, 2000). <strong>The</strong>reby, a foreign currency cash-<br />

flow can be discounted at the foreign currency discount rate, converting the result into<br />

home currency at the spot exchange rate or; at the home currency discount rate,<br />

converting the result into home currency at the expected exchange rate (Froot & Kester,<br />

1995). It is important to refer that foreign currency discount rate <strong>and</strong> forward exchange<br />

rate are obtained using the interest rate parity, according to the same authors.<br />

Nevertheless, some obstacles can also diminish <strong>and</strong> detain the success <strong>of</strong> cross-border<br />

M&A, namely, the short-term factor referred above may not keep on, as the U.S dollar<br />

shift, <strong>and</strong> the barriers to trade <strong>and</strong> foreign acquisitions take by a Protectionist<br />

government. Consequently, the entry process in these markets, where assets are too<br />

cheap or margins <strong>and</strong> investment opportunities can be too high, is not easy to succeed<br />

(Bruner, 2004). Indeed, “M&A is local”, so the success depends on the local/targeted<br />

country situation, <strong>and</strong> on the knowledge <strong>and</strong> prior experience about a target country<br />

(Very & Schweiger, 2001).<br />

Notwithst<strong>and</strong>ing, cross-border M&A should be viewed as a key element <strong>of</strong> shareholder<br />

value (Zenner, M. et al, 2008). Indeed, according to Zenner & Shivdasani (2004), cross-<br />

border acquiring firms tend to outperform domestic firms, mainly because <strong>of</strong> the<br />

immediate market access <strong>and</strong> lower execution risk, <strong>and</strong> as the majority <strong>of</strong> cross-border<br />

M&A use cash as the acquisition currency, markets usually prefer cash-financed<br />

takeover rather than, stock-financed transactions. In turn, large companies purchasing<br />

emerging market companies allow them to keep growing <strong>and</strong> generate shareholder<br />

value, when the growth in its domestic market is limited (Zenner, M. et al, 2008). At the<br />

same time, emerging market companies, selling at a high price <strong>and</strong> using mainly cash,<br />

acquire access to developed markets.<br />

<strong>The</strong>refore, cross-border M&A always bring benefits <strong>and</strong> cost for the participating<br />

companies which dictate the success or failure <strong>of</strong> the transaction (Kiymaz & Kilic). In<br />

case things go on the wrong direction, either firms quit from the transaction, or they try<br />

to overcome such bias, collecting a more reliable data about the country/market in<br />

question <strong>and</strong> integrating the acquired firm, overstepping cultural dichotomies (Very &<br />

Schweiger, 2001). Moreover, the prior experience <strong>and</strong> expertise about the target country<br />

or emerging market is fundamental, since the more similar a new transaction is to<br />

historical <strong>and</strong> past ones, the better will be its performance <strong>and</strong> the higher will be the<br />

likelihood <strong>of</strong> well-succeed future takeovers in that country/market (Haleblian &<br />

Finkelstein, 1999).<br />

2.2.4. Methods <strong>of</strong> Payment<br />

According to Zenner, M. et al (2008), transactions, either domestic or cross-border can<br />

be financed with cash, stock, a mix <strong>of</strong> both, or even through a payout depending on the<br />

target assets future performance – earnout contract – which provides a greater<br />

performance incentive for the seller <strong>and</strong> a risk management device for the buyer<br />

(Bruner, 2004).<br />

Loughran & Vijh (1997) <strong>and</strong> Martin (1996) argue that the majority <strong>of</strong> mergers are<br />

financed through stock, while tender <strong>of</strong>fers are generally cash-financed, despite markets<br />

do not react to news about the method <strong>of</strong> payment. In turn, several authors, such as<br />

Bruner (2004), Savor & Lu (2009), or even, Sirower & Sahni (2006) consider that<br />

acquiring firms usually prefer cash instead <strong>of</strong> stock when possible, with some going so<br />

far as to assert that the use <strong>of</strong> cash might destroy value. On the other h<strong>and</strong> <strong>and</strong> when the<br />

target’s future performance is unclear, the use <strong>of</strong> stock might be more rational (Zenner,<br />

M. et al, 2008).<br />

Indeed, the decision <strong>of</strong> using cash, stock or even, “earnouts” depend on certain aspects.<br />

First <strong>of</strong> all, it is essential to evaluate acquirer <strong>and</strong> target stock, whether it is overvalued<br />

or undervalued. Normally, when managers believe its stock is overvalued, they will<br />

prefer to pay with stock in order to obtain assets at an effective discount, <strong>and</strong> the<br />

opposite is also true (Savor & Lu, 2009). Additionally, the consequences <strong>of</strong> the payment<br />

form on the capital structure <strong>and</strong> on the rating agencies are also relevant to highlight.<br />

According to Sirower & Sahni (2006), in cash transactions, acquiring shareholders take<br />

on the entire risk <strong>of</strong> not match the expected synergies, while in stock transactions the<br />

risk is shared with selling shareholders. At the same time, paying with cash, the<br />

acquiring company is showing confidence in the transaction <strong>and</strong> it will get the entire<br />

amount <strong>of</strong> post-merger synergy benefits, being the opposite also veracious (Bruner,<br />

2004). Furthermore, the importance <strong>of</strong> tax implications <strong>and</strong> financing choices must be<br />

taken into account because cash is directly taxed rather than stock, which is tax-<br />

deferred. Besides that, a cash-financed project means an additional debt issuance, so<br />

according to Zenner, M. et al (2008), the issued currency should match the currency <strong>of</strong><br />

the target’s cash-flows, the new debt should be located close to the supported assets <strong>and</strong><br />

cash-flows, <strong>and</strong> the issuance market depends on the market access that acquiring <strong>and</strong><br />

target managers own.<br />

2.2.5. Post-acquisition Returns<br />

According to the theory, the sharing <strong>of</strong> synergy returns should follow the principle <strong>of</strong><br />

who contributes more for its creation, it should consequently receive more benefits, in a<br />

word, it depends on the effort <strong>and</strong> skills disbursed by the target <strong>and</strong> acquirer for the<br />

existence <strong>of</strong> the synergy (Damodaran, 2005). Consequently, an acquiring company to be<br />

able to receive the largest part <strong>of</strong> synergy gains, it must outperform the bids <strong>of</strong> others<br />

<strong>and</strong> match the shareholders expectations <strong>and</strong> promises (Sirower & Sahni, 2006).<br />

Moreover <strong>and</strong> according to the same authors, a cash-financed transaction tends to<br />

outperform, <strong>and</strong> consequently larger share <strong>of</strong> benefits than stock-financed deals.<br />

However, in M&A transactions the evidence indicates that targets extract positive<br />

wealth gains, whereas the wealth effects for the acquirers are negligible at best (Kiymaz<br />

& Kilic, 2004). Thus, it is fair to say, supported obviously by authors such as Sirower &<br />

Sahni (2006) that target companies <strong>and</strong> their shareholders are the greater gainers <strong>of</strong><br />

M&A, at least in the short-term period.<br />

Indeed, Damodaran (2005) warns that half <strong>of</strong> acquiring companies earn negative returns<br />

at the announcement <strong>of</strong> transactions, which shows the investors’ skepticism about the<br />

ability <strong>of</strong> the acquirer to keep or not the initial values <strong>of</strong> each firm composing the<br />

combined company, <strong>and</strong> in turn, the ability to reach the expected synergies initially<br />

proposed as a way to warrant the premium price paid. Actually, a higher premium price<br />

without any growth expectations represents more risk for shareholders <strong>and</strong> an inferior<br />

stock price performance for the whole acquiring firm (Sirower & Sahni, 2006).<br />

On the long-run period (more than 5 years), the wealth gain effects are shared distinctly.<br />

Loughran & Vijh (1997) state that stock mergers accepted by target shareholders, have<br />

the worst returns for themselves. In fact, there is a connection between stockholders’<br />

returns <strong>and</strong> the type <strong>of</strong> M&A <strong>and</strong> the consequently, method <strong>of</strong> payment. <strong>Mergers</strong>,<br />

normally stock-financed, in agreement with Loughran & Vijh (1997) findings, produce<br />

relative or negative abnormal returns as the size <strong>of</strong> the target compared with buyer<br />

increases. On the other h<strong>and</strong>, tender <strong>of</strong>fers, usually cash-financed, have positive excess<br />

returns, despite acquirers earn little or nothing from them. Additionally, cash tender<br />

<strong>of</strong>fers may also create extra value whether after the transaction, a new management<br />

board is appointed or not. Nonetheless, at the time <strong>of</strong> purchase, if the acquiring firm<br />

assets are overvalued, there is an extra incentive to use stock because <strong>of</strong> their effective<br />

price paid drop (Savor & Lu, 2009).<br />

<strong>The</strong>refore, in order to verify the risk for the stockholders <strong>of</strong> using cash or stock <strong>and</strong> the<br />

consequent effects on the combined firm performance, Sirower & Sahni (2006) propose<br />

a ratio allowing to know how much a company is risking in a certain takeover if<br />

synergies are not matched:<br />

Shareholder Value at Risk (SVAR) =<br />

In fact, in order to meet growth <strong>and</strong> synergy expectations, managers should spend time<br />

on the company’s assets evaluation process, providing detailed <strong>and</strong> completed<br />

information about the takeover benefits to the shareholders <strong>and</strong> to the markets, <strong>and</strong><br />

ultimately, the board <strong>of</strong> directors must be more realistic on their forecasts (Sirower &<br />

Sahni, 2006). As a consequence <strong>and</strong> given the projection <strong>and</strong> large returns generated by<br />

Leverage buyouts, a possible alignment between shareholders’ compensation <strong>and</strong><br />

company’s goals, as well as a more decentralized decision-making process - the Private-<br />

Equity methodology – might be an accurate approach able to invert M&A into a<br />

“winner’s game” (Shivdasani & Zak, 2007).<br />

Moreover, Sirower & Sahni (2006) also present a graphical analysis for the purpose <strong>of</strong><br />

showing the principal M&A gains to the markets. First <strong>of</strong> all, it includes the “Meet-the-<br />

Premium” Line (MTP), which represents the combinations <strong>of</strong> revenue <strong>and</strong> cost<br />

synergies that justify the premium paid; <strong>and</strong> the “Plausibility Box”, as the name implies,<br />

the revenue <strong>and</strong> cost synergies plausible to achieve by the company, knowing that<br />

markets respond worse to revenue synergies (Bruner, 2004). At best, a company should<br />

be above the MTP Line <strong>and</strong> within the Plausibility Box. Furthermore, a company may<br />

also disclose to the markets its own capabilities simultaneously with its market access.<br />

2.3. Conclusion<br />

Pursuant to the theoretical M&A analysis <strong>and</strong> consequent evidences from it, many<br />

interesting findings are still unclear <strong>and</strong> hard to underst<strong>and</strong>, <strong>and</strong> might deserve future<br />

research. Indeed, particular arguments throughout this section are based on statistical<br />

data, which might not be reliable since each situation is different from the previous one<br />

(Bruner, 2004). Additionally, such results usually computed, even though, through valid<br />

<strong>and</strong> in vigor approaches, are more <strong>and</strong> more old-fashioned, as the case <strong>of</strong> WACC<br />

method (Luehrman, 1997).<br />

According to Sirower & Sahni (2006), even whether acquirer shareholders lose value, or<br />

the target shareholders earn value, which results at the end, M&A transactions generate<br />

value for the economy. In spite <strong>of</strong> valuation pitfalls <strong>and</strong> limitations, managers shall<br />

spend a great time on it considering the positive <strong>and</strong> wealthy consequences for the<br />

participating firms’ shareholders (Damodaran, 2005).<br />

3. Industry <strong>and</strong> Company Analysis<br />

3.1. Overview <strong>of</strong> the Global Mobile Industry<br />

<strong>The</strong> global wireless h<strong>and</strong>set market has seen an exponential growth since its first<br />

commercial introduction in 1983, becoming an essential part <strong>of</strong> our daily lives. Indeed,<br />

from the first generation <strong>of</strong> devices to the launch <strong>of</strong> digital technologies (as SMS) <strong>and</strong><br />

the way to the ultra-fast third <strong>and</strong> fourth generation networks, the mobile phones have<br />

become more powerful, have enhanced their capabilities <strong>and</strong> have attracted several<br />

entrepreneurs, operators, major corporations <strong>and</strong> media. <strong>The</strong> development <strong>of</strong> mobile<br />

h<strong>and</strong>sets, s<strong>of</strong>tware <strong>and</strong> networks has opened several market opportunities, endured by<br />

the evolution <strong>of</strong> mobile phone technologies, in terms <strong>of</strong> performance <strong>and</strong><br />

miniaturization. <strong>The</strong>refore, the Global Mobile H<strong>and</strong>set Market is worth USD$172.2<br />

billion in terms <strong>of</strong> revenues <strong>and</strong> the global mobile phone vendors shipped 1,39 billion<br />

units on a cumulative worldwide basis in 2010, compared to the 1,17 billion units<br />

shipped in 2009.<br />

At the same time, the worldwide mobile device sales totaled 1,6 billion units in 2010,<br />

which represents a 31.8% increase from 2009 (Figure 1).<br />

Company 2010 Units<br />

2010<br />

Market<br />

Share (%) 2009 Units<br />

2009<br />

Share (%)<br />

<strong>Nokia</strong> 461,318.2 28.9 440,881.6 36.4<br />

Samsung 281,065.8 17.6 235,772.0 19.5<br />

LG Electronics 114,154.6 7.1 121,972.1 10.1<br />

Research In<br />

Motion 47,451.6 3.0 34,346.6 2.8<br />

Apple 46,598.3 2.9 24,889.7 2.1<br />

Sony Ericsson 41,819.2 2.6 54,956.6 4.5<br />

Motorola 38,553.7 2.4 58,475.2 4.8<br />

ZTE 28,768.7 1.8 16,026.1 1.3<br />

HTC 24,688.4 1.5 10,811.9 0.9<br />

Huawei 23,814.7 1.5 13,490.6 1.1<br />

Others 488,569.3 30.6 199,617.2 16.5<br />

Total 1,596,802.4 100.0 1,211,239.6 100.0<br />

source: Gartner (February 2011)<br />

Figure 1: Worldwide Mobile device sales to end-users in 2010 (Thous<strong>and</strong>s <strong>of</strong> Units)<br />

Nevertheless, the current unstable macroeconomic environment must be taken into<br />

account in future projections <strong>and</strong> forecasts. In fact, the global financial crisis affects the<br />

mobile industry through three ways: a weaker consumer confidence, credit shortage <strong>and</strong><br />

currency volatility, mainly for global companies. As a result, operators are nowadays,<br />

turning to new services in order to increase pr<strong>of</strong>itability, h<strong>and</strong>set makers still rely on<br />

s<strong>of</strong>tware <strong>and</strong> content rather than equipment for product differentiation which will drive<br />

sales <strong>of</strong> new products, <strong>and</strong> the end-users role consists <strong>of</strong> leading this transition through<br />

innovation. Additionally, the impact <strong>of</strong> such unsettled environment is still reasonable<br />

<strong>and</strong> moderate given the essentiality <strong>of</strong> devices for consumers. According to<br />

International Telecommunication Union, there were 5.3 billion mobile phone<br />

subscribers by the end <strong>of</strong> 2010 (Figure 2).<br />

Subscribers (millions)<br />

3000<br />

2500<br />

2000<br />

1500<br />

1000<br />

500<br />

0<br />

333 282<br />

2649<br />

Figure 2: Mobile Subscriptions by Region in 2010<br />

Regarding to the mobile phone main segments, the wireless h<strong>and</strong>sets may be grouped<br />

into three general categories: basic phones, feature phones <strong>and</strong> smartphones. Basic<br />

phones are usually the lowest priced, <strong>and</strong> <strong>of</strong>fer essentially voice <strong>and</strong> texting<br />

functionality. For instance, <strong>Nokia</strong>’s 2630 model or even Motorola’s RAZR phones were<br />

successful basic phones on the past. Feature phones are characterized by at least, one<br />

outst<strong>and</strong>ing feature: a high-quality camera or even a mobile music player. LG’s<br />

Chocolate phones are popular feature phones in the market. Lately, the smartphones<br />

364<br />

741<br />

Africa Arab Asia & Pacific CIS Europe <strong>The</strong> Americas<br />

880<br />

widen the range <strong>of</strong> a mobile phone’s functionality beyond voice, texting, music, videos,<br />

emails, pictures <strong>and</strong> internet access.<br />

Indeed, the latest generation <strong>of</strong> smartphones may be equipped with several gigabytes <strong>of</strong><br />

memory (memory cards), GPS (Global Positioning System), touchscreen interfaces. An<br />

illustrative model is the Apple’s iPhone <strong>and</strong> the Research in Motion Blackberry’s<br />

portfolio. Furthermore, smartphones are becoming a viable alternative to the feature<br />

phones, PDA’s <strong>and</strong> even laptops due to a plenty <strong>of</strong> factors: the lower product cost <strong>and</strong><br />

improved h<strong>and</strong>set design <strong>and</strong> functionalities, the global mobile email <strong>and</strong> browsing<br />

services boom, the emergence <strong>and</strong> need <strong>of</strong> 3G <strong>and</strong> 4G technologies, the increasing<br />

competition among mobile manufacturers <strong>and</strong> operators, <strong>and</strong> the st<strong>and</strong>ardization <strong>and</strong><br />

constant upgrades <strong>of</strong> operating systems as well. In fact, global smartphones market<br />

accounted for USD$85.1 billion in 2010, which represents 22% <strong>of</strong> the global mobile<br />

h<strong>and</strong>set sales. Hence, it was one <strong>of</strong> the few markets which remained stable during the<br />

financial recession, with an annual growth rate <strong>of</strong> 29.5% in 2009 over 2008<br />

(USD$53.488 billion <strong>and</strong> USD$41.303 billion, respectively) <strong>and</strong> 59.3% in 2010 over<br />

2009. Additionally, the global smartphones market may be also classified into two<br />

subgroups: consumer smartphones, which is the larger <strong>and</strong> fastest-growing market <strong>and</strong><br />

business smartphones, which is expected to be the prevailing segment in the future,<br />

mainly due to the increasing traction <strong>of</strong> mobility between companies.<br />

Indeed, smartphones are today, the most pr<strong>of</strong>itable segment <strong>of</strong> the global wireless<br />

h<strong>and</strong>set market, with a wide leeway in terms <strong>of</strong> technical upgrades. For this reason, it is<br />

crucial to approach this lucrative <strong>and</strong> fastest-growing segment <strong>of</strong> the mobile market. On<br />

the past, the high cost <strong>and</strong> limited scope <strong>of</strong> smartphone services limited such devices to<br />

business users, essentially. Notwithst<strong>and</strong>ing, recent developments – flat-rate charges for<br />

data plans, faster networks, improved user interfaces, 3D technology <strong>and</strong> new forms <strong>of</strong><br />

payments – are helping to boost the adoption by consumers.<br />

Figure 3: Top 5 Mobile smartphone manufacturers, by 2010 global sales<br />

In Figure 3, we can easily claim that smartphones market is consolidated with the three<br />

main players – <strong>Nokia</strong>, RIM <strong>and</strong> Apple – holding more than 2/3 rd <strong>of</strong> the global market.<br />

In other h<strong>and</strong>, the operating system is one <strong>of</strong> the most essential considerations for the<br />

selection <strong>of</strong> a specific smartphone device (Figure 4). In advance, there are specific<br />

companies which are merely specialized in Operating Systems, like Micros<strong>of</strong>t<br />

(Windows Phone) <strong>and</strong> Google (Android).<br />

2010 Market Share<br />

2009 Market Share<br />

Company (OS) 2010 Units (%) 2009 Units (%)<br />

<strong>Nokia</strong> (Symbian) 111,576.7 37.6 80,878.3 46.9<br />

Google (Android) 67,224.5 22.7 6,798.4 3.9<br />

Research In Motion (Blackberry) 47,451.6 16.0 34,346.6 19.9<br />

Apple (iPhone OS) 46,598.3 15.7 24,889.7 14.4<br />

Micros<strong>of</strong>t (Windows Phone/Mobile) 12,378.2 4.2 15,031.0 8.7<br />

Other OS 11417.4 3.8 10432.1 6.1<br />

Total<br />

296,646.6 100.0 172,376.1 100.0<br />

Figure 4: Worldwide Smartphone sales to end-users by Operating System in 2010<br />

(Thous<strong>and</strong>s <strong>of</strong> Units)<br />

Some notes related to the future projections shall be highlighted: taking into account the<br />

the <strong>Nokia</strong>’s decision to dump its principal smartphone OS in favor <strong>of</strong> Micros<strong>of</strong>t’s<br />

Windows phone, the Symbian OS may decrease in the next years; Android platform<br />

should keep its growth in the following years due to the popular royalty-free business<br />

model.<br />

7,10%<br />

Smartphones: Global market share, 2010<br />

<strong>Nokia</strong> RIM Apple Samsung HTC Others<br />

7,60%<br />

20,30%<br />

15,70%<br />

33,10%<br />

16,10%<br />

After this brief introduction to the smartphones segment, conversely the fixed-line<br />

services are in declined as a result <strong>of</strong> improvements in the quality <strong>of</strong> wireless networks,<br />

<strong>and</strong> the unlimited calling plans for the mobile h<strong>and</strong>set users.<br />

Meanwhile, the Global mobile h<strong>and</strong>set industry is dominated by five main players:<br />

<strong>Nokia</strong>, Samsung, LG Electronics, Apple <strong>and</strong> ZTE in the first quarter <strong>of</strong> 2011 (Figure 5).<br />

Surprisingly, RIM has been knocked out from the top-five ranking on mobile phone<br />

market share compared to previous years.<br />

40,00%<br />

35,00%<br />

30,00%<br />

25,00%<br />

20,00%<br />

15,00%<br />

10,00%<br />

5,00%<br />

0,00%<br />

Figure 5: Top five mobile phone manufacturers market-share<br />

Moreover, in terms <strong>of</strong> revenues, Apple has recently become the largest wireless h<strong>and</strong>set<br />

seller in the same period (Q1 2011), overtaking <strong>Nokia</strong> <strong>and</strong> achieving the pole position in<br />

h<strong>and</strong>set, smartphone <strong>and</strong> tablets revenues, mainly due to the higher Average Selling<br />

Price (Figure 6).<br />

<strong>Nokia</strong> Samsung LG Apple ZTE Others<br />

source: IDC Worldwide Mobile Phone Tracker (April, 2011)<br />

Apple<br />

Q1/10<br />

<strong>Nokia</strong><br />

Q1/11<br />

Shipments (millions <strong>of</strong> units) 8,8 107,8 18,6 108,5<br />

Wholesale ASP (USD$) $606 $83 $638 $87<br />

Revenues (USD$ billions) $5,3 $8,9 $11,9 $9,4<br />

source: Strategy Analytics (April, 2011)<br />

Figure 6: Apple <strong>and</strong> <strong>Nokia</strong> annual revenues (2010-2011)<br />

Q1/2010<br />

Q1/2011<br />

Additionally, the mobile sales have grown constantly over the last 6 years, despite a<br />

little decrease at the end <strong>of</strong> 2009 registering at 14.4% CAGR 2005-2010 (Figure 7).<br />

Figure 7: Worldwide mobile phone sales growth (in millions)<br />

Indeed in 2010, the global market sales increased 31.8% from 2009, a sales growth rate<br />

not even seen in 2006, principally because <strong>of</strong> the sales growth on the smartphone<br />

segment.<br />

Global H<strong>and</strong>set sales<br />

1800<br />

1600<br />

1400<br />

1200<br />

800<br />

2005 2006 2007 2008 2009 2010 2011/1Q<br />

Regarding to the mobile network operators, as the mobile phone manufacturers, the<br />

leading firms are predominantly American, European <strong>and</strong> Asian headquartered<br />

companies, which is positive in terms <strong>of</strong> regional competitiveness (Figure 8).<br />

Operator Group Revenues (USD$ Million) Ranking<br />

China Mobile 17,715 1<br />

Vodafone Group 14,561 2<br />

Verizon Wireless 14,046 3<br />

AT & T 13,186 4<br />

NTT DOCOMO Group 11,829 5<br />

Deutsche Telekom Group 10,423 6<br />

Telefonica Group 8,851 7<br />

America Movil Group 6,95 8<br />

source: Wireless Intelligence<br />

Figure 8: Worldwide operator revenue ranking 2010<br />

Concerning to the production process for mobile phones <strong>and</strong> respective supply chain,<br />

while the later is more global, the production model is essentially concentrated in Asia<br />

<strong>and</strong> Latin America, <strong>and</strong> to a smaller extent Eastern Europe. Conversely, the major<br />

regions for penetration <strong>of</strong> mobile phones (3G h<strong>and</strong>sets) are those where the production<br />

model is not present (Figure 9). In addition, the outsourcing services are also increasing<br />

due to the entrance <strong>of</strong> low-cost-focused new companies, such as the chinese Huawei<br />

into the industry, <strong>and</strong> the growing commoditization <strong>of</strong> wireless h<strong>and</strong>sets.<br />

Top Regions for penetration <strong>of</strong> 3G mobile phones<br />

Western Europe North America<br />

Eastern Europe AsiaPac(without Japan)<br />

Japan Middle East & Africa<br />

47%<br />

4% 2%<br />

Figure 9: 3G mobile phone penetration rate by region (Morgan Stanley, 2009)<br />

In turn, the worldwide mobile industry is regulated by specific <strong>and</strong> national bodies<br />

which control the telecommunications systems <strong>and</strong> seek for consumer rights <strong>and</strong><br />

privacy issues protection, together with the respective national government <strong>and</strong><br />

ministries. Referring only few entities, for instance in Japan <strong>and</strong> Finl<strong>and</strong>, it is the<br />

respective Ministry <strong>of</strong> Communications (MIC <strong>and</strong> LVM, respectively) who regulates<br />

the wireless h<strong>and</strong>set market in agreement with National communications Regulatory<br />

Authority (FICORA, in Finl<strong>and</strong>). In USA, for instance, the Federal Communications<br />

Commission (rulemaker) together with Federal Trade Commission are the entities<br />

responsible for its regulation. Furthermore, the institution that represents the global<br />

mobile operators, its interests <strong>and</strong> competitive issues is GSM Association. In terms <strong>of</strong><br />

marketing practices, wireless h<strong>and</strong>set industry has powerful self-regulatory bodies, as<br />

Mobile Marketing Association, which provides guides on mobile marketing campaigns,<br />

<strong>and</strong> finally the CTIA, an organization that represents the wireless communications<br />

industry, striving for the protection <strong>and</strong> privacy <strong>of</strong> consumers’ mobile phone billing data<br />

<strong>and</strong> history (as collection <strong>of</strong> personal data via websites <strong>and</strong> online advertisements).<br />

3.1.1. Current Market Trend – “<strong>The</strong> emergence <strong>of</strong> the tablets”<br />

<strong>The</strong> recent commotion in the global technology industry called, tablet has been<br />

attracting several companies during the past year <strong>of</strong> 2010. A tablet, more <strong>and</strong> less<br />

20%<br />

3%<br />

19%<br />

5%<br />

positioned between a laptop <strong>and</strong> a smartphone, consists <strong>of</strong> a personal computer with a<br />

large touchscreen, being operated by a finger, a pen or even a stylus. Indeed, in 2001 the<br />

term “tablet” was already disclosed by Micros<strong>of</strong>t who had created the first prototype <strong>of</strong><br />

a tablet, despite its unpopularity among consumers due to some application flaws <strong>and</strong><br />

slow OS. However <strong>and</strong> at the beginning <strong>of</strong> last year, the Apple’s launch <strong>of</strong> the iPad has<br />

boosted the tablet market. In fact, the increasing excitement <strong>and</strong> awareness for mobile<br />

internet devices combined with the portability <strong>and</strong> comfort <strong>of</strong> such gadgets <strong>and</strong> its<br />

entertainment capabilities, has helped to drive this growth. For this reason, some mobile<br />

industry players are planning to launch their own tablets in 2010. Moreover, mobile<br />

operators are also exp<strong>and</strong>ing into the tablet segment, as well as, the Media industry who<br />

foresees a potential for growth concerning to digital versions <strong>of</strong> newspapers, magazines<br />

<strong>and</strong> books.<br />

Despite that, some concerns still prevent its potential success, specifically the low<br />

awareness generated among consumers, the lack <strong>of</strong> online content stores in order to get<br />

access to electronic books, music, games <strong>and</strong> other contents, <strong>and</strong> the absence <strong>of</strong> a<br />

keyboard (mainly for e-mails <strong>and</strong> spreadsheets) <strong>and</strong> a reduced battery life which may<br />

affect the tablet performance (take-<strong>of</strong>f applications).<br />

3.1.2. Technology market growth opportunities in Asian economies<br />

Regardless <strong>of</strong> the major financial recession effects, namely in terms <strong>of</strong> credit, currency<br />

volatility <strong>and</strong> customer reliance, the mobile phone manufacturers are seeing a<br />

tremendous growth opportunity in specific Asian nations, such as China, India <strong>and</strong><br />

Singapore, becoming a way to the future economic recovery. Further, Asian market<br />

presents today the highest number <strong>of</strong> mobile subscriptions, <strong>and</strong> several Asian mobile<br />

manufacturers <strong>and</strong> operators, such as ZTE, HTC, Samsung, China Mobile, NTT<br />

Docomo Group, are gaining ground in the wireless h<strong>and</strong>set market. Indeed, the world’s<br />

most populous nations have the largest mobile subscriptions, where China <strong>and</strong> India<br />

lead. Additionally, there are more mobile internet users in China than in any other<br />

country.<br />

<strong>The</strong>refore, Asian markets <strong>of</strong>fer significant opportunities to European <strong>and</strong> American<br />

technology firms <strong>and</strong> respective investors, in the hardware, s<strong>of</strong>tware, IT services, R&D<br />

facilities <strong>and</strong> retail outlets. Aspects like increasing available income, demographic<br />

elements, government stimulating incentives <strong>and</strong> tax breaks, <strong>and</strong> a growth in dem<strong>and</strong>,<br />

are likely to represent crucial growth drivers. Nevertheless, firms shall also take into<br />

account some political instability <strong>and</strong> security concerns, as main threats.<br />

Mobile phone manufacturers, in order to compete with local players, are producing<br />

customized h<strong>and</strong>sets <strong>and</strong> services for this specific region. At the same time, they are<br />

also creating partnerships <strong>and</strong> agreements with resident firms to get easier access to the<br />

business <strong>and</strong> marketing channels, due to certain constraints imposed by government<br />

regulations. If for one part mobile phone manufacturers reduce their costs <strong>and</strong> increase<br />

the h<strong>and</strong>sets’ performance, on the other h<strong>and</strong>, Asian companies will be looking at ways<br />

to compete with their European <strong>and</strong> American counterparts.<br />

3.2 Micros<strong>of</strong>t Corporation<br />

Micros<strong>of</strong>t is an American public multinational corporation engaged in developing,<br />

manufacturing, licensing <strong>and</strong> supporting a range <strong>of</strong> s<strong>of</strong>tware products, services <strong>and</strong><br />

solutions for distinct types <strong>of</strong> computing devices able to deliver new opportunities,<br />

suitability <strong>and</strong> increased value to customers. It was created in 1975 in order to allow<br />

people <strong>and</strong> businesses around the world to realize their full potential by creating<br />

technology which changes the way people communicate, work <strong>and</strong> even play, as MS-<br />

DOS <strong>and</strong> the followed Micros<strong>of</strong>t Windows line <strong>of</strong> operating systems. Indeed, to suit the<br />

needs <strong>of</strong> consumers <strong>and</strong> to enhance the quality <strong>of</strong> products, Micros<strong>of</strong>t localizes their<br />

products in order to reflect local languages <strong>and</strong> customs, which implies modifying the<br />

user interface <strong>and</strong> translating text. Thus, Micros<strong>of</strong>t owns today 3 main operating<br />

centers: Irel<strong>and</strong> responsible by the European, Middle Eastern <strong>and</strong> African regions;<br />

Singapore responsible by the Japanese, Chinese <strong>and</strong> Asia-Pacific regions; finally, the<br />

American centers such as, North Dakota, Florida, Puerto Rico, Redmond (where<br />

company is headquartered), Washington, Nevada responsible by the Latin <strong>and</strong> North<br />

America regions. Furthermore, the s<strong>of</strong>tware products, services <strong>and</strong> solutions comprise<br />

operating systems for personal computers, servers <strong>and</strong> intelligent devices; server<br />

applications for distributed computing environments; information worker productivity<br />

applications; business solutions applications; s<strong>of</strong>tware development tools; video games;<br />

<strong>and</strong> high performance computing applications. Moreover, Micros<strong>of</strong>t also certifies <strong>and</strong><br />

trains computer system developers <strong>and</strong> integrators, design <strong>and</strong> commercialize hardware<br />

(as Xbox 360 console, Zune digital music device, Micros<strong>of</strong>t personal computer<br />

hardware products) <strong>and</strong> <strong>of</strong>fers<br />

“suites” <strong>of</strong> products <strong>and</strong> services<br />

as, eCAL suite ( enterprise client<br />

access license) which permits<br />

access to Micros<strong>of</strong>t server<br />

s<strong>of</strong>tware products. <strong>The</strong>reby,<br />

Micros<strong>of</strong>t’ performance is the<br />

mirror <strong>of</strong> its diversified product<br />

<strong>and</strong> services portfolio (Figure<br />

10). Figure 10: Micros<strong>of</strong>t Corporation Performance<br />

In addition, Micros<strong>of</strong>t operates in five main segments: Windows & Windows Live<br />

Division (8.98% CAGR 2006-2010 <strong>of</strong> revenues), Server <strong>and</strong> Tools (11.36% CAGR<br />

2006-2010), Online Services Division ((1.07%) CAGR 2006-2010), Micros<strong>of</strong>t Business<br />

Division (6.55% CAGR 2006-2010), <strong>and</strong> Entertainment <strong>and</strong> Devices Division (14.23%<br />

CAGR 2006-2010). According to financial data from the previous five years, the<br />

revenues have been increasing year-over-year despite from 2008 to 2009 they decreased<br />

about 6% due to economic slowdown, weaker consumer <strong>and</strong> corporate spending,<br />

constrained credit<br />

availability <strong>and</strong><br />

currency volatility. A<br />

SWOT analysis is<br />

provided in Appendix<br />

1, highlighting the<br />

major Micros<strong>of</strong>t’s<br />

internal <strong>and</strong> external<br />

factors.<br />

70000<br />

60000<br />

50000<br />

40000<br />

30000<br />

20000<br />

10000<br />

Figure 11: Micros<strong>of</strong>t segment product Revenue<br />

Million dollars<br />

25000<br />

15000<br />

5000<br />

19170<br />

12600<br />

21540<br />

14070<br />

25870<br />

17681<br />

22380<br />

14569<br />

27840<br />

18760<br />

2006 2007 2008 2009 2010<br />

EBITDA<br />

Entertainment <strong>and</strong><br />

Devices Division<br />

Micros<strong>of</strong>t Business<br />

Division<br />

Net Income<br />

Online Services Division<br />

Server <strong>and</strong> Tools<br />

Windows & Windows Live<br />

Micros<strong>of</strong>t also researches <strong>and</strong> develops<br />

advanced technologies for future<br />

s<strong>of</strong>tware products <strong>and</strong> services,<br />

representing this expense in average,<br />

15% <strong>of</strong> revenues in each annual<br />

operating expenses (Figure 12). In fact,<br />

this ongoing innovation conducted by<br />

Micros<strong>of</strong>t, highlighting the importance<br />

<strong>of</strong> product excellence, business efficacy<br />

<strong>and</strong> delivering value to customers is the<br />

best way to meet consumers’ needs <strong>and</strong><br />

the company’s future growth. Figure 12: Micros<strong>of</strong>t Operating Expenses - 2010<br />

For this reason <strong>and</strong> on the last years, Micros<strong>of</strong>t’s ability to begin <strong>and</strong> foster technology<br />

trends has been focusing on areas such as: cloud computing, natural user interfaces <strong>and</strong><br />

intelligent computing. For instance, cloud-based computing (such as, Micros<strong>of</strong>t Office<br />

Web Apps., Windows Azure, Windows Live Messenger) is becoming a great<br />

opportunity whose involves providing s<strong>of</strong>tware, services <strong>and</strong> contents over the internet<br />

by way <strong>of</strong> shared computing resources located in specific centralized data centers.<br />

<strong>The</strong>refore, consumers <strong>and</strong> companies access these resources from a wide range <strong>of</strong><br />

devices as smartphones. Additionally, Micros<strong>of</strong>t employees nowadays almost 89000<br />

people, 60% in the USA <strong>and</strong> 40% internationally.<br />

Regarding the ownership policy structure, Micros<strong>of</strong>t Corp. executive <strong>of</strong>ficers <strong>and</strong> other<br />

executives should keep a specific material personal financial stake in order to promote a<br />

long-term perspective <strong>and</strong> to align the shareholder <strong>and</strong> executive interests. At the same<br />

time, the ownership is largely shared by 6493 owners: including 18 direct owners,<br />

namely Bill Gates (founder <strong>and</strong> current chairman), Steve Balmer (CEO) or Stephen<br />

Elop (previous head <strong>of</strong> the Micros<strong>of</strong>t Business Division <strong>and</strong> current <strong>Nokia</strong>’s CEO),<br />

2320 Institutional holders <strong>and</strong> 4155 Mutual Fund holders (see Appendix 2). Further,<br />

Micros<strong>of</strong>t Corp. market capitalization is approximately $223.15 billion dollars. Finally,<br />

as Micros<strong>of</strong>t owns a considerable amount <strong>of</strong> convertibles <strong>and</strong> stock options, the more<br />

accurate information about the firm’s real earning power is the diluted EPS which was<br />

USD $2.10 at the end <strong>of</strong> 2010.<br />

4004 59<br />

13214<br />

12395<br />

8714<br />

Cost <strong>of</strong><br />

Revenue<br />

R&D<br />

Sales <strong>and</strong><br />

Marketing<br />

General &<br />

Administrativ<br />

e<br />

Employee<br />

Severance<br />

Moreover, as a way to diversify the company’s portfolio <strong>and</strong> to penetrate into the tablet<br />

<strong>and</strong> smartphone segments, during the last three years, Micros<strong>of</strong>t acquired several<br />

companies, all <strong>of</strong> which paid in cash which demonstrates the firm’s confidence <strong>and</strong> the<br />

ability to get the entire amount <strong>of</strong> the post-acquisition synergy benefits. Consequently, a<br />

Micros<strong>of</strong>t takeover attempt <strong>of</strong> <strong>Nokia</strong> may reflect once again, eagerness to diversify its<br />

range <strong>of</strong> products <strong>and</strong> services <strong>and</strong> refine its weaknesses on the increasing mobile<br />

h<strong>and</strong>set segment where its presence is still unclear <strong>and</strong> null.<br />

3.2.1. Windows <strong>and</strong> Windows Live Division<br />

<strong>The</strong> Windows Division (WD) is responsible for development <strong>and</strong> marketing <strong>of</strong> the<br />

Windows operating system <strong>and</strong> related s<strong>of</strong>tware <strong>and</strong> online services, as Windows Live<br />

<strong>and</strong> Internet Explorer. In turn, the revenue growth <strong>of</strong> this segment is mainly correlated<br />

to the growth <strong>of</strong> the PC market worldwide. Indeed, 75% <strong>of</strong> the total division revenues<br />

come from the pre-installed version <strong>of</strong> the Windows OS bought by the original<br />

equipment manufacturers (Figure 13).<br />

13% 12%<br />

OEM<br />

Figure 13: Windows Division’s breakdown <strong>of</strong> Revenue (2010)<br />

It is crucial to highlight that OEM revenues are impacted by: changes in the hardware<br />

market due to the impact <strong>of</strong> lower cost PC’s <strong>and</strong> shifts between emerging markets <strong>and</strong><br />

developed markets; pricing changes <strong>and</strong> special promotions; <strong>and</strong> changes in the<br />

inventory levels within the OEM channel <strong>and</strong> the attachment <strong>of</strong> Windows to PC’s<br />

shipped. Further, Windows Division <strong>of</strong>fers several products <strong>and</strong> services, such as:<br />

75%<br />

Commercial & Retail Sales <strong>of</strong> Windows<br />

Online Advertising from Windows Live<br />

Windows OS which includes Windows 7 (Home Basic, Home Premium, Pr<strong>of</strong>essional,<br />

Enterprise, Starter Edition <strong>and</strong> Ultimate), Windows Vista (same versions as Windows<br />

7), Windows XP Home <strong>and</strong> Windows Live range <strong>of</strong> applications <strong>and</strong> web services.<br />

An important aspect regarding<br />

each segment is the competition<br />

matter. <strong>The</strong> Windows OS faces<br />

contention from Apple, Google<br />

<strong>and</strong> the Linux OS. <strong>The</strong> latter is<br />

an OS available without any<br />

payment under a General Public<br />

License. Figure 14: PC Operating System Market<br />

At the same time, the Windows OS also faces competition from different platforms <strong>and</strong><br />

new devices as tablets <strong>and</strong> smartphones, which may reduce the dem<strong>and</strong> <strong>and</strong> growth for<br />

PC’s. In fact, these competitors referred above, also <strong>of</strong>fer s<strong>of</strong>tware that competes with<br />

web browsing capabilities <strong>of</strong> Internet Explorer. Concerning to the Windows Live<br />

s<strong>of</strong>tware which generates revenue mainly from online advertising, it competes directly<br />

with Google, Yahoo! <strong>and</strong> a set <strong>of</strong> websites <strong>and</strong> portals providing <strong>and</strong> sharing tools <strong>and</strong><br />

services.<br />

Despite Windows 7 is the fastest selling OS in history, indeed the PC units’ growth will<br />

tend to slow in the future due to the proliferation <strong>of</strong> smartphones <strong>and</strong> the tablet<br />

cannibalization <strong>of</strong> PC’s. As a result, this merger attempt with <strong>Nokia</strong> <strong>and</strong> the Windows 8<br />

announcement in 2012 are two important steps in order to fill these gaps.<br />

3.2.2. Server <strong>and</strong> Tools<br />

3,65%<br />

10,22%<br />

1,30% 1,23% 5,15%<br />

25,11%<br />

53,18%<br />

Windows XP Windows 7 Windows Vista<br />

Mac OS X 10.6 Mac OS X 10.5 iPhone<br />

Other<br />

<strong>The</strong> Server <strong>and</strong> Tools (S&T) segment is responsible for development <strong>and</strong> marketing <strong>of</strong><br />

server s<strong>of</strong>tware, s<strong>of</strong>tware developer tools <strong>and</strong> related services <strong>and</strong> tools that allow IT<br />

pr<strong>of</strong>essional <strong>and</strong> their systems to become more effective <strong>and</strong> productive. Server<br />

s<strong>of</strong>tware is designed to support the Windows Server OS applications <strong>and</strong> includes<br />

server platform, database, storage, security <strong>and</strong> identity s<strong>of</strong>tware, management <strong>and</strong><br />

operations, <strong>and</strong> service-oriented architecture platform. Moreover, these <strong>of</strong>ferings can be<br />

operated on-site or in a partner-hosted <strong>and</strong> Micros<strong>of</strong>t-hosted environment. Additionally,<br />

this segment also <strong>of</strong>fers an extent <strong>of</strong> enterprise consulting <strong>and</strong> product support services,<br />

called Enterprise Services; <strong>and</strong> finally, it provides training <strong>and</strong> certification to<br />

developers <strong>and</strong> IT pr<strong>of</strong>essionals for the remainder segments. Besides in this segment,<br />

half <strong>of</strong> revenues come from annual volume licensing agreements (Figure 15).<br />

Figure 15: Server <strong>and</strong> Tools Division’s breakdown <strong>of</strong> Revenues<br />

<strong>The</strong>reupon, Server <strong>and</strong> Tools division <strong>of</strong>fers a sort <strong>of</strong> products <strong>and</strong> services: Windows<br />

Server OS, Windows Azure, Micros<strong>of</strong>t SQL Server, SQL Azure, Visual Studio,<br />

Silverlight, Biz Talk Server, Micros<strong>of</strong>t Consulting Services, System Center products<br />

<strong>and</strong> other product support services.<br />

Once again, competition in this segment comes from a wide array <strong>of</strong> server OS <strong>and</strong><br />

server applications <strong>of</strong>fered by several firms as Hewlett-Packard, IBM or Oracle (Figure<br />

16).<strong>The</strong>se manufacturers <strong>of</strong>fer their own version <strong>of</strong> the Unix OS preinstalled on the<br />

server hardware. Indeed, almost all manufacturers <strong>of</strong>fer server hardware for the Linux<br />

OS <strong>and</strong> many contribute to Linux OS development, which benefited Linux’s<br />

competitive position in the market. In addition, several commercial s<strong>of</strong>tware sellers<br />

<strong>of</strong>fer competing s<strong>of</strong>tware applications for connectivity, security, hosting, database, <strong>and</strong><br />

e-business servers. For instance, s<strong>of</strong>tware developer products compete against Adobe,<br />

IBM, Oracle <strong>and</strong> open-source projects, while Windows Azure faces competition from<br />

Google <strong>and</strong> VMWare.<br />

30%<br />

50%<br />

Annual volume Licensing Agreements<br />

Transactional volume licensing programs, retail product,<br />

OEM's licenses<br />

Enterprise Services<br />

1,30% 3,65%<br />

. Figure 16: Worldwide Server Market<br />

Concerning to the future growth, in fact Server <strong>and</strong> Tools grew almost 11% on the first<br />

quarter 2011 compared to the first quarter 2010 due to a strong business adoption <strong>of</strong><br />

Windows Server OS, Micros<strong>of</strong>t SQL Server <strong>and</strong> System Center products. However, the<br />

server industry will face a threat from virtualization s<strong>of</strong>tware which implies an increase<br />

<strong>of</strong> the physical server utilization rates whose are only running at low utilization rates.<br />

Nevertheless, Windows Azure, the Micros<strong>of</strong>t’s public cloud platform is likely to<br />

become one <strong>of</strong> the more important public Cloud platforms in a near future.<br />

3.2.3. Online Services Division<br />

<strong>The</strong> Online Services Division (OSD) is responsible for development <strong>and</strong> marketing<br />

information <strong>and</strong> content which help people to simplify tasks, to make more informed<br />

decisions online <strong>and</strong> to provide more effective ways <strong>of</strong> connecting advertisers with<br />

audiences. In fact, online information suggestions as Bing, MSN portals <strong>and</strong> online<br />

advertising platforms benefit <strong>and</strong> attract advertisers because they provide access to<br />

targeted end-users in a huge traffic network.<br />

1,23% 5,15%<br />

Windows XP Windows 7<br />

Windows Vista Mac OS X 10.6<br />

Mac OS X 10.5 iPhone<br />

On the other h<strong>and</strong>, the majority <strong>of</strong> revenues in this segment come primarily from Online<br />

Advertising which includes search, display, <strong>and</strong> advertiser <strong>and</strong> publisher tools revenues.<br />

<strong>The</strong> remainder revenues consist <strong>of</strong> Access revenues which may be affected by price<br />

competition service providers <strong>and</strong> shifts to broadb<strong>and</strong>. In addition, at the end <strong>of</strong> 2009,<br />

Micros<strong>of</strong>t make a commercial agreement with Yahoo! in order to enhance the value <strong>and</strong><br />

efficiency <strong>of</strong> Micros<strong>of</strong>t’s search <strong>of</strong>fering, <strong>and</strong> to amplify the competitiveness <strong>of</strong> the<br />

advertising marketplace. <strong>The</strong>refore, Online Services Division <strong>of</strong>ferings comprise Bing,<br />

MSN, Micros<strong>of</strong>t adCenter, <strong>and</strong> Atlas online tools for advertisers <strong>and</strong> publishers.<br />

Consequently, in terms <strong>of</strong> competition, Online Services Division goes up against<br />

Google, Yahoo! <strong>and</strong> a variety <strong>of</strong><br />

websites <strong>and</strong> portals providing<br />

content <strong>and</strong> online services to<br />

the customers (Figure 17).<br />

Figure 17: Top 5 Online Ad<br />

Selling firms<br />

<strong>The</strong> main concern in this segment is the ability to provide advertising opportunities for<br />

the sellers toward a high<br />

linkage with end-users. For<br />

instance, Bing, the Micros<strong>of</strong>t’s<br />

main search engine by providing<br />

relevant search results <strong>and</strong> a<br />

large selection <strong>of</strong> content leads<br />

to better <strong>and</strong> well-structured<br />

decisions taken by users. Figure 18: Top 4 Search Providers<br />

Regarding the future growth, indeed Online Services Division increased 14% year-over-<br />

year as a result <strong>of</strong> a growth in Bing’s search revenues.<br />

3.2.4. Micros<strong>of</strong>t Business Division<br />

<strong>The</strong> Micros<strong>of</strong>t Business Division (MBD) is responsible for development <strong>and</strong> marketing<br />

<strong>of</strong> s<strong>of</strong>tware solutions <strong>and</strong> services through Micros<strong>of</strong>t Office System <strong>and</strong> Micros<strong>of</strong>t<br />

Dynamics business solutions towards a greater individual, team <strong>and</strong> organization<br />

productivity.<br />

14,37%<br />

9,85% 2,19%<br />

71,65%<br /><br />

Further, Micros<strong>of</strong>t Office System accounts almost 90% <strong>of</strong> total segment revenues<br />

through the ability to extend the product <strong>of</strong>ferings in other information areas as<br />

enterprise search, content management <strong>and</strong> business intelligence. <strong>The</strong> remaining<br />

percentage <strong>of</strong> revenues is generated by Micros<strong>of</strong>t Dynamics products, such as CRM<br />

(customer relationship management) solutions, Supply-Chain <strong>and</strong> financial management<br />

solutions <strong>and</strong> business solutions for small, mid-sized <strong>and</strong> large organizations.<br />

Simultaneously in terms <strong>of</strong> the nature <strong>of</strong> the end-user, 80% <strong>of</strong> these MBD revenues<br />

come from sales to businesses (volume licensing agreements), while 20% are generated<br />

from sales to consumers (retail packaged product sales <strong>and</strong> OEM). Hence, Micros<strong>of</strong>t<br />

Business Divisions <strong>of</strong>fers: Micros<strong>of</strong>t Office, Micros<strong>of</strong>t SharePoint, Micros<strong>of</strong>t<br />

Exchange, Micros<strong>of</strong>t Dynamics ERP <strong>and</strong> CRM, <strong>and</strong> Micros<strong>of</strong>t Office Web<br />

Applications. Moreover, Micros<strong>of</strong>t Office is today the highest Micros<strong>of</strong>t pr<strong>of</strong>it<br />

generator, which leads this segment to become the greatest revenue segment.<br />

Respecting to competition, Micros<strong>of</strong>t Office System competes with Adobe, Apple,<br />

Corel, Google, IBM, Novell, Oracle, Zoho <strong>and</strong> few local developers in Asia <strong>and</strong> Europe<br />

primarily. For instance, Apple distributes versions <strong>of</strong> its application s<strong>of</strong>tware products<br />

through its mobile devices. Additionally, the open-source application “”<br />

provides a free platform application which has been adapted by several s<strong>of</strong>tware sellers,<br />

as IBM, Oracle or Novell becoming an alternative to Micros<strong>of</strong>t Office system products.<br />

About Micros<strong>of</strong>t Dynamics products competition, it is important to highlight Infor, Sage<br />

<strong>and</strong> SAP.<br />

Concerning to the future, since the release <strong>of</strong> Micros<strong>of</strong>t Office 2010, it has become the<br />

fastest selling Office version in history so, the revenues will tend to increase despite the<br />

competition. In fact, on the first quarter <strong>of</strong> this 2011, revenues grew 21% year-over-<br />

year. Nevertheless, in order to follow a corporate strategy <strong>of</strong> flexibility, <strong>and</strong> diversified<br />

portfolio <strong>of</strong> services <strong>and</strong> s<strong>of</strong>tware solutions, in the future Micros<strong>of</strong>t should be able to<br />

incorporate <strong>and</strong> provide such s<strong>of</strong>tware solutions in tablet <strong>and</strong> smartphone devices.<br />

3.2.5. Entertainment <strong>and</strong> Devices Division<br />

<strong>The</strong> Entertainment <strong>and</strong> Devices Division (EDD) is responsible for development <strong>and</strong><br />

marketing <strong>of</strong> products <strong>and</strong> services designed to delight <strong>and</strong> connect consumers.<br />

<strong>The</strong>se products <strong>and</strong> services include: Xbox 360 platform which comprises Xbox 360<br />

console, games <strong>and</strong> accessories, Kinect for Xbox 360, Xbox Live services, PC s<strong>of</strong>tware<br />

games <strong>and</strong> online games, Mediaroom (Internet Protocol Television s<strong>of</strong>tware), Windows<br />

embedded device platforms, Windows Phone, the Zune digital music platform,<br />

applications for Apple’s Macintosh PC’s <strong>and</strong> Windows Automotive. Furthermore, EDD<br />

is also responsible for retail sales <strong>and</strong> marketing for the packaged versions <strong>of</strong> the<br />

Micros<strong>of</strong>t Office systems <strong>and</strong> the Windows OS. In terms <strong>of</strong> revenues, the largest<br />

percentage comes from the Xbox 360 platform <strong>and</strong> PC games, while the remainder<br />

comes primarily from Windows Phone <strong>and</strong> Zune.<br />

Regarding the competition, Entertainment <strong>and</strong> Devices businesses are normally highly<br />

competitive due to the rapid<br />

product life cycles, the<br />

development <strong>of</strong> new technologies<br />

<strong>and</strong> consequent release <strong>of</strong> new<br />

products, <strong>and</strong> essentially focus on<br />

price competition. <strong>The</strong>reby, the<br />

Xbox gaming console competes<br />

mainly with Nintendo <strong>and</strong> Sony<br />

consoles (figure 19). Figure 19: Game Console Market<br />

About Windows Phone, it competes directly with Apple, Google, Palm, Research in<br />

Motion <strong>and</strong> <strong>Nokia</strong>. Figure 20 shows the Windows Phone market-share in USA which<br />

tends to decrease, so a merger with <strong>Nokia</strong> incorporating the Windows Phone on the new<br />

devices would be good strategy for the future.<br />

Figure 20: U.S. Windows Phone Market-Share<br />

Zune competes generally with Apple, SanDisk <strong>and</strong> other manufacturers <strong>of</strong> digital music<br />

<strong>and</strong> entertainment devices.<br />

26,37%<br />

28,27%<br />

45,36%<br />

Nintendo Wii Xbox 260 Playstation 3<br />

Jan-10<br />

Feb-10<br />

Mar-10<br />

Apr-10<br />

May-10<br />

Jun-10<br />

Jul-10<br />

Aug-10<br />

Sep-10<br />

Oct-10<br />

Nov-10<br />

Dec-10<br />

Jan-11<br />

With regard to the future, this is a segment with a considerable scope for growth<br />

(14.23% CAGR 2006-2010 <strong>of</strong> revenues), principally Windows Phone <strong>and</strong> Xbox 360<br />

console. Indeed, according to the first quarter <strong>of</strong> 2011, revenues increased more than<br />

50% which means that this division is a growing segment led by Kinect <strong>and</strong> Windows<br />

Phone 7. Even though the latter does not generate as many queries as its competitors,<br />

being preferred mainly by old people who spend less time online, it represents a solid<br />

opportunity through this acquisition attempt with <strong>Nokia</strong> able to drive this division ahead<br />

<strong>of</strong> expectations.<br />

3.3. <strong>Nokia</strong> Corporation<br />

<strong>Nokia</strong> is a Finnish multinational communications corporation engaged in the production<br />

<strong>of</strong> mobile devices <strong>and</strong> in converging Internet <strong>and</strong> communications industries. Indeed,<br />

since its foundation in 1865, the main purpose <strong>of</strong> the company is still “to connect<br />

people”, creating innovation, differentiation <strong>and</strong> producing great <strong>and</strong> high quality<br />

mobile products at a high speed in order to reduce distance among people <strong>and</strong> to<br />

accelerate the firm’s pace <strong>of</strong> execution in a fast-growing <strong>and</strong> dynamic competitive<br />

environment. In fact, <strong>Nokia</strong> is today the largest mobile phone manufacturer in the<br />

world, <strong>and</strong> its br<strong>and</strong> name <strong>and</strong> strategy is known by a great number <strong>of</strong> people around the<br />

world. Additionally, <strong>Nokia</strong> owns production centers in several countries, such as:<br />

Finl<strong>and</strong>, Germany, Great Britain, Hungary, Romania, China, India, Mexico <strong>and</strong> South<br />

Korea.<br />

<strong>Nokia</strong>’s strategy has essentially been focusing on investing in new <strong>and</strong> disruptive<br />

technologies, as well as, in developing growth markets. In truth, <strong>Nokia</strong> had always a<br />

main goal which is to be ahead <strong>of</strong> the competitors on industry innovation evolution,<br />

creating consequently impact <strong>and</strong> br<strong>and</strong> image <strong>of</strong> success <strong>and</strong> pioneering. At the same<br />

time, providing compelling <strong>and</strong> localized mobile products <strong>and</strong> services, renewing its<br />

products portfolio <strong>and</strong> investing in the future, namely to the emerging markets as China<br />

<strong>and</strong> India, <strong>Nokia</strong> manages to keep its sales volume <strong>and</strong> leadership in the markets.<br />

Meanwhile, the emergence <strong>of</strong> smartphones <strong>and</strong> tablets challenged the <strong>Nokia</strong>’s<br />

leadership <strong>and</strong> its structure.<br />

For this reason, a merger with Micros<strong>of</strong>t may represent a decisive <strong>and</strong> fundamental<br />

change <strong>of</strong> strategy, bringing together complementary assets <strong>and</strong> technical skills able to<br />

provide a sustainable differentiated mobile force against the two main powerful<br />

ecosystems: Apple <strong>and</strong> Google. On the other h<strong>and</strong>, the new Executive Board led by<br />

Stephen Elop (ex President <strong>of</strong> Micros<strong>of</strong>t Business Division) <strong>and</strong> focus on results <strong>and</strong><br />

accountability can be viewed as an essential component to this merger towards a new<br />

governance model <strong>and</strong> operational strategy (a SWOT analysis is provided in Appendix<br />

3). In turn, <strong>Nokia</strong> products <strong>and</strong> services comprise: mobile devices for every mobile<br />

industry segment <strong>and</strong> protocol as GSM (Global System for Mobile Communications)<br />

<strong>and</strong> CDMA (Code division multiple access); internet services like games, music, maps,<br />

media, applications <strong>and</strong> messaging through the “Ovi platform” which can be accessed<br />

from a mobile device, computer<br />

or even via webpage; <strong>and</strong><br />

finally, digital map information<br />

<strong>and</strong> navigation services.<br />

<strong>The</strong>refore, <strong>Nokia</strong>’s performance<br />

is the mirror <strong>of</strong> its range <strong>of</strong><br />

products <strong>and</strong> services, <strong>and</strong> the<br />

constrained economic<br />

environment, besides the limited<br />

credit availability <strong>and</strong> currency<br />

volatility (Figure 21). Figure 21: <strong>Nokia</strong> Corporation Performance<br />

In addition, <strong>Nokia</strong> is organized into three operating segments: Devices & Services<br />

((3.56% CAGR 2006-2010 <strong>of</strong> revenues), NAVTEQ, acquired in 2007 (66.6% CAGR<br />

2008-2010) <strong>and</strong> <strong>Nokia</strong> Siemens Network (14.16% CAGR 2006-2010). According to the<br />

income statements from the previous<br />

five years, in general the total<br />

revenues have been increasing year-<br />

over-year until 2008. After that,<br />

<strong>Nokia</strong>’s pr<strong>of</strong>itability was negatively<br />

impacted by a deteriorated economic<br />

context beyond the factors referred<br />

MIllion dollars<br />

14000<br />

12000<br />

8000<br />

6000<br />

4000<br />

8743,41<br />

6071,46<br />

12956,49<br />

10159,05<br />

9290,49<br />

5623,08<br />

4203,21<br />

1256,31<br />

5415,81<br />

above. Figure 22: <strong>Nokia</strong> segment product Revenue<br />

80000<br />

2608,5<br />

<strong>Nokia</strong> Siemens<br />

Networks<br />

NAVTEQ<br />

Devices &<br />

Services<br />

Regarding R&D, a fundamental component toward a successful <strong>and</strong> well-structured<br />

strategy, in the case <strong>of</strong> <strong>Nokia</strong>, this expense represents in average, 14% <strong>of</strong> revenues in<br />

each annual operating expenses (Figure 23). Indeed, this ongoing R&D approach<br />

followed by <strong>Nokia</strong>,<br />

representing three times more<br />

than its competitors, is<br />

undoubtedly the best way to<br />

meet market requirements <strong>and</strong><br />

new consumption practices,<br />

despite R&D might suffer a<br />

reduction in terms <strong>of</strong> personnel<br />

according to the new leadership<br />

team. Figure 23: <strong>Nokia</strong> Operating Expenses - 2010<br />

Meantime <strong>and</strong> since the new Executive board arrived, <strong>Nokia</strong> has been focusing on the<br />

smartphones segment, which led to a restructuring process initiated at the beginning <strong>of</strong><br />

2011. As it was already mentioned, smartphones are penetrating into the market at a<br />

very fast rate, capturing a high percentage <strong>of</strong> the overall market sales. In spite <strong>of</strong> <strong>Nokia</strong><br />

is the market leader; its presence in this segment is reduced compared to competitors.<br />

<strong>The</strong>refore, if <strong>Nokia</strong> <strong>and</strong> its competitors perform at the same rate according to its<br />

historical financial data, it will take less time for <strong>Nokia</strong> to lose its leadership position.<br />

Consequently, this is a crucial <strong>and</strong> alarming aspect to approach in the near future, where<br />

<strong>Nokia</strong> has all the components to “turn the story”.<br />

In addition, <strong>Nokia</strong> employed at the end <strong>of</strong> 2010 132427 people, 15% in Finl<strong>and</strong> <strong>and</strong><br />

85% internationally. About the ownership structure, <strong>Nokia</strong> is composed by 721 owners,<br />

including Institutional holders, Mutual Fund holders <strong>and</strong> direct owners (members <strong>of</strong> the<br />

Board <strong>of</strong> Directors <strong>and</strong> the Group Executive Board). Further, shareholders registered in<br />

Finl<strong>and</strong> represent 17.24% <strong>and</strong> the remainders are shareholders registered in the name <strong>of</strong><br />

nominee. In turn, <strong>Nokia</strong> Corp. market capitalization is approximately $ 32.11 billion<br />

dollars. Additionally, as <strong>Nokia</strong> owns a large number <strong>of</strong> stock options <strong>and</strong> convertibles,<br />

the <strong>Nokia</strong>’s earning power is symbolized by the diluted EPS, which was USD $0.70 at<br />

the end <strong>of</strong> 2010.<br />

5466,57<br />

8266,83<br />

1572,15<br />

41776,89<br />

Cost <strong>of</strong> Revenue<br />

Administrative<br />

On the other h<strong>and</strong>, <strong>Nokia</strong> has a significant historical background in terms <strong>of</strong> past<br />

acquisitions towards an easy access to certain segments <strong>and</strong> markets. Two <strong>of</strong> its three<br />

operating segments show that acquiring strategy. For instance, NAVTEQ a leading<br />

provider <strong>of</strong> digital map information was acquired by <strong>Nokia</strong> in 2007, 50% in cash <strong>and</strong><br />

the rest with debt. At the same time, <strong>Nokia</strong> Siemens Networks is the result <strong>of</strong> a joint-<br />

venture between <strong>Nokia</strong> <strong>and</strong> Siemens in order to provide sophisticated<br />

telecommunications hardware, s<strong>of</strong>tware <strong>and</strong> pr<strong>of</strong>essional services; or even the<br />

acquisition at the end <strong>of</strong> 2008 <strong>of</strong> Symbian Ltd., the company behind the Symbian OS<br />

for <strong>Nokia</strong> mobile phones. Indeed, <strong>Nokia</strong> has a trend towards acquisitions which can<br />

help in the takeover with Micros<strong>of</strong>t, rising the user numbers, attracting more developers<br />

<strong>and</strong> providing a wide range <strong>of</strong> applications <strong>and</strong> services on platforms, as Apple <strong>and</strong><br />

Google did in the past.<br />

3.3.1. Devices & Services<br />

<strong>The</strong> Devices & Services segment (D&S) is responsible for producing <strong>and</strong> controlling<br />

the <strong>Nokia</strong>’s portfolio <strong>of</strong> h<strong>and</strong>set devices <strong>and</strong> consumer internet services (under the Ovi<br />

br<strong>and</strong>), designing <strong>and</strong> developing new services which include applications <strong>and</strong> content<br />

for the end-users. Moreover, it also manages the whole supply-chain, sales channels,<br />

br<strong>and</strong> <strong>and</strong> marketing campaigns, <strong>and</strong> lastly it seeks future growth <strong>and</strong> strategic<br />

opportunities for the company. Due to the new strategy implemented into the company<br />

<strong>and</strong> focus on the smartphone market, this division is composed by two business units:<br />

Smart Devices <strong>and</strong> Mobile Phones. <strong>The</strong> first is obviously focus on smartphones <strong>and</strong> the<br />

next-generation opportunities in devices, platforms <strong>and</strong> user experiences, while the<br />

second business unit is focus on the mass market mobile phones, making them modern<br />

<strong>and</strong> affordable for all customers. In terms <strong>of</strong> revenues, each business unit is responsible<br />

for more <strong>and</strong> less 50% <strong>of</strong> the total segment revenues, representing in general, the largest<br />

segment responsible for most <strong>of</strong> the company’s net sales.<br />

An important aspect is the s<strong>of</strong>tware platforms <strong>and</strong> operating systems used in each<br />

business unit. In the case <strong>of</strong> mid-tier mobile phones, Series 30 <strong>and</strong> Series 40 are the<br />

most used s<strong>of</strong>tware platforms, including several applications, generally mobile Java<br />

applications. Smartphones normally use the Symbian OS <strong>and</strong> the MeeGo. Symbian<br />

includes a user interface component based on S60 s<strong>of</strong>tware, being today the market<br />

leader OS for smartphones (Figure 24).<br />

Figure 24: Smartphone OS market<br />

In turn, MeeGo is the consequence <strong>of</strong> a partnership between <strong>Nokia</strong> <strong>and</strong> Intel resulting<br />

into a new OS for netbooks, tablet computers <strong>and</strong> mobile phones. Regarding<br />

competition, as the chart presented above shows, the major competitors in this segment<br />

are: Research in Motion, Apple, Google, LG Electronics <strong>and</strong> Samsung, beside the<br />

appearance <strong>of</strong> new organizations in the emerging markets as ZTE <strong>and</strong> Huawei.<br />

With regard to future growth expectations, this segment grew approximately 5% on the<br />

first quarter <strong>of</strong> 2011 compared to the same period <strong>of</strong> 2010. However, the smart devices<br />

unit will tend to increase more than mobile phones due to the increasing adoption <strong>and</strong><br />

interest showed by users. Additionally, this merger with Micros<strong>of</strong>t may represent a<br />

dilemma to Symbian <strong>and</strong> Meego OS. Despite Symbian at least is more successful,<br />

Windows Phone 7 is more modern, considering the WP7 as the main smartphone OS<br />

after the takeover. At the same time, it is essential to highlight that <strong>Nokia</strong>, unlike Apple<br />

<strong>and</strong> Research in Motion, does not just sell smart devices, so a slice <strong>of</strong> revenues will<br />

continue to come from mass-market h<strong>and</strong>set devices.<br />

3.3.2. NAVTEQ<br />

4,20% 3,80%<br />

37,60%<br />

16,00%<br />

22,70%<br />

Symbian OS Android<br />

Blackberry OS iPhone OS<br />

Windows Phone/Mobile Other OS<br />

<strong>The</strong> NAVTEQ segment was integrated into <strong>Nokia</strong> only in 2008, after an acquisition<br />

process with Navigation Technologies Corporation, being considered today a <strong>Nokia</strong>’s<br />

subsidiary. NAVTEQ is a producer <strong>of</strong> digital map information <strong>and</strong> related location-<br />

based content <strong>and</strong> services for mobile navigation devices, automotive navigation<br />

systems, Internet-based mapping applications, <strong>and</strong> enterprise <strong>and</strong> government solutions.<br />

In fact, NAVTEQ is used by <strong>Nokia</strong> with the purpose <strong>of</strong> adding context-time, place <strong>and</strong><br />

people-to-web services optimized for mobility.<br />

In terms <strong>of</strong> Revenues, they come mainly from map licenses to mobile device users <strong>and</strong><br />

personal navigation devices, representing approximately 2.5% <strong>of</strong> total corporate<br />

revenues. <strong>The</strong> main service provided by this segment is the <strong>Nokia</strong> Maps embedded into<br />

the <strong>Nokia</strong>’s internet service (Ovi), where any customer may download maps <strong>and</strong> use<br />

guided navigation. In terms <strong>of</strong> competition, Google, Tele Atlas (TomTom subsidiary),<br />

Facet Technology, CloudMade <strong>and</strong> Automotive Navigation Data are considered the<br />

main competitors <strong>of</strong> NAVTEQ. Regarding to the future, in the first quarter <strong>of</strong> 2011 this<br />

segment grew 23% year-over-year. However, this segment is directly correlated with<br />

the smartphone devices, since NAVTEQ applications are, most <strong>of</strong> them accessed via<br />

mobile phones. Even though a small operating segment, it might represent an interesting<br />

business in the future depending certainly on vehicle sales <strong>and</strong> automotive industry.<br />

3.3.3. <strong>Nokia</strong> Siemens Networks<br />

<strong>The</strong> <strong>Nokia</strong> Siemens Networks (NSN) is once again, a result <strong>of</strong> a joint-venture between<br />

<strong>Nokia</strong> <strong>and</strong> Siemens in 2006, being considered a <strong>Nokia</strong>’s subsidiary as NAVTEQ. This<br />

network firm provides mobile <strong>and</strong> fixed network services <strong>and</strong> solutions either to<br />

operators or to service providers. Additionally, this segment is composed by three main<br />

business units: Business Solutions, Network Systems <strong>and</strong> Global Services. About<br />

revenues, they represent approximately 30% <strong>of</strong> the <strong>Nokia</strong>’s revenues, with the main<br />

services being: mobile TV, outsourcing, inventory management, device management,<br />

customer care support, <strong>and</strong> unified charging <strong>and</strong> billing for the service providers. On the<br />

other h<strong>and</strong>, NSN also focuses in GSM (Global System for Mobile Telecommunications)<br />

<strong>and</strong> EDGE (Enhanced Data Rates for<br />

GSM Evolution) radio access<br />

networks.With regard to<br />

competition, Huawei, Ericsson <strong>and</strong><br />

Alcatel-Lucent are considered the<br />

principal contenders to NSN (Figure<br />

25). Figure 25: Top Suppliers by base station shipments<br />

Indeed, NSN continue to announce commercial LTE (3GPP Long Term Evolution)<br />

contracts with Deutsche Telekom <strong>and</strong> doing LTE world-first trials throughout the<br />

world, which lead to a sales growth in the first quarter <strong>of</strong> 2011 year-on-year.<br />

4. Performance <strong>of</strong> both companies in the Stock Market<br />

During the current economic crisis, Stock Markets have been affected since a while,<br />

although showing on the first quarter <strong>of</strong> the current year, a small growth in their indices.<br />

Despite the Middle-East War which leads to a rise on the oil prices <strong>and</strong> the Tsunami in<br />

Japan, 2011 is presented <strong>and</strong> forecasted as a thriving <strong>and</strong> prospering year, which<br />

directly affects the Stock Markets. Indeed, the downward trends during the last years led<br />

to an increase in the inflation rate, which consequently implied a rise in the interest<br />

rates, limiting the economic growth <strong>and</strong> as a result, creating less jobs. In turn, even<br />

though this seems to be a vicious cycle, stock markets are starting to recover from the<br />

financial downturn, with the BRIC countries (Brazil, Russia, India <strong>and</strong> China)<br />

representing interesting opportunities in the short <strong>and</strong> medium term in terms <strong>of</strong><br />

investment solutions. Furthermore, NYSE Euronext Inc. <strong>and</strong> NASDAQ Stock Market,<br />

the two largest stock exchange markets are currently fundamental l<strong>and</strong>marks for<br />

investors <strong>and</strong> companies. Figure 26 represents the evolution <strong>of</strong> Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong><br />

stock prices over the last two years. Both companies have suffered a relative decline at<br />

the end <strong>of</strong> the first quarter 2010, having dropped from a value <strong>of</strong> USD$32 <strong>and</strong> USD$16,<br />

Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> respectively, to a value <strong>of</strong> approximately USD$24 <strong>and</strong> USD$8<br />

respectively. Since August 2010, we have attended to a smaller recover due to<br />

consolidation perspectives that contributed to raise the share prices. Recently on May<br />

13, 2011, Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong>’s stock prices were USD$25.32 <strong>and</strong> USD$8.66<br />

respectively.<br />

Figure 26: 2-year Historical Stock Prices: Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong><br />

5. Historical <strong>of</strong> M&A – “A route for portfolio diversification”<br />

<strong>The</strong> unsettled macroeconomic atmosphere has affected the h<strong>and</strong>set industry through a<br />

weaker consumer dem<strong>and</strong> <strong>and</strong> credit scarcity. Indeed, consumers since a while became<br />

more <strong>and</strong> more risk-averse affecting directly the credit spreads <strong>and</strong> debt financing.<br />

Consequently, as the majority <strong>of</strong> M&A deals are essentially financed through debt, this<br />

has put too much pressure on M&A. After a low cycle in 2009, technological global<br />

deals in terms <strong>of</strong> volume, have recovered over the course <strong>of</strong> 2010, while deal values<br />

recovered even more<br />

strongly. Statistically, 2658<br />

deals were completed in<br />

2010, up 41% from 2009<br />

(Technology M&A<br />

Insights). Nonetheless, the<br />

M&A practice still remains<br />

far from deal volumes <strong>and</strong><br />

values achieved in 2007<br />

<strong>and</strong> 2008 (Figure 27).<br />

Figure 27: Global Deal Value <strong>and</strong> Volume<br />

Indeed, M&A dynamics are changing <strong>and</strong> global technology players are diversifying<br />

even more to suit consumer preferences <strong>and</strong> needs in a faster-growing technology<br />

industry. Factors such as, high quality assets are being brought into the industry, since<br />

vendors seek to exploit the presence <strong>of</strong> cash-rich companies with a high urge for mega<br />

deals; the aggressive private equity buyers are back to the action; <strong>and</strong> the improved<br />

capital markets are providing an essential <strong>and</strong> underst<strong>and</strong>ing influence, in terms <strong>of</strong> debt<br />

financing. An important point that should be highlighted is the fact that, cash-rich<br />

companies are looking more aggressively at deal origination (in terms <strong>of</strong> acquisition<br />

opportunities), rather than competing in auction processes. Concerning to the private<br />

equity buyers, these under pressure to deploy capital, are becoming more vigorous in<br />

the technology sector, either as acquirers or as providers <strong>of</strong> growth capital, providing at<br />

the same time, an alternative source <strong>of</strong> capital to the continued fancies <strong>of</strong> the public<br />

equity market. Statistically, the combined value <strong>of</strong> all private-equity takeovers in this<br />

sector in 2010 was USD$ 15.2 billion.<br />

<strong>The</strong> financial downturn has led companies to address their cost bases <strong>and</strong> to increase<br />

their operational efficiency. As a result, firms are now able to deploy the accumulative<br />

cash to buy growth opportunities <strong>and</strong> are looking to complete deals focusing on<br />

strategic purposes, which more than doubled in 2010 compared to 2009 (Appendix 4).<br />

Concerning the M&A marketplace, after the gap narrowed in 2009, cross-border<br />

takeovers increased in 2010, particularly driven by US acquirers. Indeed, US bidders<br />

acquired more 68% European targets in 2010 compared to 2009 (Appendix 5),<br />

representing 39% <strong>of</strong> global deals. Further, European companies are becoming more<br />

attractive targets for overseas firms (as it happened with the Swedish<br />

telecommunications firm –<br />

Ericsson - which has merged<br />

with Sony Corp. at the end <strong>of</strong><br />

2001), namely US trade <strong>and</strong><br />

private equity companies who<br />

are looking for portfolio<br />

diversification <strong>and</strong> strategic<br />

expansion. In terms <strong>of</strong><br />

transactions value flow by<br />

sector, s<strong>of</strong>tware was the<br />

biggest net seller <strong>and</strong> net buyer<br />

<strong>of</strong> transaction value in 4Q10<br />

(Figure 28). Figure 28: Technology transactions value flow, 4Q10<br />

Certainly, today is a good time to realize value as quality businesses with a strategic<br />

position <strong>and</strong> scale will be able on the future to attract strong prices. From the buyer’s<br />

perspective, they need to trust on financial headlines, firm’s accounting policies <strong>and</strong> its<br />

management teams, while business sponsors must convince their own boards <strong>and</strong><br />

respective shareholders that a specific deal is on the right terms in a risky economic<br />

environment. Furthermore, leading firms consider today M&A, as the favorite route for<br />

portfolio diversification. Due to changing dem<strong>and</strong> from consumers, who are likely<br />

seeking better pricing strategies <strong>and</strong> product consolidation, thus companies need to<br />

diversify in order to gain competitive advantage over the competitors <strong>and</strong> to mitigate<br />

risks.<br />

Afterwards, technology big player such as, IBM, Micros<strong>of</strong>t, Cisco, HP are exp<strong>and</strong>ing to<br />

other segments beyond their core businesses, applying a diversification strategy in order<br />

to boost sales, decrease uncertainty about revenues, attract new users <strong>and</strong> keep pace<br />

with competitors. <strong>The</strong>reby, the M&A trend is expected to continue in the long-run,<br />

since companies need to grow the scale <strong>and</strong> scope <strong>of</strong> their affairs.<br />

6. Performance Forecast<br />

As it was referred previously by Damodaran (2005), in order to analyze the synergies<br />

between Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong>, it is essential to value each one <strong>of</strong> the companies<br />

separately. Consequently, this valuation implies certain assumptions about its future<br />

evolution, in a word, the way each firm will perform inside its industry in the following<br />

years, as well as, the evolution <strong>of</strong> the computer s<strong>of</strong>tware <strong>and</strong> telecommunications sector.<br />

<strong>The</strong>reby, Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> will be analyzed through two different methods (WACC,<br />

<strong>and</strong> Multiples Valuation), taking always into account that the results shall be similar as<br />

long as the same considerations are used for all <strong>of</strong> them. At the end <strong>of</strong> each St<strong>and</strong>alone<br />

Valuation, a sensitivity analysis will also be done so that one may underst<strong>and</strong> the<br />

changes in the firm value in result <strong>of</strong> distinct assumptions taken. In a word, the<br />

valuation process will start with a base case situation <strong>and</strong> then a bear <strong>and</strong> bull case<br />

scenarios will be computed, representing the lower <strong>and</strong> upper bounds respectively.<br />

An important aspect which should be highlighted is the fact that, the valuation process<br />

(projections) will be based in three components: the firm’s future strategic goals, its<br />

own tendency <strong>of</strong> growth based on the historical data, <strong>and</strong> the Investment Banking<br />

projections as a reliable source able to support the assumptions. Moreover, the historical<br />

data considers the 3 previous years – from 2008 until the present – <strong>and</strong> the projections<br />

will consider the next 5 years – until 2015 – since the transition process (merger) is<br />

assumed to take 1 to 2 years, so 2015 is an enough period to forecast a more<br />

consolidated process. Hence, the FCFF (Free Cash-Flow to the Firm) will be calculated<br />

for the next 5 years <strong>and</strong> discounted at the respective discount rate. In the Relative<br />

Valuation, the firm’s financial indicator must be multiplied by the average multiple<br />

value <strong>of</strong> the respective Peer Group.<br />

6.1. Micros<strong>of</strong>t’s St<strong>and</strong>alone Valuation – Base case scenario<br />

Despite the cutback in Micros<strong>of</strong>t’s market-share from 2009 to 2010 due to its main<br />

growth competitors – Apple <strong>and</strong> Google – <strong>and</strong> the economic crisis which has affected<br />

the financial results in 2009, even so Micros<strong>of</strong>t still appears as owning a strong market<br />

power, as the historical results show.<br />

This is a consequence <strong>of</strong> its diversified portfolio <strong>of</strong> products <strong>and</strong> services, <strong>and</strong> its strong<br />

Marketing campaigns <strong>and</strong> capital structure. However, sometimes Micros<strong>of</strong>t has been a<br />

history <strong>of</strong> delayed product launches which has allowed its competitors to gain share <strong>and</strong><br />

momentum. Even though, Micros<strong>of</strong>t’s pr<strong>of</strong>itability <strong>and</strong> br<strong>and</strong> image allows <strong>and</strong> seems<br />

to be changing this current situation to a more precisely <strong>and</strong> fast-delivered strategy<br />

through this takeover <strong>and</strong> the consequent penetration into the tablet <strong>and</strong> smartphone<br />

segments, delivering higher cash-flows compared to the past results (Appendixes, 10,<br />

11, 12, 13, 14). <strong>The</strong>refore, this section will analyze the main categories/components in<br />

the Income Statement <strong>and</strong> Balance Sheet, the Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital<br />

information. Furthermore, all the categories will be analyzed in a consolidated<br />

perspective with an exception regarding to revenues (by segment). At this point, it will<br />

be computed a price target through the WACC method <strong>and</strong> then it must be compared<br />

with the Multiples valuation price target. In fact, the Cash-flows calculation will be<br />

estimated till 2015, assuming a nominal growth rate <strong>of</strong> 4.98% afterwards (appendix 13),<br />

based on IMF’s expectations for the U.S. market <strong>of</strong> 2.83% real growth rate <strong>and</strong> 2.15%<br />

inflation (Appendix 6). Lastly, the multiples valuation will also be applied through<br />

specific peer group expectations.<br />

6.1.1. Revenues<br />

<strong>The</strong> revenues calculation represents a crucial step <strong>of</strong> any valuation process, since it will<br />

affect directly other values as the cost <strong>of</strong> revenues <strong>and</strong> operating expenses consequently.<br />

Thus, the five Micros<strong>of</strong>t’s segments will be presented independently, namely because<br />

certain segments has much more weight in total revenues than others, <strong>and</strong> different<br />

growth rates (CAGR’s <strong>of</strong> revenues) <strong>and</strong> operating margins.<br /> Windows & Windows Live Division<br />

This segment represented in 2010 almost 29.5% <strong>of</strong> total revenues <strong>and</strong> according to the<br />

tendency <strong>of</strong> growth, it has been increasing 15% in total since 2008 (4.71% CAGR <strong>of</strong><br />

revenues 2008-2010), in spite <strong>of</strong> 2009 results due to the financial crisis. Although this<br />

segment presents an operating margin around 70%, meaning that the company makes<br />

$0.70 for each dollar <strong>of</strong> revenues, it is expected to decrease due to the Lion OS launch<br />

in July by Apple – the newest Apple’s OS – despite Windows 7 <strong>and</strong> XP are the most<br />

selling OS. Furthermore, the threat <strong>of</strong> tablets <strong>and</strong> smartphones will tend to reduce the<br />

dem<strong>and</strong> for PC’s – friction <strong>of</strong> tablets.<br />

In addition, revenues have decreased 4% on the first quarter <strong>of</strong> 2011 compared with the<br />

first quarter <strong>of</strong> 2010. Thus, revenues are expected to decrease 2% until the end <strong>of</strong> 2011.<br />

Nevertheless from 2012 on, with the Windows 8 launch able to address the tablet<br />

market, this segment will tend to recover it, increasing 2.5% year until 2015 (1.87%<br />

CAGR <strong>of</strong> revenues 2011-2015).<br /> Micros<strong>of</strong>t Business Division<br />

This segment represented in 2010, almost 30% <strong>of</strong> total revenues with a tendency <strong>of</strong><br />

growth equals to 1% from previous years (-0.77% CAGR <strong>of</strong> revenues 2008-2010),<br />

presenting an operating margin <strong>of</strong> about 63%. Indeed, this segment is expected to<br />

increase mainly due to Office 2010, who generates over 90% <strong>of</strong> Micros<strong>of</strong>t Business<br />

Division revenues. Further, Office is today the Micros<strong>of</strong>t’s highest pr<strong>of</strong>it generator.<br />

Revenues have grown 21% on the first quarter <strong>of</strong> 2011, so this division is expected to<br />

grow 2% until 2012 <strong>and</strong> 3% afterwards due to the Windows 8, as well (3% CAGR <strong>of</strong><br />

revenues 2011-2015).<br /> Server <strong>and</strong> Tools<br />

This segment represented in 2010, 24% <strong>of</strong> total revenues presenting as well, a tendency<br />

<strong>of</strong> growth equal to 6.24% since 2008 (6.24% CAGR <strong>of</strong> revenues 2008-2010) <strong>and</strong> an<br />

operating margin <strong>of</strong> about 37%. Server <strong>and</strong> Tools division is directly correlated with<br />

Windows <strong>and</strong> Windows Live Division in the sense that, half <strong>of</strong> its revenues come from<br />

OS licensing agreements. Meanwhile, Apple will launch in June the iCloud in order to<br />

compete with Micros<strong>of</strong>t’s cloud platform. Additionally in the future, server units are<br />

expected to slow due to the server virtualization.<br />

<strong>The</strong>reby, despite revenues have increased 11% on the first quarter <strong>of</strong> 2011 because <strong>of</strong><br />

the strong adoption <strong>of</strong> windows server, the year <strong>of</strong> 2011 is expected to be moderated,<br />

assuming a growth <strong>of</strong> 1%, but from 2012 on, it will tend to decline 2% year due to the<br />

virtualization referred above (-2% CAGR <strong>of</strong> revenues 2011-2015).<br /> Online Services Division<br />

This division represented in 2010 only 3.5% <strong>of</strong> total revenues, with a tendency <strong>of</strong><br />

growth equals to -17.3% p.a. since 2008 (-17.3% CAGR <strong>of</strong> revenues 2008-2010) <strong>and</strong> a<br />

negative operating margin <strong>of</strong> -7%. Indeed, this is the smallest division in Micros<strong>of</strong>t,<br />

eing only the third online advertising selling site, behind Google <strong>and</strong><br />

Yahoo!.<br />

Notwithst<strong>and</strong>ing, the revenues have increased 14% in the first quarter <strong>of</strong> 2011 <strong>and</strong> the<br />

commercial agreement with Yahoo! shall provoke positive results in the future,<br />

increasing Micros<strong>of</strong>t position ( on the Online Ad Selling firms ranking<br />

(Figure 17). As so, it is expected a moderate growth till 2011 <strong>of</strong> 1% <strong>and</strong> from 2012 on,<br />

an increase <strong>of</strong> 2% year-by-year (2% CAGR <strong>of</strong> revenues 2011-2015).<br /> Entertainment <strong>and</strong> Devices Division<br />

Despite this segment represented only 13% <strong>of</strong> total revenues in 2010, as well as, a<br />

tendency <strong>of</strong> growth equals to 3% in total since 2008 (-0.5% CAGR <strong>of</strong> Revenues 2008-<br />

2010) <strong>and</strong> operating margin equals to 8.4% in 2010, this division has a considerable<br />

scope for growth. Indeed, Windows Phone <strong>and</strong> Kinect for Xbox 360 will be the main<br />

responsible for this boost. <strong>The</strong> emergence <strong>of</strong> tablets <strong>and</strong> smartphones leads Micros<strong>of</strong>t to<br />

consider this division the main goal area in the near future. Further, the first quarter <strong>of</strong><br />

2011 shows a growth <strong>of</strong> 50% compared with the same period in 2010 due to Kinect for<br />

Xbox 360, the fastest selling consumer electronics device in history.<br />

Windows Phone 7 had a considerable launch but not comparable with Apple or<br />

Google’s devices. <strong>The</strong>reby, this segment must become one <strong>of</strong> the core businesses in<br />

Micros<strong>of</strong>t, expecting a growth <strong>of</strong> 4% in 2011 due to Xbox 360 console, 10% in 2012<br />

<strong>and</strong> from 2013 on, an increase <strong>of</strong> 20% per year, due also to the emerging markets<br />

facilities. Indeed, this segment should be along with Micros<strong>of</strong>t Business Division <strong>and</strong><br />

Windows & Windows Live Division the main areas <strong>of</strong> business in the future. Windows<br />

Phone 7 <strong>and</strong> Kinect should be able to drive this division ahead <strong>of</strong> expectation, <strong>and</strong> for<br />

that reason, the growth will be significant (17.4% CAGR <strong>of</strong> revenues 2011-2015).<br />

6.1.2. Operating Expenses<br />

Looking at Micros<strong>of</strong>t’s cost <strong>of</strong> revenues, one can figure that they have been decreasing<br />

on the last three years, representing more <strong>and</strong> less, 20% <strong>of</strong> total revenues – tendency. At<br />

the same time, cost <strong>of</strong> revenues seemed to be stable according to the historical results,<br />

due to the revenues consistency. Hence, as the revenues are expected to increase, the<br />

cost <strong>of</strong> revenues will consequently increase, assuming from 2011 on an average <strong>of</strong> 20%<br />

<strong>of</strong> total revenues.<br />

Concerning to Research & Development expenses, which represents 15% <strong>of</strong> total<br />

revenues on average, are one <strong>of</strong> the Micros<strong>of</strong>t hearts. In fact, innovation is the<br />

foundation <strong>of</strong> Micros<strong>of</strong>t’s success. Cloud computing, natural user interfaces <strong>and</strong><br />

intelligent computing are some <strong>of</strong> the hot topics in the future therefore, 15% <strong>of</strong> total<br />

revenues are assumed as the R&D expenses for the next years. Moreover, R&D is not<br />

assumed to increase since in the long-term, this amount might be shared with <strong>Nokia</strong><br />

(from 2016 on).<br />

<strong>The</strong> Sales & Marketing expenses represented on average in the last three years a value<br />

between 21% <strong>and</strong> 22% <strong>of</strong> total revenues. Even though, they are expected to increase<br />

namely due to Windows Phone 7 <strong>and</strong> Kinect advertising campaigns in order to rise the<br />

user numbers, attract more developers <strong>and</strong> a wide range <strong>of</strong> applications <strong>and</strong> services in<br />

both products. <strong>The</strong>refore, it is assumed a value equal to 23% <strong>of</strong> total revenues on the<br />

next years.<br />

Regarding to General <strong>and</strong> Administrative expenses, they are expected to keep stable on<br />

the next years, representing since 2008 6.5% <strong>of</strong> total revenue, thus the same percentage<br />

is assumed in the following years until 2015.<br />

<strong>The</strong> last operating expenses aspect are the Employee Severance which has started in<br />

2009 as a consequence <strong>of</strong> the financial downturn <strong>and</strong> the Depreciation <strong>and</strong><br />

Amortization. <strong>The</strong>refore <strong>and</strong> following the new strategy plan, the Employee Severance<br />

value will tend to increase, cutting on the employee headcount <strong>and</strong> reducing the number<br />

<strong>of</strong> positions; a value <strong>of</strong> 1% <strong>of</strong> cut year-over-year, as a percentage <strong>of</strong> total revenues, will<br />

be considered in the projections. Concerning to Depreciation <strong>and</strong> Amortization <strong>of</strong> the<br />

year they represent 3.07% <strong>of</strong> total assets based on the historical trends, thus it is<br />

expected to be in line with the current trend.<br />

Concerning to the provision for income taxes (based on Earnings before taxes), from<br />

2011 on, the fiscal year rate will reflect a higher mix <strong>of</strong> foreign earnings taxed at lower<br />

rates, therefore it is considered a value <strong>of</strong> 35% as the tax rate.<br />

In terms <strong>of</strong> Dividends, it is assumed the same value till 2015 in order to maintain the<br />

cash <strong>and</strong> the capital structures at a constant level, <strong>and</strong> the stock price at a stable level, as<br />

well.<br />

6.1.3. Assets, Liabilities <strong>and</strong> Equity<br />

Starting by Assets, Cash <strong>and</strong> short-term investments in order to facilitate liquidity <strong>and</strong><br />

capital preservation, it is assumed the average tendency <strong>of</strong> growth from the past years;<br />

so, a growth <strong>of</strong> 25% till 2013, tending to reduce in 2014 to 15% <strong>and</strong> 7.5% in 2015, as<br />

we are assuming that in 2014 <strong>and</strong> 2015 a more stable stage is addressed.<br />

Concerning to the accounts receivable <strong>and</strong> inventories, both follow the tendency <strong>of</strong><br />

growth from the past years, representing 20.5% <strong>and</strong> 1.35% <strong>of</strong> total revenues<br />

respectively. <strong>The</strong> accounts payable follow the cost <strong>of</strong> revenues’ tendency <strong>of</strong> growth,<br />

which is 39% from the past years.<br />

Regarding to the Short-term debt, according to the 2010 Annual Report, on the next five<br />

years, the short-term debt will be always the same (Appendix 11). <strong>The</strong> long-term debt<br />

will increase almost to the double in 2011, representing 95% more due to the maturities<br />

<strong>of</strong> long-term debt for the next five years, as it is referred on the 2010 Annual Report.<br />

An important aspect is the fact that non-controlling interests (minority interests) are<br />

considered 0 according to the previous annual reports, so the portion <strong>of</strong> subsidiary<br />

firm’s stock that is not owned by the parent company is equal to 0.<br />

6.1.4. Net Working Capital<br />

Net Working Capital is an essential component to the FCFF calculation, representing<br />

the operating liquidity <strong>of</strong> the company. Indeed, it is calculated through the following<br />

formula:<br />

NWC = Inventories + Total Accounts Receivable – Total Accounts Payable<br />

All the components were already referred above, as well as it future expectations. In<br />

fact, NWC over the last three years has been quite unstable, being impossible to identify<br />

any historical tendency. <strong>The</strong>reby, the expected NWC value is the pure application <strong>of</strong> the<br />

formula, taking into accounts the composed items considerations done before.<br />

6.1.5. Capital Expenditures<br />

Capital Expenditures are considered new investments <strong>and</strong> additions to property <strong>and</strong><br />

equipment (new infrastructures) in the Micros<strong>of</strong>t structure. In that case, over the last<br />

three years, Micros<strong>of</strong>t has announced a cut in the capital expenditures, reducing<br />

investments, which is reflected on the historical data (appendix 12). Indeed, this last<br />

three years have been quite unstable in terms <strong>of</strong> investments due to the economic<br />

downturn in 2008. Nevertheless in the future, the required Micros<strong>of</strong>t positioning <strong>and</strong><br />

investment in the new “cash-cows” areas – smartphones <strong>and</strong> tablet segments – which is<br />

currently weak <strong>and</strong> obsolete, it must increase in order to invert the situation. <strong>The</strong>reby,<br />

on the next three years, CAPEX is assumed to be equal to the average <strong>of</strong> past years’<br />

values which is currently 30%.<br />

From 2014 on, as cash <strong>and</strong> short-term investments will grow slowly, the company<br />

should be in a more stable phase where CAPEX will be equal to Depreciation <strong>and</strong><br />

Amortization.<br />

6.1.6. Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital<br />

According to the Literature review, in the WACC methodology, the cash flows are<br />

expected to be discounted at the WACC - cost <strong>of</strong> capital – in the FCFF method. First <strong>of</strong><br />

all, it is considered the Micros<strong>of</strong>t’s rating equal to the U.S’s rating, thus in May 2011<br />

<strong>and</strong> in July 2011, according to the S&P’s <strong>and</strong> Moody’s rating respectively, Micros<strong>of</strong>t<br />

has a rating <strong>of</strong> AAA <strong>and</strong> Aaa in both credit rating agencies (appendixes 7 <strong>and</strong> 8).<br />

Furthermore, the yield on the U.S 10-year government bond (risk free rate) is 2.10%<br />

according to the IMF’s website (appendix 6), <strong>and</strong> the total risk premium is considered to<br />

be 5% according to Damodaran (2008). Regarding the unlevered beta in the Computer<br />

S<strong>of</strong>tware industry in U.S.A, it is assumed to be 1.12 (Appendix 9).<br />

Based on this information, it is easy to compute the levered beta <strong>and</strong> the unlevered <strong>and</strong><br />

levered cost <strong>of</strong> equity, through the following formulas:<br />

Meanwhile, in order to calculate the cost <strong>of</strong> capital ( ), in accordance to the Literature<br />

Review, it will be equal to the risk-free rate plus the default-risk spread according to<br />

Micros<strong>of</strong>t’s probability <strong>of</strong> default. In a word, the Micros<strong>of</strong>t debt cost <strong>of</strong> capital will be<br />

2.10% plus a spread <strong>of</strong> 0.50% (Appendix 7) which adds up to 2.60%.<br />

<strong>The</strong> corporate tax rate applied in the American market is 35% (Damodaran’s website)<br />

<strong>and</strong> the Micros<strong>of</strong>t’s capital structure at market values is 0.1867% (D/D+E - net debt<br />

divided by Equity value plus net debt) which is almost null due to the smaller net debt,<br />

so consequently, the WACC computation will be directly computed through the<br />

following formula:<br />

Concerning to same data, the Market Capitalization was computed multiplying the<br />

number <strong>of</strong> shares outst<strong>and</strong>ing by the stock price. <strong>The</strong> net debt is considered the value <strong>of</strong><br />

net debt in 2010 – 434 - (appendix 11) <strong>and</strong> the equity value equals to the stock price<br />

(last year) – 25.99 - multiplied by the diluted number <strong>of</strong> shares outst<strong>and</strong>ing (8,927<br />

billions). As the minority interest is 0, therefore the enterprise value is the sum <strong>of</strong><br />

Equity value plus Net Debt.<br />

Thus, the unlevered cost <strong>of</strong> equity is 7.70%, while the levered cost <strong>of</strong> equity is 7.71%,<br />

because in this case instead <strong>of</strong> the unlevered beta (1.12), one uses the levered beta<br />

(1,122). Finally, the WACC is 7.69% <strong>and</strong> the differences between them are small<br />

because <strong>of</strong> the reduced net debt value, meaning that the company owns a considerable<br />

amount <strong>of</strong> equity. All things considered, the Micros<strong>of</strong>t’s Enterprise value through the<br />

WACC method is $232.447 Billion USD. In turn, the price target for Micros<strong>of</strong>t using<br />

this methodology is $26.33 USD (equity value divided by the number <strong>of</strong> shares<br />

outst<strong>and</strong>ing).<br />

Computing the FCFF through the assumptions already mentioned <strong>and</strong> using the WACC<br />

as the discount factor (horizon date, n=4), the Enterprise Value is directly calculated<br />

through the following formula already describe it on the literature review:<br />

6.1.7. Sensitivity Analysis<br />

Despite the computation <strong>of</strong> the base-case scenario, sometimes the assumptions taken<br />

may not happen in the future <strong>and</strong> the projections might be difficult to approach, since<br />

the Computer S<strong>of</strong>tware Industry is characterized by its strong competitiveness <strong>and</strong> the<br />

steady appearance <strong>of</strong> new services <strong>and</strong> products as well as, technological developments<br />

as tablets. As a consequence, it might be useful to analyze changes in the firm value in<br />

result <strong>of</strong> distinct assumptions taken – sensitivity analysis. First <strong>of</strong> all, it will be<br />

considered changes in revenues, operating expenses <strong>and</strong> terminal growth rate. <strong>The</strong> bear-<br />

case situation considers an increase <strong>of</strong> 1% in the Operating Expenses <strong>and</strong> a decrease <strong>of</strong><br />

1% either in Revenues or in the terminal growth rate (appendix 15), in a word, there is a<br />

lack <strong>of</strong> confidence in the market; while the bull-case situation assumes an increase <strong>of</strong><br />

1% in Revenues <strong>and</strong> in the terminal growth rate, <strong>and</strong> a decrease <strong>of</strong> 1% in the Operating<br />

Expenses where the market is showing confidence (appendix 16). <strong>The</strong>reupon, for the<br />

bear-case scenario the price target would be $25.03 <strong>and</strong> for the bull-case scenario it<br />

would be $27.63.<br />

Thus, the main inference that might be extracted from this sensitivity analysis is the fact<br />

that Micros<strong>of</strong>t is a bit overvalued, since the price target under the bear-case scenario is<br />

still lower than the current price (May, 13).<br />

6.1.8. Multiples Valuation<br />

<strong>The</strong> Relative Valuation will compare Micros<strong>of</strong>t with similar companies operating in the<br />

computer s<strong>of</strong>tware industry. <strong>The</strong>se companies were selected on the basis <strong>of</strong> growth <strong>and</strong><br />

risk similarities with Micros<strong>of</strong>t. Most <strong>of</strong> the companies are also U.S headquartered<br />

companies operating in the same geography <strong>of</strong> Micros<strong>of</strong>t, thus it will represent a good<br />

final result in terms <strong>of</strong> reliability. <strong>The</strong> Micros<strong>of</strong>t’s Peer Group was based on Reuter’s<br />

expectations in 2011 while Micros<strong>of</strong>t’s indicators were based on the current valuation.<br />

(Figure 29). Looking at the ratios, in some <strong>of</strong> them Micros<strong>of</strong>t is more <strong>and</strong> less in line<br />

with industry average.<br />

Company Country<br />

Stock<br />

Price Target Price Market Capitalization (in million) P/E P/Book P/Sales EV/Sales EV/EBITDA EV/EBIT<br />

Adobe Systems USA 35,33 12,120 13,09 2,25 2,99 2,51 6,26 7,00<br />

Apple USA 340,50 355,613 15,18 5,13 3,54 3,29 8,00 8,86<br />

Dell USA 16,37 26,801 7,87 3,23 0,43 0,27 2,97 3,50<br />

eBay USA 33,57 37,967 22,27 2,34 3,78 2,77 8,49 10,50<br />

Google USA 529,55 170,117 19,00 3,27 5,10 4,87 8,95 10,10<br />

Hewlett Packard USA 40,41 51,481 5,83 1,33 0,40 0,52 3,58 4,67<br />

IBM USA 169,92 202,000 13,78 8,73 1,93 1,99 8,16 10,20<br />

Oracle USA 35,19 134,996 16,02 3,40 3,79 2,93 6,03 6,43<br />

Philips NED 28,93 19,925 1,03 0,57 0,54 4,70 7,43<br />

Sony JAP 27,58 20,648 0,63 0,23 0,14 1,90 4,70<br />

Yahoo! USA 16,55 16,086 14,47 1,28 2,89 2,82 8,52 15,60<br />

Average 95,250 14,17 2,97 2,33 2,06 6,14 8,09<br />

Micros<strong>of</strong>t USA 25,32 26,33 223,145 12,35 4,45 3,55 3,70 9,41 10,74<br />

Figure 29:Micros<strong>of</strong>t Peer Group<br />

In fact, enterprise-value multiples normally perform better than equity-value multiples.<br />

In this case, it is important to take into account the Micros<strong>of</strong>t’s dimension compared to<br />

its peer firms, which is much bigger which explains the higher values compared to the<br />

industry average. This relative valuation only confirms that Micros<strong>of</strong>t stock price is<br />

overvalued, since its P/Sales ratio is bigger than one.<br />

6.2. <strong>Nokia</strong>’s St<strong>and</strong>alone Valuation – Base <strong>Case</strong> Scenario<br />

Over the last years, <strong>Nokia</strong> has been losing market-share due to its old-fashioned<br />

business model characterized as Micros<strong>of</strong>t by a track <strong>of</strong> delayed product launches –<br />

slow market response - <strong>and</strong> the competitors’ growth in the mobile segment, namely<br />

Google <strong>and</strong> Apple, beside the financial crisis. Nonetheless, its br<strong>and</strong> awareness among<br />

customers <strong>and</strong> its global distribution network still places the company on the top <strong>of</strong> the<br />

ranking. In turn, the tablets <strong>and</strong> smartphones trend has jeopardized its own business<br />

plan, due to its weak presence when compared to its main competitors <strong>and</strong> its respective<br />

devices <strong>and</strong> services. <strong>The</strong>refore, a new restructuring plan based mainly on the reduction<br />

<strong>of</strong> R&D costs, as well as the new leadership headed by Stephen Elop will allow the<br />

company to a more fast-delivering strategy in the future (Appendix 17, 18, 19, 20, 21).<br />

As a result, <strong>Nokia</strong>’s st<strong>and</strong>alone valuation will follow the same structure as Micros<strong>of</strong>t’s,<br />

through WACC <strong>and</strong> Multiples valuation <strong>and</strong> a sensitivity analysis at the end. <strong>The</strong> Cash-<br />

flows will be estimated until 2015 considering a currency exchange rate <strong>of</strong> $1.41 (1€),<br />

assuming a nominal growth rate <strong>of</strong> 4.82% afterwards (appendix 20), based on IMF’s<br />

expectations for the Finnish Market <strong>of</strong> 3.12% real growth rate <strong>and</strong> 1.7% inflation<br />

(appendix 6)<br />

6.2.1. Revenues<br />

<strong>The</strong> <strong>Nokia</strong>’s revenues will tend to decrease on the next two years, since that is<br />

considered the transition period to the merger with Micros<strong>of</strong>t. Despite in 2011, the<br />

decrease is more accented, from 2012 on, one shall already assist to a recovery phase.<br />

Additionally, the inexistence <strong>of</strong> products which might compete against Apple <strong>and</strong><br />

Google’s devices, it will worsen the situation in 2011. Thus, the three <strong>Nokia</strong>’s segments<br />

will be presented independently taking into account its different CAGR’s, operating<br />

margins <strong>and</strong> its weight in total revenues.<br /> Devices <strong>and</strong> Services<br />

This segment represented in 2010 around 68% <strong>of</strong> total revenues, being composed by<br />

smart devices <strong>and</strong> mobile phones, each one representing around 50% <strong>of</strong> total sector<br />

revenues (-8.89% CAGR <strong>of</strong> revenues 2008-2010). Indeed, smart devices are expected<br />

to increase more than mass-market h<strong>and</strong>set devices due to the factors already<br />

mentioned.<br />

However, this segment presents an operating margin around 11.32% meaning that is<br />

pr<strong>of</strong>itable sector with small financial risk. In the smart devices market, the Symbian OS<br />

represented 37.60% <strong>of</strong> the total market (figure 24). Nonetheless, if the takeover<br />

approach takes place, the Windows Phone 7 should be the new smartphone OS; while<br />

the Symbian OS will be retained for use in the mid-to-low-end devices (mobile phones).<br />

In turn, the absence <strong>of</strong> a reliable <strong>and</strong> strong device able to contender against Google’s<br />

Android <strong>and</strong> Apple’s iOS will lead to a decrease in revenues in 2011.<br />

In addition, revenues have grown 5% on the first quarter <strong>of</strong> 2011 compared with the<br />

2010 first quarter, but comparing with the fourth quarter <strong>of</strong> 2010, they have decreased<br />

almost 17%, thereby, one can expect a decrease <strong>of</strong> 3% in 2011 <strong>and</strong> 2% in 2012, due to<br />

the reasons mentioned before <strong>and</strong> the changes in the smartphones platform/OS as a<br />

consequence <strong>of</strong> the merger. From 2013 on, it is expected to grow 4% a year after the<br />

transition process had been achieved - post transition – (2.47% CAGR <strong>of</strong> revenues<br />

2011-2015).<br /> NAVTEQ<br />

This division represented in 2010 only 2.3% <strong>of</strong> total revenues, a tendency <strong>of</strong> growth<br />

equals to 67% since 2008 (66.6% CAGR <strong>of</strong> revenues 2008-2010) <strong>and</strong> a negative<br />

operating margin <strong>of</strong> 22.46%. However, one shall bear in mind that this segment was<br />

only integrated into <strong>Nokia</strong> in 2008 after an acquisition process. NAVTEQ is directly<br />

correlated with the Smartphones devices since its main services – <strong>Nokia</strong> Maps – <strong>and</strong><br />

applications are only accessed through smartphones. <strong>The</strong>refore, despite revenues have<br />

increased 23% on the first quarter <strong>of</strong> 2011, in the year <strong>of</strong> 2011 it is expected to decrease<br />

2% (correlated with the smartphones revenues decrease) <strong>and</strong> after that, a growth <strong>of</strong> 4%<br />

year. In fact, <strong>Nokia</strong> digital maps will be considered the heart <strong>of</strong> Bing an AdCenter –<br />

search engines for all <strong>Nokia</strong> phones whether the merger takes place (4% CAGR <strong>of</strong><br />

revenues 2011-2015)<br /> <strong>Nokia</strong> Siemens Networks<br />

This segment is a result <strong>of</strong> a joint-venture in 2006 with Siemens providing solutions to<br />

the operators <strong>and</strong> service providers representing in 2010, 29.7% <strong>of</strong> total revenues (-<br />

9.06% CAGR <strong>of</strong> revenues 2008-2010).<br />

In spite <strong>of</strong> its growth <strong>of</strong> 17% on the first quarter <strong>of</strong> 2011 compared with the first quarter<br />

<strong>of</strong> 2010, this segment is expected to follow the other <strong>Nokia</strong>’s segments, decreasing in<br />

about 2% in 2011 <strong>and</strong> 2012 due to the transition process; nevertheless, from 2013 on it<br />

will tend to increase in about 2% year. However, with the merger this segment might be<br />

challenged, due to the new strategy focus <strong>and</strong> partnership with Micros<strong>of</strong>t, which is<br />

somehow a Micros<strong>of</strong>t’s competitor (Siemens), in terms <strong>of</strong> equipment <strong>and</strong> peripherals<br />

(1% CAGR <strong>of</strong> revenues 2011-2015).<br />

6.2.2. Operating Expenses<br />

Looking at <strong>Nokia</strong>’s cost <strong>of</strong> revenues, one can figure that they have been representing<br />

more <strong>and</strong> less 63.5% <strong>of</strong> total revenues since 2008. In turn, cost <strong>of</strong> revenues seems to be<br />

flat according to the historical trend, thereby as revenues are expected to decrease until<br />

2012, the cost <strong>of</strong> revenues will also decrease, assuming its weight as a percentage <strong>of</strong><br />

revenues – 63.5% - will be kept in the following years.<br />

Regarding to Research & Development expenses, as it was referred before, this item<br />

will tend to decrease as a part <strong>of</strong> the new restructuring plan headed by the new<br />

leadership team (Stephen Elop). Indeed, R&D represents 13.3% <strong>of</strong> total revenues on<br />

average. As innovation is one <strong>of</strong> the main secrets for the Micros<strong>of</strong>t success, in the<br />

future, <strong>Nokia</strong>’s R&D expenses will follow the historical trend average <strong>and</strong> in the<br />

medium <strong>and</strong> long term – from 2016 on – this item might be shared with Micros<strong>of</strong>t.<br />

Concerning to Sales & Marketing item, which represented on average in the last three<br />

years a tendency <strong>of</strong> 9% <strong>of</strong> revenues, it is expected to decrease from 2011 on due to the<br />

<strong>Nokia</strong>’s market-share loss as a consequence <strong>of</strong> Google <strong>and</strong> Apple success. <strong>The</strong>refore, it<br />

is assumed a value equals to 9% on the next years. Furthermore <strong>and</strong> with the merger in<br />

place, <strong>Nokia</strong> may take advantage <strong>of</strong> the strong Micros<strong>of</strong>t’s Marketing support to<br />

achieve the network effects – increase the user numbers, attract more customers.<br />

With regard to General <strong>and</strong> Administrative expenses, its weight as a percentage <strong>of</strong> total<br />

revenues has been kept at 2.6% <strong>of</strong> revenues, <strong>and</strong> the same trend is assumed until 2015.<br />

Concerning to Employee Severance item, it has been null over the past three years.<br />

Nonetheless, from 2011 on <strong>Nokia</strong> is expected to start cutting <strong>of</strong>f on jobs <strong>and</strong> its<br />

respective personnel expenses in about 1% <strong>of</strong> total revenues year-over-year, being<br />

considered another major strategy shift taken by the new leadership.<br />

Depreciation <strong>and</strong> Amortization, as it represented 4.5% <strong>of</strong> total assets based on the<br />

historical trends, thus in the following years it is assumed to be in line with the current<br />

tendency. <strong>The</strong> provision for income taxes from 2011 on, it is expected to follow the<br />

corporate tax rate <strong>of</strong> 26%.<br />

In terms <strong>of</strong> Dividends as it was done with Micros<strong>of</strong>t, it is expected the same value until<br />

2015 as a way to keep capital structures <strong>and</strong> cash at constant levels, as well as to build a<br />

strong balance sheets. In fact, <strong>Nokia</strong> should follow its restructuring plan initiated in<br />

2010 by the new Board <strong>of</strong> Directors as well as, the telecommunications market trend<br />

towards a reduction <strong>of</strong> costs, focus in turn on, the new tablets <strong>and</strong> smartphone segment<br />

as Apple <strong>and</strong> Google did.<br />

6.2.3. Assets, Liabilities <strong>and</strong> Equity<br />

Starting by Assets, cash <strong>and</strong> short-term investments are expected to decrease 10% in<br />

2011 due to the pre-merger agreement <strong>and</strong> from 2012 on, the total cash <strong>and</strong> short-term<br />

investments are expected to increase 5% a year. Concerning to the accounts receivable<br />

<strong>and</strong> inventories, both will follow the historical tendency <strong>of</strong> growth, representing 29.6%<br />

<strong>and</strong> 5.25% <strong>of</strong> total revenues respectively. In turn, the accounts payable will follow the<br />

cost <strong>of</strong> revenues’ average tendency <strong>of</strong> growth – 19.6%. Regarding to the Short-term<br />

debt, on the next five years the short-term debt will be considered the same value as<br />

2010 (appendix 18), while the Long-term debt will decrease will decrease 4% until<br />

2012, as the historical trend from 2009 to 2010, <strong>and</strong> from 2013 to 2015, with the post-<br />

transition phase, it is expected to start increasing in about 4%, according to the<br />

Goldman Sachs projections. As opposite to Micros<strong>of</strong>t, <strong>Nokia</strong> considered minority<br />

interests according to the previous annual reports; hence, non-controlling interests for<br />

the next 5 years will be 14.5% <strong>of</strong> total Retained earnings <strong>and</strong> common stock per year,<br />

following the historical tendency (2008-2010).<br />

6.2.4. Net Working Capital<br />

Net Working Capital represents the amount <strong>of</strong> money that a firm has in order to operate<br />

day-by-day. According to the formula already mentioned as well as, the composed<br />

items <strong>and</strong> its respective projections, the <strong>Nokia</strong>’s NWC over the last three years has been<br />

relatively stable, directly correlated with the total revenues. <strong>The</strong>reupon, the expected<br />

NWC value is expected to be the direct application <strong>of</strong> the formula.<br />

6.2.5. Capital Expenditures<br />

<strong>Nokia</strong>’s CAPEX over the last three years has been very unstable, being impossible to<br />

come up with a historical trend. Further, <strong>Nokia</strong> has been cutting in capital expenditures<br />

since the beginning <strong>of</strong> the economic downturn (appendix 19). However <strong>and</strong> in a near<br />

future, more precisely, from 2011 on, <strong>Nokia</strong> must start investing more <strong>and</strong> more in the<br />

new tablet <strong>and</strong> smartphones infrastructures due to the two other powerful ecosystems –<br />

Google <strong>and</strong> Apple. Moreover, <strong>Nokia</strong>’s restructuring plan contains in itself <strong>and</strong> by<br />

nature, an increase in the capital expenses in order to accomplish with its goals <strong>and</strong><br />

market-leader’ duties. <strong>The</strong>reby, on the next three years, CAPEX is assumed to be equal<br />

to the average <strong>of</strong> past year’s values, which is equal to 37.4% <strong>and</strong> from 2014 on,<br />

assuming a more stable stage, CAPEX will be equal to Depreciation <strong>and</strong> Amortization.<br />

In fact, this new investments <strong>and</strong> corresponding growth in CAPEX should be viewed by<br />

<strong>Nokia</strong> as a way to come up with a sustainable differentiation business model <strong>and</strong><br />

products in order to compete against Google <strong>and</strong> Apple.<br />

6.2.6. Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital<br />

After the calculation <strong>of</strong> the FCFF, it is now necessary to compute the respective<br />

discount rate – WACC - bearing in mind that in order to compute the firm value, it is<br />

going to be used the WACC methodology. Additionally, the assumptions taken to<br />

calculate the discount rate <strong>of</strong> <strong>Nokia</strong> cash-flows will be quite similar to those used in<br />

Micros<strong>of</strong>t’s valuation, as well as the formulas. Firstly, <strong>Nokia</strong>’s rating – AAA <strong>and</strong> Aaa -<br />

is considered the same as the Finl<strong>and</strong>’s rating according to S&P’s <strong>and</strong> Moody’s credit<br />

rating agencies (appendixes 7 <strong>and</strong> 8). In turn, the Finnish risk free rate is 2.52%<br />

according to the IMF’s website, <strong>and</strong> the total risk premium in January 2011 is<br />

considered 5% according to Damodaran (2008). Concerning to the unlevered beta in the<br />

Telecommunications Equipment industry in Europe, it is assumed to be 0.86 (appendix<br />

9).<br />

<strong>The</strong> cost <strong>of</strong> capital ( ) will be the sum <strong>of</strong> the risk-free rate with the default risk<br />

according to the <strong>Nokia</strong>’s probability <strong>of</strong> default, which is 0.50%, in a word, cost <strong>of</strong> debt<br />

capital will be equal to 3.02%. Concerning to the corporate tax rate applied in the<br />

Finnish market, it is 26% (Damodaran’s website) <strong>and</strong> the <strong>Nokia</strong>’s capital structure at<br />

market values is 11.57%, so the debt’s weight is almost 1/8 <strong>of</strong> equity. Regarding the<br />

diluted number <strong>of</strong> shares outst<strong>and</strong>ing in 2010, this item was around 3,713 Billion <strong>of</strong><br />

shares. At the same time, the minority interest was $2.604 Billion USD, thus the<br />

enterprise value is the sum <strong>of</strong> Equity value plus Net Debt <strong>and</strong> the non-controlling<br />

interests. As result, the unlevered cost <strong>of</strong> equity is expected to be 6.82%, while the<br />

levered cost <strong>of</strong> equity is 7.22%, since instead <strong>of</strong> using the unlevered beta (0.86), one<br />

uses the levered beta (0.94); lastly, the WACC is 6.64%. All this considered, the<br />

<strong>Nokia</strong>’s Enterprise value through the WACC method is $48.620 Billion USD <strong>and</strong> the<br />

price target for <strong>Nokia</strong> using the same method is $10.98 USD.<br />

6.2.7. Sensitivity Analysis<br />

After the base-case scenario valuation, now it is going to be taken different assumptions<br />

in order to analyze the changes in the firm value. Indeed, Telecommunications industry<br />

is labeled as competitive, innovative, with constant developments, thus the<br />

considerations made before may not concretize in the future. Firstly, it is considered<br />

changes in revenues, operating expenses <strong>and</strong> terminal growth rate. <strong>The</strong> bear-case<br />

scenarios assumes revenues <strong>and</strong> terminal growth rate 1% lower for each <strong>of</strong> the<br />

following years <strong>and</strong> operating expenses 1% higher (appendix 22); while the bull-case<br />

scenario assumes revenues <strong>and</strong> terminal growth rate 1% higher <strong>and</strong> operating expenses<br />

1% lower (appendix 23). Thus, for the bear-case situation the price target would be<br />

$6.86 <strong>and</strong> for the bull-case scenario it would be $14.78. In conclusion, this sensitivity<br />

analysis allows us to claim that <strong>Nokia</strong> is overvalued, since the price target under the<br />

bear-case scenario is still smaller than the stock price at May, 13.<br />

6.2.8. Multiples Valuation<br />

In this case, the Relative valuation method will compare <strong>Nokia</strong> with similar companies<br />

operating in the Telecommunications Equipment Industry based on similar growth <strong>and</strong><br />

risk levels. This is an industry that shows a bit more internationalization with several<br />

Europeans <strong>and</strong> Asiatic companies, though 40% <strong>of</strong> the Peer Group is composed by U.S.<br />

headquartered companies. <strong>The</strong> same source (Reuters) <strong>and</strong> method was applied in the<br />

computation <strong>of</strong> the financial indicators for 2011 (Figure 30). Looking at the ratios,<br />

<strong>Nokia</strong> is more <strong>and</strong> less in line with the industry.<br />

Alcatel-Lucent FRA 6,10 7,924 17,07 1,62 0,33 0,32 3,36 7,00<br />

Cisco Systems USA 16,88 84,263 13,17 1,78 1,95 1,23 4,20 4,77<br />

LG Electronics KOR 18,46 8,698 0,66 0,16 0,23 6,32 13,14<br />

Motorola USA 46,65 13,873 21,81 2,06 0,96 1,23 6,73 8,05<br />

Qualcomm USA 57,12 82,206 18,65 3,12 5,96 4,89 11,30 12,70<br />

RIM CAN 43,24 15,306 4,63 1,60 0,74 0,57 2,55 3,30<br />

Samsung KOR 852,89 110,584 7,53 1,08 0,76 0,52 3,14 5,39<br />

TomTom NV NED 8,53 656 1,00 0,45 0,66 3,86 6,45<br />

ZTE CHN 3,38 9,933 17,72 2,43 0,90 0,84 10,30 15,70<br />

Average 162,57 127,93 14,97 2,03 1,76 1,57 5,88 8,35<br />

<strong>Nokia</strong> FIN 8,66 32,11 12,03 1,50 0,55 0,83 7,73 12,46<br />

Figure 30: <strong>Nokia</strong> Peer Group<br />

Indeed, this multiple valuation only confirms that <strong>Nokia</strong> stock price is somehow<br />

undervalued since the P/Sales ratio in lower than 1. This is also a complement which<br />

underlies the WACC methodology results.<br />

7. Valuation <strong>of</strong> the Merged Entity<br />

Following the Damodaran’s approach (2005), the next step in order to compute the<br />

synergies created by combining Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> is to estimate the enterprise value<br />

<strong>of</strong> the combined firm without synergies in place. Hence, Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong><br />

projections will be combined, bearing in mind the same considerations as each<br />

st<strong>and</strong>alone valuation, in order to isolate the value <strong>of</strong> synergies. Additionally, the<br />

obtained enterprise value must equal to the sum <strong>of</strong> the st<strong>and</strong>alone enterprise values <strong>of</strong><br />

each firm independently valued. After that, the last valuation phase consists <strong>of</strong><br />

computing the value <strong>of</strong> synergies, as the difference between the value <strong>of</strong> the combined<br />

corporation with synergies (called Microsokia) <strong>and</strong> the value <strong>of</strong> the combined firm<br />

without synergies. This merger between Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> will lead to a stronger<br />

position for the new entity in the market.<br />

7.1. Valuation <strong>of</strong> the Merged Entity without Synergies<br />

<strong>The</strong> valuation <strong>of</strong> the combined firm without synergies will follow the same assumptions<br />

considered before using only the WACC methodology; therefore the results obtained<br />

must be equal to the sum <strong>of</strong> the st<strong>and</strong>alone firm values <strong>of</strong> each independent firm - the<br />

new Income Statement, Balance Sheet <strong>and</strong> CAPEX are presented in the respective<br />

appendixes – (Appendixes 24, 25 <strong>and</strong> 26). Nonetheless, this is considered a cross-border<br />

valuation since the performers – acquirer <strong>and</strong> target – are headquartered an operated in<br />

different countries, thus certain implications must be explained with respect to financial<br />

leverage <strong>and</strong> cost <strong>of</strong> capital items.<br />

7.1.1. Revenues<br />

Concerning to the revenues <strong>and</strong> taking into account that <strong>Nokia</strong> mainly operates in the<br />

wireless h<strong>and</strong>set market as Micros<strong>of</strong>t - Entertainment & Devices Division – despite it<br />

has a larger portfolio <strong>of</strong> products <strong>and</strong> services, the new merged entity will focus<br />

essentially on the smartphones <strong>and</strong> tablets sector as well as the computer equipment <strong>and</strong><br />

peripherals, in a word, D&S, EDD, W&WLD <strong>and</strong> MBD segments. Regarding to the<br />

other segments, they will all continue in the new entity.<br />

7.1.2. Financial Leverage <strong>and</strong> Cost <strong>of</strong> Capital<br />

<strong>The</strong> valuation <strong>of</strong> Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> as it was mentioned before, it is considered a<br />

cross-border valuation <strong>and</strong> thereby certain considerations must be taken, despite in<br />

some items both face the same trends. Starting with the currency rate, the <strong>Nokia</strong><br />

financial data is already in $USD, assuming: 1€ is equal to $1.41 USD as the exchange<br />

rate. According to Froot <strong>and</strong> Kester (1995), the corporate tax rate used in such situations<br />

should be the higher tax rate, thus the U.S Corporate tax rate is the one adopted (35%).<br />

As Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> belongs to different industry sectors, the unlevered beta will be<br />

the average <strong>of</strong> unlevered betas weighted by the firm value <strong>of</strong> each company – 1.08. <strong>The</strong><br />

risk premium is equal in both cases, thus 5% will considered in the valuation process,<br />

while the risk-free rate will be assumed the foreign risk free rate, which is in this case,<br />

the U.S risk-free rate – 2.10%. As a consequence the cost <strong>of</strong> debt will be the U.S cost <strong>of</strong><br />

debt – 2.60%. As a result, the levered beta is expected to be 1.095; the unlevered <strong>and</strong><br />

levered cost <strong>of</strong> equity will be 7.48% <strong>and</strong> 7.58% respectively; finally the terminal growth<br />

rate is assumed as the average <strong>of</strong> US <strong>and</strong> Finnish terminal growth rates – 4.90%. With<br />

all the gathered information, the discount rate – WACC – is expected to be 7.46%.<br />

<strong>The</strong>reupon <strong>and</strong> using the WACC method (Appendix 27), an enterprise value <strong>of</strong><br />

$281.067 Billion USD corresponding to the merged entity without synergies was<br />

obtained, being equal to the sum <strong>of</strong> both firm values (Micros<strong>of</strong>t - $232.447 Billion<br />

USD; <strong>Nokia</strong> - $48.620 Billion USD). Moreover, the WACC’s method terminal value is<br />

more than double <strong>of</strong> explicit value because the majority <strong>of</strong> cash-flows are expected to be<br />

realized late in the business development. Additionally, the number <strong>of</strong> outst<strong>and</strong>ing<br />

shares was not yet computed because it will depend on the type <strong>of</strong> acquisition<br />

(Loughran & Vijh, 1997).<br />

7.2. Synergies<br />

After the calculation <strong>of</strong> the merged entity value without synergies, from now on the<br />

focus <strong>of</strong> analysis will be the new opportunities resulting from combining both firms –<br />

synergies. Indeed, the h<strong>and</strong>set market is characterized by its intense competition <strong>and</strong><br />

technological improvements, with the appearance <strong>of</strong> new devices <strong>and</strong> updates day-by-<br />

day. In turn, once we are in a post-financial downturn period, the cost reduction is still<br />

fundamental. In this consolidation process <strong>of</strong> Micros<strong>of</strong>t with <strong>Nokia</strong>, only operating<br />

synergies will be created <strong>and</strong> thus approached: cost synergies <strong>and</strong> revenue synergies. In<br />

fact, the combined enterprise shall become more cost-efficient <strong>and</strong> pr<strong>of</strong>itable; moreover,<br />

combining its different strengths, Micros<strong>of</strong>t’s strong capital structure <strong>and</strong> marketing<br />

campaign with <strong>Nokia</strong>’s product line <strong>and</strong> hardware expertise, the combined entity may<br />

achieve new markets <strong>and</strong> higher growth in existing ones.<br />

7.2.1 Cost Synergies<br />

First <strong>of</strong> all, costs are the most reliable source <strong>of</strong> synergy, once with the combination <strong>of</strong><br />

efforts, a reduction on the operating expenses is possible to achieve. Moreover, cost<br />

synergies are characterized by its fast implementation <strong>and</strong> perpetual results. <strong>The</strong>reby, in<br />

the Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> case, cost synergies will be computed by saving in the<br />

operating expenses <strong>and</strong> they are expected to take effect from 2011 onwards.<br /> Cost <strong>of</strong> Revenues<br />

This consolidation process between Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> shall lead to a considerable<br />

cost reduction <strong>of</strong> in the Entertainment & Devices Division <strong>and</strong> in the Devices &<br />

Services segment (a more pr<strong>of</strong>itable segment than EDD segment). In fact, they will be<br />

focus on the same target – smartphones <strong>and</strong> tablets – therefore it does not make sense to<br />

continue operating independently <strong>and</strong> a cost reduction is possible. At the same time, as<br />

NAVTEQ <strong>and</strong> Online Services Division are directly correlated with the smartphone<br />

segment through maps <strong>and</strong> Bing, as the new search engine for the devices, combining<br />

the strengths <strong>of</strong> each segment, an additional value might be created. Regarding the<br />

Windows & Windows Live Division as well as the Micros<strong>of</strong>t Business Division, they<br />

are expected to continue performing according to the historical trend, as well as, the<br />

Server & Tools division which is correlated with the W&WLD. <strong>The</strong> <strong>Nokia</strong> Siemens<br />

Networks, as business solutions provider in a medium-term might be considered a<br />

combination with Micros<strong>of</strong>t Business Division, since it also provides enterprise<br />

solutions <strong>and</strong> it is a more developed <strong>and</strong> pr<strong>of</strong>itable segment. However, this is<br />

disregarded in the cost synergies. In conclusion, the combined reduction in the cost <strong>of</strong><br />

revenues <strong>of</strong> the merged entity should 1.5% due to the synergies between EDD <strong>and</strong> D&S<br />

segments. Indeed, EDD represents 25% <strong>of</strong> Micros<strong>of</strong>t operating expenses <strong>and</strong> Micros<strong>of</strong>t<br />

represents 40% <strong>of</strong> total operating expenses <strong>of</strong> the new entity, thus a reduction <strong>of</strong> 15% <strong>of</strong><br />

Micros<strong>of</strong>t’s cost <strong>of</strong> revenues represents 1.5% cut in the global cost <strong>of</strong> revenues. In fact,<br />

15% is the value contemplated for the cost synergies in consolidated processes among<br />

telecommunication industry, according to the historical trends (Damodaran’s website).<br /> Sales & Marketing, General & Administrative <strong>and</strong> R&D<br />

In fact, both companies have a strong br<strong>and</strong> image <strong>and</strong> br<strong>and</strong> awareness with respect to<br />

the customers. As a consequence, a combination <strong>of</strong> EDD <strong>and</strong> D&S, in a word, the<br />

Windows Phone 7 with <strong>Nokia</strong> devices, it will even create a stronger br<strong>and</strong>. Concerning<br />

to the Windows br<strong>and</strong> – W&WLD – it should keep in a segment with direct correlation<br />

with MBD <strong>and</strong> NSN segments. Indeed, <strong>Nokia</strong> expertise in hardware design, language<br />

support <strong>and</strong> operating billing agreements, the EDD product – Windows Phone 7 – will<br />

be brought to a larger range <strong>of</strong> price points, market segments <strong>and</strong> geographies. At the<br />

same time, Micros<strong>of</strong>t adCenter will provide search advertising services on <strong>Nokia</strong>’s line<br />

<strong>of</strong> devices <strong>and</strong> services. <strong>Nokia</strong> Maps will be the “core” part <strong>of</strong> Micros<strong>of</strong>t’s mapping<br />

services <strong>and</strong> in turn, those maps will be integrated with Bing search engine <strong>and</strong><br />

adCenter advertising platform to form a new local search <strong>and</strong> advertising platform. All<br />

these strengths might be combined because in fact, they can be transferable across<br />

businesses. Additionally, as a way to integrate both corporate cultures, the new entity<br />

will be called Microsokia. As so, <strong>Nokia</strong> may reduce its sales <strong>and</strong> marketing expenses<br />

due to the strong Micros<strong>of</strong>t Marketing support <strong>and</strong> Yahoo! agreement as a convergence<br />

<strong>of</strong> efforts. Regarding the general <strong>and</strong> administrative expenses, cost savings are<br />

insignificant in this case. Concerning to the R&D, due to the Micros<strong>of</strong>t’s long-term<br />

approach to R&D <strong>and</strong> one <strong>of</strong> the main keys to success, the convergence <strong>of</strong> strengths by<br />

Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> may lead to a cost saving. All this considered, sales <strong>and</strong> marketing<br />

shall decrease 1.5% mainly because <strong>of</strong> the EDD <strong>and</strong> D&S convergence <strong>of</strong> efforts as<br />

well as, R&D in the same amount, <strong>and</strong> it was obtained from the same cost <strong>of</strong> revenues<br />

equation.<br /> Employee Severance<br />

Firstly, the impact <strong>of</strong> such cost reduction is considered quite small. However, this new<br />

policy is already put in practice in both companies. In the case <strong>of</strong> <strong>Nokia</strong>, it makes part<br />

<strong>of</strong> the new restructuring plan, thereby no cost reductions will considered in this item.<br /> CAPEX<br />

CAPEX is also considered a way to obtain cost synergies. Nonetheless, the combined<br />

entity do not contemplate cost reductions because both companies already consider<br />

more investments in the segments in order to increase their positions <strong>and</strong> market-share,<br />

as well as, face the tough competition. <strong>The</strong>reupon, the purpose should be once again,<br />

the combination <strong>of</strong> both investments in order to deliver a new entity with unrivaled<br />

global reach <strong>and</strong> scale, so new investments will be required as a way to own higher<br />

growth potential in existing <strong>and</strong> emerging markets.<br />

7.2.2. Revenue Synergies<br />

Revenue synergies depend on competitors <strong>and</strong> customer reaction, <strong>and</strong> they are harder to<br />

get. In fact, they tend to be deferred until the business is stabilized – medium <strong>and</strong> long-<br />

term. Once again, these synergies can be achieved through a combination <strong>of</strong> different<br />

functional strengths. In this case, revenues synergies will assume gains in the Windows<br />

<strong>and</strong> Windows Live Division as well as, <strong>Nokia</strong> Siemens Networks.<br /> Windows <strong>and</strong> Windows Live Division <strong>and</strong> <strong>Nokia</strong> Siemens Networks<br />

With a possible combination <strong>of</strong> these two segments, <strong>and</strong> the respective combination <strong>of</strong><br />

efforts, such assumption may create new benefits to the merged entity. WWLD is the<br />

second largest Micros<strong>of</strong>t segment by revenues, hence, in spite <strong>of</strong> high competition <strong>and</strong><br />

the threat <strong>of</strong> tablets, with the launch in 2012 <strong>of</strong> the Windows 8, this segment will be<br />

perpetually higher in 1% from 2012 onwards. It is considered a reduced approach<br />

because it is already by itself a pr<strong>of</strong>itable segment due to business solutions – <strong>Nokia</strong><br />

Siemens Networks - <strong>and</strong> Windows OS. In the NSN segment, the synergies expectations<br />

are considered only 1% from 2013 on, since the forecasted growth in this segment on<br />

the <strong>Nokia</strong>’s st<strong>and</strong>alone valuation already included at Micros<strong>of</strong>t’s operating expenses. In<br />

turn, this joint-venture with Siemens shall be kept; despite it is somehow considered a<br />

Micros<strong>of</strong>t competitor in terms <strong>of</strong> computer peripherals.<br />

7.2.3. Integration Costs<br />

<strong>The</strong> new opportunities generated by combining Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> come at a specific<br />

cost – integration costs. Indeed, the total net synergies value will be only obtained after<br />

taking out such costs from the value <strong>of</strong> all synergies. However, their estimation requires<br />

internal information about Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong>, which is not the case; thereby certain<br />

assumptions will be considered towards the integration cost calculations. <strong>The</strong>se<br />

integration costs include legal costs with law firms who defend the interest <strong>of</strong> both<br />

parts, workforce reduction costs which is considered a gain in the future but in fact, it is<br />

a cost today – compensation for the job cut -, consulting project costs regarding<br />

repositioning <strong>of</strong> the new company (combined entity) <strong>and</strong> finally, costs related to the<br />

need <strong>of</strong> building a new br<strong>and</strong> entity for the new company – Microsokia. All in all,<br />

integration costs will be considered to be 5% <strong>of</strong> <strong>Nokia</strong> sales which is considered the<br />

average amount in this industry (Damodaran’s website). <strong>Nokia</strong> sales represent basically<br />

50% <strong>of</strong> new entity sales, so the cut will be approximately 2.5% <strong>of</strong> sales in the new<br />

entity with synergies. <strong>The</strong>se costs will be higher initially in order to create impact in the<br />

market, therefore 1.5% in 2011, 0.5% in 2012, 0.4% in 2013 <strong>and</strong> 0.35% in 2014.<br />

7.3. Valuation <strong>of</strong> the Merged Entity with Synergies<br />

<strong>The</strong> valuation <strong>of</strong> the combined firm with synergies will follow the same assumption<br />

considered before using the WACC methodology. <strong>The</strong>refore, the value <strong>of</strong> synergies will<br />

correspond to the difference between the value obtained here with all the synergies <strong>and</strong><br />

the enterprise merged entity value without synergies (Appendixes 28, 29, 30 <strong>and</strong> 31).<br />

As a result, it is essential to compute the value <strong>of</strong> each synergy in order to calculate the<br />

firm value with synergies.<br />

7.3.1. Value <strong>of</strong> Synergies<br />

<strong>The</strong> total value <strong>of</strong> synergies estimated for the consolidation <strong>of</strong> Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> is<br />

$8.396 Billion USD. However due to the integration costs which are $3.095 Billion<br />

USD, the value <strong>of</strong> net synergy is $5.301 Billion USD (Figure 31).<br />

(in Millions) Value <strong>of</strong> Synergy % <strong>of</strong> Total Synergies<br />

Revenue Synergies<br />

Windows & Windows Live Division 952 11%<br />

<strong>Nokia</strong> Siemens Networks 882 10,50%<br />

Total 1,884 22,50%<br />

Cost Synergies<br />

Cost <strong>of</strong> Revenues 3,578 42,50%<br />

Sales <strong>and</strong> Marketing 1,572 19,00%<br />

Research & Development 1,362 16%<br />

Total 6,512 77,50%<br />

Total Value <strong>of</strong> Synergies 8,396 100%<br />

Integration Costs 3,095<br />

Total Net Synergies 5,301<br />

Figure 31: Value <strong>of</strong> Synergies<br />

As it was mentioned before, in fact cost synergies are the most reliable source <strong>of</strong><br />

synergy which in this case represents 77.5% <strong>of</strong> total net synergies, while the 22.5%<br />

elongs to the revenue synergies. Concerning to the Integration costs, they represent<br />

around 58% reflecting high need to invest in the internal market in order avoid the<br />

damage <strong>of</strong> employees motivation when they misunderst<strong>and</strong> their function within the<br />

new merged enterprise taking into account, we are dealing with different corporate<br />

cultures.<br />

8. <strong>The</strong> Acquisition Process<br />

This acquisition <strong>and</strong> consolidated process considers that Micros<strong>of</strong>t will acquire <strong>Nokia</strong>.<br />

In fact, Micros<strong>of</strong>t has a bigger dimension than <strong>Nokia</strong>, as well as, equity availability.<br />

Moreover, <strong>Nokia</strong> ownership structure is more concentrated than Micros<strong>of</strong>t ones, with<br />

721 owners, 17.4% registered in Finl<strong>and</strong>, thus it is easier to get control in an acquisition<br />

<strong>of</strong> Micros<strong>of</strong>t. Micros<strong>of</strong>t ownership structure contemplates 6493 owners. In turn, the new<br />

leadership team headed by Stephen Elop (ex President <strong>of</strong> Micros<strong>of</strong>t Business Division)<br />

may already have a certain availability to listen the Micros<strong>of</strong>t proposal, since it has<br />

already worked in Micros<strong>of</strong>t. <strong>The</strong> third reason that justifies this acquisition proposal by<br />

Micros<strong>of</strong>t is the fact that the computer s<strong>of</strong>tware leading company has a weak presence<br />

in the smartphone <strong>and</strong> h<strong>and</strong>set market, so it may take advantage <strong>of</strong> a more consistent<br />

<strong>and</strong> mature position in such segments as <strong>Nokia</strong>. Additionally, the growth potential for<br />

Micros<strong>of</strong>t is high which allows building a more competitive <strong>and</strong> stronger company,<br />

represented in the all segments. Nevertheless, one shall bear in mind that both<br />

companies were <strong>and</strong> still are market leaders in their respective segments, thus a new <strong>and</strong><br />

unprecedented ecosystem may burst threatening the Apple’s <strong>and</strong> Google’s current<br />

market-power.<br />

8.1.Type <strong>of</strong> Acquisition<br />

In the case <strong>of</strong> Micros<strong>of</strong>t acquiring <strong>Nokia</strong>, a tender <strong>of</strong>fer will be considered the mode <strong>of</strong><br />

acquisition. As a result, Micros<strong>of</strong>t should make an <strong>of</strong>fer to <strong>Nokia</strong>’s shareholders (at<br />

least, 51% <strong>of</strong> them must accept the tender) in order to buy <strong>Nokia</strong>’s outst<strong>and</strong>ing stocks at<br />

a specific price. This proposal should contemplate a high price in order to be perceived<br />

by target shareholders as a friendly proposal <strong>and</strong> to accelerate the culture assimilation<br />

process.<br />

8.2. Synergy Benefits<br />

<strong>The</strong> sharing <strong>of</strong> synergy returns should depend on the effort <strong>and</strong> skills disbursed by<br />

Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> for the existence <strong>of</strong> such additional value. In this case, the cost<br />

synergies arise mainly from the Micros<strong>of</strong>t’s side, in the case <strong>of</strong> cost <strong>of</strong> revenues due to<br />

the <strong>Nokia</strong>’s higher skills in the Devices & Services segment, while the revenue<br />

synergies are created more <strong>and</strong> less by both sides. In fact, Micros<strong>of</strong>t will benefit more<br />

from the synergies created than <strong>Nokia</strong>, since <strong>Nokia</strong> has recently lost its pole-position in<br />

the h<strong>and</strong>set market to Apple; despite Micros<strong>of</strong>t has also lost market-share in some<br />

segments as the smartphones OS, it still has a more stable position than <strong>Nokia</strong>. All in<br />

all, the post-acquisition returns will be based on the enterprise values <strong>of</strong> each company.<br />

Micros<strong>of</strong>t’s enterprise value represents 82.7% <strong>of</strong> the firm value <strong>of</strong> the merged entity<br />

without synergies, thus it should receive 82.7% <strong>of</strong> the net synergies, which means<br />

$4.384 Billion USD, while <strong>Nokia</strong> will only receive 17.3% <strong>of</strong> net synergies representing<br />

$0.917 Billion USD. <strong>The</strong>reby, Micros<strong>of</strong>t’s proposal to <strong>Nokia</strong> should also reflect the<br />

<strong>Nokia</strong>’s percentage <strong>of</strong> total net synergies.<br />

8.3. Premium Offered<br />

<strong>Nokia</strong>’s average market capitalization during the last year (2010) was $40.639 Billion<br />

USD, but its st<strong>and</strong>alone valuation considers<br />

an equity value equals to $40.694 Billion<br />

USD (0.14% upside potential).<br />

Additionally, the new <strong>Nokia</strong>’s equity value<br />

with synergies is $41.611 Billion USD<br />

(2.25% upside potential compared to<br />

st<strong>and</strong>alone equity value). All this<br />

considered, the total premium <strong>of</strong>fered to last<br />

year’s market capitalization is 19.4%<br />

(Figure 32). Figure 32: Premium Offered<br />

8.4. Method <strong>of</strong> Payment<br />

(in millions)<br />

Micros<strong>of</strong>t's Acquisition <strong>of</strong> <strong>Nokia</strong><br />

Value <strong>of</strong> Synergies 5,301<br />

% <strong>of</strong> <strong>Nokia</strong>'s average market cap. 13.04%<br />

% synergies paid to <strong>Nokia</strong> 17.3%<br />

Value <strong>of</strong> Synergies paid to <strong>Nokia</strong> 917<br />

<strong>Nokia</strong>'s Market cap. (average last year) 40.639<br />

<strong>Nokia</strong>'s Equity value 40.694<br />

<strong>Nokia</strong>'s Equity value with synergies 41.611<br />

Total Premium Offered 19.4%<br />

According to Martin (1996), tender <strong>of</strong>fers are usually financed with cash. However<br />

several considerations should be made before. If Micros<strong>of</strong>t is going to pay with cash<br />

which means <strong>and</strong> additional debt issuance, it is showing a high confidence in the<br />

acquisition process <strong>and</strong> thus, it will get the majority <strong>of</strong> post-merger synergy benefits, as<br />

it is the case. Nonetheless, the rating agencies’ considerations shall also bear in mind,<br />

since it is essential to keep the investment grade rating. In general, markets consider a<br />

BBB rating (in the S&P’s rating) as the lowest investment grade rating, which<br />

corresponds to a Net Debt/EBITDA ratio not exceeding 3.75 times (Damodaran’s<br />

website). <strong>The</strong> Figure 33 summarizes the Debt capacity <strong>of</strong> Microsokia, on which the<br />

maximum additional debt that the merged can sustain is $107.093 Billion USD.<br />

2011 Forecasts (in millions) Micros<strong>of</strong>t <strong>Nokia</strong> Microsokia BBB rating requisite Microsokia with extra Leverage<br />

Cash 5,505 2,476 7,981 7,981<br />

Net Debt 3,784 5,358 9,142<br />

EBITDA 24,704 6,292 30,996<br />

EBIT 21,648 3,903 25,551<br />

116,235<br />

30,996<br />

25,551<br />

Net Debt/EBITDA 0,153 0,85 0,295

9. Conclusion<br />

<strong>The</strong> constant technological improvements <strong>and</strong> competition in the Global Mobile<br />

Industry, as well as, the appearance <strong>of</strong> new devices – tablets <strong>and</strong> smartphones – which<br />

are today almost a “must” among newer <strong>and</strong> older customers has been challenging the<br />

main players’ leadership <strong>and</strong> business model. <strong>The</strong>reby, a consolidation between these<br />

two complementary firms as Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> must be a good way to achieve<br />

success in these new trendy segments <strong>and</strong> to achieve the network effects that would not<br />

be possible whether these companies operated independently. In turn, this new entity<br />

called Microsokia will be in a better position to compete against the two main<br />

competitors –Google <strong>and</strong> Apple.<br />

Regarding the new opportunities resulting from the merger between Micros<strong>of</strong>t <strong>and</strong><br />

<strong>Nokia</strong>, they will come mainly from the combination <strong>of</strong> efforts <strong>and</strong> skills which will<br />

result in higher growth potential <strong>and</strong> cost savings. Considering the <strong>Nokia</strong>’s hardware<br />

expertise <strong>and</strong> global distribution network with Micros<strong>of</strong>t’s s<strong>of</strong>tware wisdom <strong>and</strong><br />

pr<strong>of</strong>itability, a new ecosystem will emerge into the market. Essentially focus on the<br />

tablet segment, the <strong>Nokia</strong>’s respective segment –Devices <strong>and</strong> Services – which has<br />

already a sophisticated background <strong>and</strong> track on the segment will merge with the<br />

Entertainment <strong>and</strong> Devices Division from Micros<strong>of</strong>t which is characterized by its<br />

modern <strong>and</strong> appellative products <strong>and</strong> services. In sum, this consolidation process shall<br />

create synergies in costs <strong>and</strong> revenues, with the bigger section belonging to the cost<br />

synergies – 77.50% <strong>of</strong> total net synergies; the rest is considered revenue synergies.<br />

Concerning to the acquisition which will be totally financed with cash, Micros<strong>of</strong>t shall<br />

acquire <strong>Nokia</strong> through a tender <strong>of</strong>fer targeting directly the <strong>Nokia</strong>’s shareholders.<br />

<strong>The</strong>reupon, the price <strong>of</strong>fered for <strong>Nokia</strong> will consists <strong>of</strong> its value as a st<strong>and</strong>alone firm<br />

plus its synergy benefits percentage – 17.3% <strong>of</strong> total net synergies.<br />

10. Appendixes<br />

Appendix 1: Micros<strong>of</strong>t’s SWOT analysis<br />

Strengths Weaknesses<br />

Worldwide leader in s<strong>of</strong>tware, services <strong>and</strong> solutions Insignificant presence in the wireless market<br />

Strong <strong>and</strong> stable capital structure Falling to anticipate the Internet <strong>and</strong> acting flexibly in the early days<br />

Long-term approach to R&D Employee turnover<br />

Br<strong>and</strong> Image <strong>and</strong> Br<strong>and</strong> Awareness Antitrust Track Record<br />

Opportunities Threats<br />

Increased friction/traction <strong>of</strong> tablets <strong>and</strong> smartphones segment Economic Environment<br />

Leading the Cloud transformation Competitive Industry (Apple's Threatening)<br />

Range & Quality <strong>of</strong> the product advances delivered Government litigation & regulation<br />

Consolidation with <strong>Nokia</strong> Threat <strong>of</strong> Piracy<br />

Appendix 2: Micros<strong>of</strong>t Corp. Institutional Ownership<br />

Appendix 3: <strong>Nokia</strong>’s SWOT analysis<br />

Worldwide largest manufacturer <strong>of</strong> Mobile Phones Few promotions regarding low price phones<br />

Expertise in Imaging, Maps <strong>and</strong> operator billing agreements Slow responsiveness (delayed product launches)<br />

Br<strong>and</strong> Name <strong>and</strong> Br<strong>and</strong> Awareness Reduced market share in U.S.<br />

Global Distribution network Ngage failure (first smartphone launched by <strong>Nokia</strong>)<br />

<strong>Nokia</strong>’s new Executive Board Competitive <strong>and</strong> dynamic Industry<br />

Consolidation with Micros<strong>of</strong>t Economic Environment<br />

Growing <strong>and</strong> emerging market presence Strong price pressure from competitors<br />

Fashion <strong>and</strong> stylish h<strong>and</strong>set design Threat <strong>of</strong> entry from new players<br />

Use <strong>of</strong> NSN to reduce the mobile operators bargaining power<br />

Appendix 4: Top 10 M&A deals by technology companies in 2010<br />

Date Deal Value (US$ billion) Target Target country Acquirer Acquirer country<br />

January 2010 USD$8.29 billion Sun Microsystems Inc. USA Oracle Corp. USA<br />

July 2010 USD$7.94 billion Sybase Inc. USA SAP AG Germany<br />

February 2010 USD$7.86 billion Affiliated Computer Services Inc. USA Xerox Corp. USA<br />

April 2010 USD$3.97 billion Renesas Technology Corp. Japan NEC Electronics Corp. Japan<br />

October 2010 USD$3.49 billion Dimension Data Holdings plc. South Africa Nippon Telegraph & Telephone Corp. Japan<br />

April 2010 USD$3.02 billion 3Com Corp. USA Hewlett-Packard USA<br />

September 2010 USD$2.61 billion 3PAR Inc. USA Hewlett-Packard USA<br />

October 2010 USD$2.40 billion Intergraph Corp. USA Hexagon AB Sweden<br />

May 2010 USD$2.15 billion SkillS<strong>of</strong>t plc. Irel<strong>and</strong> Berkshire Partners; Bain Capital Partners; AIC USA<br />

November 2010 USD$2.08 billion Netezza Corp. USA IBM USA<br />

Appendix 5: International <strong>and</strong> Domestic Takeovers Map in 2010<br />

source: Dealogic, M&A Global, MergerMarket<br />

Appendix 6: Valuation Data in the American <strong>and</strong> Finnish markets<br />

Risk free (10 year government bond - USA) 2,10%<br />

Risk free (10 year government bond - Finl<strong>and</strong>) 2,52%<br />

Total Risk Premium (USA) 5%<br />

Total Risk Premium (Finl<strong>and</strong>) 5%<br />

IMF's expected Real Growth Rate (USA) 2,83%<br />

IMF's expected Inflation (USA) 2,15%<br />

Expected Future Growth Rate (USA) 4,98%<br />

IMF's expected Real Growth Rate (Finl<strong>and</strong>) 3,12%<br />

IMF's expected Inflation (Finl<strong>and</strong>) 1,70%<br />

Expected Future Growth Rate (Finl<strong>and</strong>) 4,82%<br />

Source: Damodaran's <strong>and</strong> IMF's website<br />

Appendix 7: St<strong>and</strong>ard & Poor’s rating: Default Spread by credit rating (USA <strong>and</strong><br />

Finl<strong>and</strong>)<br />

Country Rating Spread Prob.Default<br />

USA AAA 0,50% 0,02%<br />

Finl<strong>and</strong> AAA 0,50% 0,02%<br />

Source: Damodaran's website (May, 2011)<br />

US<br />

Industry NºFirms<br />

Appendix 8: Moody’s rating: Default Spread by credit rating (USA <strong>and</strong> Finl<strong>and</strong>)<br />

Rating Default Spread<br />

Aaa 0<br />

Aa1 25<br />

Aa2 50<br />

Aa3 70<br />

A1 85<br />

A2 100<br />

A3 115<br />

Baa1 150<br />

Baa2 175<br />

Baa3 200<br />

Ba1 240<br />

Ba2 275<br />

Ba3 325<br />

B1 400<br />

B2 500<br />

B3 600<br />

Caa1 700<br />

Caa2 850<br />

Caa3 1000<br />

Source: Damodaran's website (July, 2011)<br />

Appendix 9: Unlevered beta by industry in U.S. <strong>and</strong> Europe<br />

Average<br />

Beta<br />

Market D/E<br />

Ratio<br />

Tax<br />

Rate<br />

Unlevered<br />

Cash/Firm<br />

Value<br />

Unlevered beta corrected for cash<br />

Computer S<strong>of</strong>tware 247 1,06 4,68% 13,88% 1,02 9,48% 1,12<br />

Europe<br />

Telecom.<br />

Equipment 56 0,88 22,47% 11,26% 0,74 13,90% 0,86<br />

Source: Damodaran's website<br />

Appendix 10: Historical <strong>and</strong> Expected Micros<strong>of</strong>t’s Income Statement<br />

Historical results Expected Values<br />

Period End Date 2008 2009 2010 2011 2012 2013 2014 2015<br />

Annual Income Statement (USD, in millions)<br />

Revenues 60,323 58,573 62,256 62,750 64,357 67,004 70,055 73,585<br />

WD 16,865 14,712 18,491 18,121 18,575 19,038 19,515 20,002<br />

S&T 13,171 14,126 14,866 15,014 14,714 14,420 14,131 13,849<br />

OSD 3,214 3,088 2,199 2,221 2,265 2,311 2,357 2,404<br />

MBD 18,932 18,894 18,642 19,014 19,585 20,173 20,778 21,401<br />

EDD 8,141 7,753 8,058 8,380 9,218 11,062 13,274 15,929<br />

Total Revenues 60,323 58,573 62,256 62,750 64,357 67,004 70,055 73,585<br />

Cost <strong>of</strong> Revenues (without D&A) 9,542 9,593 9,722 9,494 9,333 9,262 9,457 9,631<br />

Gross Pr<strong>of</strong>it 50,781 48,980 52,534 53,256 55,024 57,742 60,598 63,954<br />

Research & Development 8,164 9,010 8,714 9,413 9,654 10,051 10,508 11,038<br />

Sales <strong>and</strong> Marketing 13,039 12,879 13,214 14,433 14,802 15,411 16,113 16,925<br />

General <strong>and</strong> Administrative 5,127 3,700 4,004 4,079 4,183 4,355 4,554 4,783<br />

Depreciation <strong>and</strong> Amortization 2,056 2,562 2,673 3,056 3,538 4,139 4,663 5,086<br />

Employee Severance 0 330 59 627 644 670 701 736<br />

Total Operating Expenses 37,928 38,074 38,386 41,102 42,154 43,888 45,886 48,198<br />

OPERATING INCOME (EBIT) 22,395 20,499 23,870 21,648 22,203 23,116 24,169 25,387<br />

EBITDA 24,451 23,061 26,543 24,704 25,741 27,255 28,832 30,473<br />

Investment Income <strong>and</strong> other 1,548 -542 915 961 1,009 1,059 1,112 1,168<br />

Total Investment Income <strong>and</strong> other 1,548 -542 915 961 1,009 1,059 1,112 1,168<br />

INCOME BEFORE INCOME TAXES (EBT) 23,943 19,957 24,785 22,609 23,212 24,175 25,281 26,555<br />

Provision for income taxes (or Income Taxes) 6,133 5,252 6,253 4,522 4,642 4,835 5,056 5,311<br />

Total Provision for income taxes 6,133 5,252 6,253 4,522 4,642 4,835 5,056 5,311<br />

NET INCOME 17,810 14,705 18,532 18,087 18,570 19,340 20,225 21,244<br />

Basic Weighted Average shares <strong>of</strong> common stock 9,328 8,945 8,813 8,813 8,813 8,813 8,813 8,813<br />

Basic EPS 1,90 1,63 2,13 2,05 2,11 2,19 2,29 2,41<br />

Cash Dividends per common share 0,44 0,52 0,52 0,52 0,52 0,52 0,52 0,52<br />

Appendix 11: Historical <strong>and</strong> Expected Micros<strong>of</strong>t’s Balance Sheet<br />

Historical Results Expected Values<br />

Annual Balance Sheet (USD, in millions)<br />

Cash <strong>and</strong> Cash Equivalents 10,339 6,076 5,505 6,881 8,602 10,752 12,365 13,292<br />

Short-term investments 13,323 25,371 31,283 39,104 48,880 61,100 70,265 75,534<br />

Total cash, cash Equivalents <strong>and</strong> short-term investments 23,662 31,447 36,788 45,985 57,481 71,852 82,629 88,826<br />

Tangible Assets<br />

Intangible Assets<br />

Accounts receivable (total receivables, net) 13,589 11,192 13,014 12,864 13,193 13,736 14,361 15,085<br />

Inventories 985 717 740 847 869 905 946 994<br />

Other current assets 5,006 5,924 5,134 5,134 5,134 5,134 5,134 5,134<br />

Total current assets 43,242 49,280 55,676 64,830 76,677 91,627 103,071 110,039<br />

Property <strong>and</strong> Equipment 12,544 15,082 16,259 18,535 21,130 24,088 27,461 31,305<br />

Accumulated depreciation -6,302 -7,547 -8,629 -9,453 -10,776 -12,285 -14,005 -15,966<br />

Total tangible assets 6,242 7,535 7,630 9,082 10,354 11,803 13,456 15,340<br />

Equity <strong>and</strong> other Investments 6,588 4,933 7,754 9,693 12,116 15,145 18,931 23,663<br />

Goodwill 12,108 12,503 12,394 12,394 12,394 12,394 12,394 12,394<br />

Gross Intangibles 3,630 4,040 3,887 4,179 4,492 4,829 5,191 5,580<br />

Accumulated amortization -1,657 -2,281 -2,729 -2,131 -2,291 -2,463 -2,647 -2,846<br />

Total intangible assets 1,973 1,759 1,158 2,047 2,201 2,366 2,544 2,734<br />

Other long-term assets 1,691 1,599 1,501 1,501 1,501 1,501 1,501 1,501<br />

Total non-current assets 29,551 28,608 30,437 34,717 38,565 43,209 48,825 55,632<br />

TOTAL ASSETS 72,793 77,888 86,113 99,547 115,242 134,836 151,896 165,671<br />

Accounts Payable 4,034 3,324 4,025 3,703 3,640 3,612 3,688 3,756<br />

Short-term debt 0 2,000 1,000 1,000 1,000 1,000 1,000 1,000<br />

Other Current Liabilities 3,659 21,710 21,122 23,912 29,480 35,489 43,257 49,506<br />

Total current liabilities 29,886 27,034 26,147 28,615 34,120 40,101 47,945 54,262<br />

Long-term debt 0 3,746 4,939 9,665 11,598 15,077 14,323 13,607<br />

Long-term unearned revenue 1,900 1,281 1,178 0,000 0,000 0,000 0,000 0,000<br />

Long-term deferred income tax liabilities 0 0 229 229 229 229 229 229<br />

Other Long-Term Liabilities 6,621 7,550 8,852 11,201 16,265 23,758 31,528 37,851<br />

Total non-current liabilities 6,621 11,296 13,791 20,866 27,863 38,835 45,851 51,458<br />

TOTAL LIABILITIES 36,507 38,330 39,938 49,481 61,983 78,937 93,796 105,720<br />

Common stock <strong>and</strong> paid-in capital 62,849 62,382 62,856 63,327<br />

-<br />

63,802 64,281 64,763 65,249<br />

Retained deficit -26,563 -22,824 -16,681 13,261 -10,543 -8,382 -6,663 -5,297<br />

Total Stockholders' Equity 36,286 39,558 46,175 50,066 53,260 55,899 58,100 59,951<br />

TOTAL LIABILITIES AND SHAREHOLDER EQUITY 72,793 77,888 86,113 99,547 115,242 134,836 151,896 165,671<br />

Debt<br />

Long-term Debt 0 3,746 4,939 9,665 11,598 15,077 14,323 13,607<br />

Short-term Debt 0 2,000 1,000 1,000 1,000 1,000 1,000 1,000<br />

Total Debt 0 5,746 5,939 10,665 12,598 16,077 15,323 14,607<br />

Cash <strong>and</strong> cash equivalents 10,339 6,076 5,505 6,881 8,602 10,752 12,365 13,292<br />

Working Capital<br />

Appendix 12: Micros<strong>of</strong>t’s CAPEX<br />

Net Debt -10,339 -330 434 3,784 3,996 5,325 2,958 1,315<br />

Total Receivables 13,589 11,192 13,014 12,864 13,193 13,736 14,361 15,085<br />

Accounts payable 4,034 3,324 4,025 3,703 3,640 3,612 3,688 3,756<br />

Other payables 0 0 0 0 0 0 0 0<br />

Period End<br />

Date 2008 2009 2010 2011 2012 2013 2014 2015<br />

- - - - -<br />

Capex -3,182 -3,119 -1,977 2,570 3,341 4,343 4,663 5,086<br />

Appendix 13: Micros<strong>of</strong>t’s Valuation Data<br />

Nº <strong>of</strong> shares outst<strong>and</strong>ing (billions) 8,813<br />

Stock price (May,13) 25,32<br />

Average stock price (last year) 25,99<br />

Market Capitalization (billions <strong>of</strong> dollars) 223,145<br />

Average Market Capitalization 229,049<br />

Equity Value 232,013<br />

Net Debt (millions) 434<br />

Enterprise Value 232,447<br />

Price Target 26,33<br />

Upside Potential 4%<br />

Rf (10 years bond) 2,10%<br />

Risk Premium (Rm - Rf) 5%<br />

D/E Ratio 0,1870%<br />

Levered Beta 1,122<br />

D/(D+E) 0,0000%<br />

Re 7,71%<br />

Rd (10 years bond + Spread) 2,60%<br />

WACC 7,69%<br />

Ru 7,70%<br />

Terminal Growth rate (inflation + IMF prospects) 4,98%<br />

Damodaran Data (Computer S<strong>of</strong>tware)<br />

93<br />

USA<br />

Unlevered Beta 1,12<br />

Corporate Tax Rate 35%

Appendix 14: Micros<strong>of</strong>t Base-<strong>Case</strong> Valuation<br />

Micros<strong>of</strong>t Corp.<br />

USD, in million 2008 2009 2010 2011 2012 2013 2014 2015<br />

Operating Income (EBIT) 22,395 20,499 23,870 21,648 22,203 23,116 24,169 25,387<br />

Income taxes 6,133 5,252 6,253 4,522 4,642 4,835 5,056 5,311<br />

Depreciation & Amortization 2,056 2,562 2,673 3,056 3,538 4,139 4,663 5,086<br />

Change in NWC 1,449 -1,025 2,646 279 414 607 590 704<br />

CAPEX + Replacement Investments -3,182 -3,119 -1,977 -2,570 -3,341 -4,343 -4,663 -5,086<br />

Free Cash Flow to the Firm (FCFF) 13,687 15,715 15,667 17,333 17,344 17,470 18,523 19,372<br />

DCF<br />

FCFF 13,687 15,715 15,667 17,333 17,344 17,470 18,523 19,372<br />

Discount factor<br />

1,00 0,93 0,86 0,80 0,74<br />

Discounted Cash Flow 17,333 16,106 15,064 14,832 14,404<br />

Appendix 15: Micros<strong>of</strong>t Bear <strong>Case</strong> Valuation<br />

Total Revenues 60,323 58,573 62,256 62,123 63,713 66,334 69,354 72,849<br />

Total Operating Expenses 37,928 38,074 38,386 41,513 42,576 44,327 46,345 48,680<br />

Operating Income (EBIT) 22,395 20,499 23,870 20,609 21,138 22,007 23,010 24,169<br />

Income taxes 6,133 5,252 6,253 4,314 4,429 4,613 4,824 5,067<br />

Change in NWC 1,449 -1,025 2,646 276 410 601 584 697<br />

Free Cash Flow to the Firm (FCFF) 13,687 15,715 15,667 16,505 16,496 16,589 17,602 18,405<br />

FCFF 13,687 15,715 15,667 16,505 16,496 16,589 17,602 18,405<br />

Discounted Cash Flow 16,505 15,318 14,304 14,094 13,685<br />

DCF Calculation<br />

Explicit Value 77,739<br />

Terminal Value 154,708<br />

Firm Value 232,447<br />

Net Debt 434<br />

Minority interest 0<br />

Explicit Value 73,906<br />

Terminal Value 147,080<br />

Firm Value 220,986<br />

Equity Value 220,986<br />

Price Target 25,03<br />

Appendix 16: Micros<strong>of</strong>t Bull <strong>Case</strong> Valuation<br />

Total Revenues 60,323 58,573 62,256 63,378 65,001 67,674 70,756 74,32<br />

Total Operating Expenses 37,928 38,074 38,386 40,691 41,732 43,449 45,427 47,72<br />

Operating Income (EBIT) 22,395 20,499 23,870 22,687 23,268 24,225 25,328 26,605<br />

Income taxes 6,133 5,252 6,253 4,730 4,855 5,057 5,288 5,555<br />

Change in NWC 1,449 -1,025 2,646 282 418 613 596 711<br />

Free Cash Flow to the Firm (FCFF) 13,687 15,715 15,667 18,161 18,192 18,351 19,444 20,339<br />

FCFF 13,687 15,715 15,667 18,161 18,192 18,351 19,444 20,339<br />

Discounted Cash Flow 18,161 16,893 15,824 15,569 15,123<br />

Explicit Value 81,570<br />

Terminal Value 162,332<br />

Firm Value 243,902<br />

Equity Value 243,468<br />

Price Target 27,63<br />

Appendix 17: Historical <strong>and</strong> Expected <strong>Nokia</strong>’s Income Statement<br />

Revenues 71,585 57,945 60,344 58,726 57,635 59,597 61,632 63,740<br />

D&S 49,490 39,272 41,079 39,847 39,050 40,612 42,236 43,926<br />

NAVTEQ 509 944 1,413 1,385 1,440 1,498 1,558 1,620<br />

NSN 21,586 17,729 17,852 17,495 17,145 17,488 17,838 18,194<br />

Total Revenues 71,585 57,945 60,344 58,726 57,635 59,597 61,632 63,740<br />

Cost <strong>of</strong> Revenues (without D&A) 44,725 36,570 39,280 37,291 36,598 37,844 39,136 40,475<br />

Gross Pr<strong>of</strong>it 26,860 21,375 21,064 21,435 21,037 21,753 22,496 23,265<br />

Research & Development 8,415 8,331 8,267 7,811 7,665 7,926 8,197 8,477<br />

Sales <strong>and</strong> Marketing 6,176 5,545 5,466 5,285 5,187 5,364 5,547 5,737<br />

General <strong>and</strong> Administrative 1,810 1,614 1,572 1,527 1,499 1,550 1,602 1,657<br />

Depreciation <strong>and</strong> Amortization 2,280 2,515 2,497 2,388 2,397 2,461 2,529 2,600<br />

Employee Severance 0 0 0 521 576 596 616 637<br />

Total Operating Expenses 63,406 54,575 57,082 54,823 53,922 55,741 57,627 59,583<br />

OPERATING INCOME (EBIT) 8,179 3,370 3,262 3,903 3,713 3,856 4,005 4,157<br />

EBITDA 10,459 5,885 5,759 6,292 6,110 6,318 6,533 6,757<br />

Investment Income (Expense) <strong>and</strong> other -3 -374 -402 -362 -326 -293 -264 -238<br />

Total Investment Income (Expense) <strong>and</strong> other -3 -374 -402 -362 -326 -293 -264 -238<br />

INCOME BEFORE INCOME TAXES (EBT) 8,176 2,996 2,860 3,541 3,387 3,563 3,741 3,919<br />

Provision for income taxes 1,524 990 624 868 830 873 917 960<br />

Total Provision for income taxes 1,524 990 624 868 830 873 917 960<br />

NET INCOME 6,652 2,006 2,236 2,673 2,557 2,690 2,824 2,959<br />

Basic Weighted Average shares <strong>of</strong> common stock 3,743 3,705 3,708 3,708 3,708 3,708 3,708 3,708<br />

Basic EPS 1,51 0,34 0,71 0,72 0,69 0,73 0,76 0,80<br />

Cash Dividends per common share 0,56 0,56 0,56 0,56 0,56 0,56 0,56 0,56<br />

Appendix 18: Historical <strong>and</strong> Expected <strong>Nokia</strong>’s Balance Sheet<br />

Cash <strong>and</strong> Cash Equivalents 2,405 1,610 2,751 2,476 2,600 2,730 2,866 3,009<br />

Short-term investments 7,211 10,901 14,557 13,101 13,756 14,444 15,166 15,925<br />

Total cash, cash Equivalents <strong>and</strong> short-term investments 9,616 12,511 17,308 15,577 16,356 17,174 18,033 18,934<br />

Accounts receivable (total receivables, net) 21,315 18,154 17,409 17,383 17,060 17,641 18,243 18,867<br />

Inventories 3,571 2,629 3,557 3,083 3,026 3,129 3,236 3,346<br />

Total current assets 34,502 33,294 38,274 36,043 36,442 37,944 39,511 41,148<br />

Property <strong>and</strong> Equipment 7,969 7,680 7,937 7,659 7,391 7,465 7,540 7,615<br />

Accumulated Depreciation 5,022 5,048 5,182 4,956 4,782 4,830 4,878 4,927<br />

Total Tangible Assets 2,947 2,632 2,755 2,704 2,609 2,635 2,662 2,688<br />

Equity <strong>and</strong> other Investments 857 878 943 849 891 936 982 1,032<br />

Goodwill 8,822 7,291 8,069 8,069 8,069 8,069 8,069 8,069<br />

Gross Intangibles 10,306 10,035 9,125 8,669 8,235 7,824 7,432 7,061<br />

Accumulated Amortization 4,444 5,939 6,351 5,609 5,328 5,062 4,809 4,568<br />

Total Intangible Assets 5,862 4,096 2,774 3,060 2,907 2,762 2,624 2,492<br />

Other long-term assets 52 73 96 96 96 96 96 96<br />

Deferred income taxes 2,768 2,125 2,250 2,250 2,250 2,250 2,250 2,250<br />

Total non-current assets 21,308 17,095 16,887 17,028 16,822 16,748 16,682 16,628<br />

TOTAL ASSETS 55,810 50,389 55,161 53,071 53,264 54,692 56,193 57,776<br />

Accounts Payable 7,367 6,979 8,602 7,309 7,173 7,417 7,671 7,933<br />

Short-term debt 6,366 1,433 2,092 2,092 2,092 2,092 2,092 2,092<br />

Other Current Liabilities 14,967 13,002 14,036 14,474 15,513 15,72 15,95 16,19<br />

Total current liabilities 28,700 21,414 24,730 23,875 24,778 25,230 25,709 26,216<br />

Long-term debt 1,214 6,249 5,981 5,742 5,512 5,733 5,962 6,200<br />

Other long-term liabilities 2,617 1,930 1,565 2,003 3,043 3,251 3,475 3,720<br />

Total non-current liabilities 3,831 8,179 7,546 7,745 8,555 8,984 9,437 9,920<br />

TOTAL LIABILITIES 32,531 29,593 32,276 31,620 33,333 34,214 35,146 36,136<br />

Common stock <strong>and</strong> paid-in capital 3,547 4,168 5,476 5,476 5,476 5,476 5,476 5,476<br />

Retained Earnings 16,486 14,286 14,805 13,325 11,992 12,472 12,971 13,489<br />

Minority interest 3,246 2,342 2,604 2,651 2,463 2,531 2,601 2,674<br />

Total Stockholders' equity 23,279 20,796 22,885 21,451 19,931 20,478 21,048 21,640<br />

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 55,810 50,389 55,161 53,071 53,264 54,692 56,193 57,776<br />

Long-term Debt 1,214 6,249 5,981 5,742 5,512 5,733 5,962 6,200<br />

Short-term Debt 6,366 1,433 2,092 2,092 2,092 2,092 2,092 2,092<br />

Total Debt 7,580 7,682 8,073 7,834 7,604 7,825 8,054 8,292<br />

Cash <strong>and</strong> cash equivalents 2,405 1,610 2,751 2,476 2,600 2,730 2,866 3,009<br />

Net Debt 5,175 6,072 5,322 5,358 5,004 5,095 5,188 5,283<br />

Appendix 19: <strong>Nokia</strong>’s CAPEX<br />

Inventories 3,571 2,629 3,557 3,0831 3,0258 3,129 3,236 3,346<br />

Total Receivables 21,315 18,154 17,409 17,383 17,06 17,64 18,24 18,87<br />

Accounts payable 7,367 6,979 8,602 7,309 7,173 7,417 7,671 7,933<br />

Net Working Capital 17,519 13,804 12,364 13,157 12,913 13,352 13,808 14,280<br />

Change in NWC 2,760 -3,715 -1,440 793 -245 440 456 472<br />

Date 2008 2009 2010<br />

2011 2012 2013 2014 2015<br />

Capex 1,254 -749 -957 -1,315 -1,807 -2,482 -2,529 -2,600<br />

Appendix 20: <strong>Nokia</strong>’s Valuation Data<br />

Nº <strong>of</strong> shares outst<strong>and</strong>ing (billions) 3,708<br />

Stock price (May,13) 8,66<br />

Average stock price (last year) 10,96<br />

Market Capitalization (billions <strong>of</strong> dollars) 32,111<br />

Average Market Capitalization 40,639<br />

Equity Value 40,694<br />

Net Debt (millions) 5,322<br />

Firm Value 48,620<br />

Price Target 10,98<br />

Upside Potential 27%<br />

Rf (10 years bond) 2,52%<br />

D/E ratio 13,08%<br />

Levered Beta 0,94<br />

D/(D+E) 11,57%<br />

Re 7,22%<br />

Rd (10 years bond + Spread) 3,02%<br />

WACC 6,64%<br />

Ru 6,82%<br />

Terminal Growth rate (inflation + IMF prospects) 4,82%<br />

Damodaran Data (Telecom. Equipment)<br />

98<br />

Finl<strong>and</strong><br />

Unlevered Beta 0,86<br />

Tax Rate (Federal tax + Provincial tax) 26%

Appendix 21: <strong>Nokia</strong> Base-<strong>Case</strong> Valuation<br />

Operating Income (EBIT) 8,179 3,370 3,262 3,903 3,713 3,856 4,005 4,157<br />

Income taxes 1,524 990 624 868 830 873 917 960<br />

Depreciation & Amortization 2,280 2,515 2,497 2,388 2,397 2,461 2,529 2,600<br />

CAPEX + Replacement Investments -1,254 -749 -957 -1,315 -1,807 -2,482 -2,529 -2,600<br />

Free Cash Flow to the Firm (FCFF) 4,921 7,861 5,618 3,315 3,718 2,522 2,632 2,725<br />

FCFF 4,921 7,861 5,618 3,315 3,718 2,522 2,632 2,725<br />

1,00 0,94 0,88 0,82 0,77<br />

Discounted Cash Flow 3,315 3,485 2,218 2,170 2,107<br />

Appendix 22: <strong>Nokia</strong> Bear <strong>Case</strong> Valuation<br />

Total Revenues 71,585 57,945 60,344 58,139 57,059 59,001 61,015 63,10<br />

Total Operating Expenses 63,406 54,575 57,082 55,371 54,461 56,298 58,203 60,18<br />

Operating Income (EBIT) 8,179 3,370 3,262 2,768 2,597 2,703 2,812 2,92<br />

Income taxes 1,524 990 624 590 556 591 624 658,00<br />

Depreciation & Amortization 2,280 2,515 2,497 2,388 2,397 2,461 2,529 2,60<br />

Change in NWC 2,760 -3,715 -1,440 785 -243 436 451 467,28<br />

CAPEX + Replacement Investments -1,254 -749 -957 -1,315 -1,807 -2,482 -2,529 -2,60<br />

Free Cash Flow to the Firm (FCFF) 4,921 7,861 5,618 2,466 2,874 1,295 1,737 1,799<br />

FCFF 4,921 7,861 5,618 2,466 2,874 1,295 1,737 1,799<br />

Discounted Cash Flow 2,466 2,695 1,139 1,432 1,391<br />

Explicit Value 13,295<br />

Terminal Value 35,325<br />

Net Debt 5,322<br />

Minority interest 2,604<br />

Explicit Value 9,123<br />

Terminal Value 24,240<br />

Firm Value 33,363<br />

Equity Value 25,437<br />

Price Target 6,86<br />

Appendix 23: <strong>Nokia</strong> Bull <strong>Case</strong> Valuation<br />

Total Revenues 71,585 57,945 60,344 59,314 58,211 60,193 62,248 64,377<br />

Total Operating Expenses 63,406 54,575 57,082 54,275 53,383 55,184 57,051 58,987<br />

Operating Income (EBIT) 8,179 3,37 3,262 5,039 4,828 5,010 5,197 5,390<br />

Income taxes 1,524 990 624 1,146 1,103 1,156 1,209 1,262<br />

Change in NWC 2,760 -3,715 -1,440 801 -247 444 461 477<br />

Free Cash Flow to the Firm (FCFF) 4,921 7,861 5,618 4,165 4,562 3,389 3,527 3,651<br />

FCFF 4,921 7,861 5,618 4,165 4,562 3,389 3,527 3,651<br />

Discounted Cash Flow 4,165 4,278 2,980 2,908 2,823<br />

Explicit Value 17,154<br />

Terminal Value 45,578<br />

Firm Value 62,732<br />

Equity Value 54,806<br />

Price Target 14,78<br />

Appendix 24: Historical <strong>and</strong> Expected Income Statement <strong>of</strong> the Merged Entity without<br />

synergies<br />

Revenues 131,908 116,518 122,600 121,476 121,992 126,601 131,687 137,325<br />

Windows & Windows Live Division 16,865 14,712 18,491 18,121 18,575 19,038 19,515 20,002<br />

Micros<strong>of</strong>t Business Division 18,932 18,894 18,642 19,014 19,585 20,173 20,778 21,401<br />

Entertainment & Devices Division 8,141 7,753 8,058 8,380 9,218 11,062 13,274 15,929<br />

Devices & Services 49,490 39,272 41,079 39,847 39,050 40,612 42,236 43,926<br />

Online Services Division 3,214 3,088 2,199 2,221 2,265 2,311 2,357 2,404<br />

Server & Tools 13,171 14,126 14,866 15,014 14,714 14,420 14,131 13,849<br />

<strong>Nokia</strong> Siemens Networks 21,586 17,729 17,852 17,495 17,145 17,488 17,838 18,194<br />

Total Revenues 131,908 116,518 122,600 121,476 121,992 126,601 131,687 137,325<br />

Cost <strong>of</strong> Revenues (without D&A) 54,267 46,163 49,002 46,785 45,931 47,106 48,593 50,106<br />

Gross Pr<strong>of</strong>it 77,641 70,355 73,598 74,691 76,061 79,495 83,094 87,219<br />

Research & Development 16,579 17,341 16,981 17,223 17,319 17,977 18,705 19,515<br />

Sales <strong>and</strong> Marketing 19,215 18,424 18,680 19,718 19,989 20,775 21,659 22,661<br />

General <strong>and</strong> Administrative 6,937 5,314 5,576 5,606 5,682 5,905 6,156 6,440<br />

Depreciation <strong>and</strong> Amortization 4,336 5,077 5,170 5,444 5,935 6,600 7,192 7,686<br />

Employee Severance 0 330 59 1,148 1,220 1,266 1,317 1,373<br />

Total Operating Expenses 101,334 92,649 95,468 95,924 96,076 99,629 103,622 107,781<br />

OPERATING INCOME (EBIT) 30,574 23,869 27,132 25,552 25,916 26,972 28,064 29,544<br />

EBITDA 34,910 28,946 32,302 30,997 31,851 33,573 35,256 37,230<br />

Investment Income (expense) <strong>and</strong> other 1,545 -916 513 599 683 766 848 930<br />

Total Investment Income (expense) <strong>and</strong> other 1,545 -916 513 599 683 766 848 930<br />

INCOME BEFORE INCOME TAXES (EBT) 32,119 22,953 27,645 26,151 26,599 27,738 28,912 30,474<br />

Provision for income taxes (or Income Taxes) 7,657 6,242 6,877 5,390 5,472 5,708 5,973 6,271<br />

Total Provision for income taxes 7,657 6,242 6,877 5,390 5,472 5,708 5,973 6,271<br />

NET INCOME 24,462 16,711 20,768 20,761 21,127 22,030 22,939 24,203<br />

Appendix 26: Historical <strong>and</strong> Expected Balance Sheet <strong>of</strong> the Merged entity without<br />

Cash <strong>and</strong> Cash Equivalents 12,744 7,686 8,256 9,357 11,201 13,482 15,231 16,302<br />

Short-term investments 20,534 36,272 45,840 52,205 62,636 75,544 85,431 91,459<br />

Total cash, cash Equivalents <strong>and</strong> short-term investments 33,278 43,958 54,096 61,562 73,837 89,025 100,662 107,761<br />

Accounts receivable (total receivables, net) 34,904 29,346 30,423 30,247 30,253 31,377 32,604 33,952<br />

Inventories 4,556 3,346 4,297 3,930 3,895 4,034 4,182 4,340<br />

Total current assets 77,744 82,574 93,950 100,873 113,119 129,570 142,582 151,187<br />

Property <strong>and</strong> Equipment 20,513 22,762 24,196 26,194 28,521 31,553 35,000 38,920<br />

Accumulated depreciation -10,746 -13,486 -14,98 -15,062 -16,105 -17,347 -18,814 -20,534<br />

Total tangible assets 9,767 9,276 9,216 11,133 12,417 14,207 16,187 18,386<br />

Equity <strong>and</strong> other Investments 7,445 5,811 8,697 10,542 13,007 16,081 19,913 24,695<br />

Goodwill 20,930 19,794 20,463 20,463 20,463 20,463 20,463 20,463<br />

Gross Intangibles 13,936 14,075 13,012 12,847 12,727 12,652 12,623 12,641<br />

Accumulated amortization -6,101 -8,220 -9,080 -7,740 -7,619 -7,525 -7,456 -7,414<br />

Total intangible assets 7,835 5,855 3,932 5,108 5,108 5,128 5,167 5,227<br />

Other long-term assets 1,743 1,672 1,597 1,597 1,597 1,597 1,597 1,597<br />

Total non-current assets 50,488 44,533 46,155 51,092 54,842 59,725 65,577 72,618<br />

TOTAL ASSETS 106,410 128,277 141,274 152,618 168,507 189,528 208,089 223,447<br />

Accounts Payable 11,401 10,303 12,627 11,012 10,813 11,030 11,359 11,689<br />

Short-term debt 6,366 3,433 3,092 3,092 3,092 3,092 3,092 3,092<br />

Other Current Liabilities 18,626 34,712 35,158 38,386 44,993 51,21 59,203 65,697<br />

Total current liabilities 36,393 48,448 50,877 52,490 58,898 65,332 73,654 80,478<br />

Long-term debt 1,214 9,995 10,920 15,407 17,110 20,810 20,285 19,807<br />

Other Long-Term Liabilities 9,238 9,480 10,417 13,204 19,308 27,009 35,003 41,571<br />

Total non-current liabilities 10,452 19,475 21,337 28,611 36,418 47,819 55,288 61,378<br />

TOTAL LIABILITIES 46,845 67,923 72,214 81,100 95,316 113,151 128,942 141,857<br />

Common stock <strong>and</strong> paid-in capital 66,396 66,55 68,332 68,803 69,278 69,757 70,239 70,725<br />

Retained deficit -26,563 -22,824 -16,681 -13,261 -10,543 -8,382 -6,663 -5,297<br />

Minority Interest 3,246 2,342 2,604 2,651 2,463 2,531 2,601 2,674<br />

Total Stockholders' Equity 59,565 60,354 69,06 71,517 73,191 76,378 79,147 81,591<br />

TOTAL LIABILITIES AND SHAREHOLDER EQUITY 106,410 128,277 141,274 152,618 168,507 189,528 208,089 223,447<br />

Long-term Debt 1,214 9,995 10,920 15,407 17,110 20,810 20,285 19,807<br />

Short-term Debt 6,366 3,433 3,092 3,092 3,092 3,092 3,092 3,092<br />

Total Debt 7,580 13,428 14,012 18,499 20,202 23,902 23,377 22,899<br />

Cash <strong>and</strong> cash equivalents 12,744 7,686 8,256 9,357 11,201 13,482 15,231 16,302<br />

Net Debt -5,164 5,742 5,756 9,142 9,001 10,420 8,146 6,598<br />

Total Receivables 34,904 29,346 30,423 30,247 30,253 31,377 32,604 33,952<br />

Accounts payable 11,401 10,303 12,627 11,012 10,813 11,030 11,359 11,689<br />

Net Working Capital 28,059 22,389 21,911 22,983 23,153 24,199 25,245 26,421<br />

Change in NWC 4,209 -4,740 1,206 1,072 170 1,046 1,046 1,176<br />

Appendix 27: Merged Entity CAPEX without synergies<br />

Capex -4,436 -3,868 -2,934 3,885 5,148 6,825 7,192 7,686<br />

Appendix 28: Valuation <strong>of</strong> the Merged entity without synergies<br />

Market Capitalization (billions <strong>of</strong> dollars) 255,256<br />

Equity Value 272,707<br />

Net Debt (millions) 5,756<br />

Enterprise Value 281,067<br />

Upside Potential 7%<br />

D/E Ratio 2,1107%<br />

Levered Beta 1,0950<br />

D/(D+E) 2,067%<br />

Re 7,58%<br />

WACC 7,46%<br />

Ru 7,48%<br />

Terminal Growth Rate 4,90%<br />

Damodaran Data<br />

Weighted Unlev. Beta 1,08<br />

Corporate Tax Rate 35%<br />

DCF:<br />

Sum <strong>of</strong> St<strong>and</strong>alone Firm Value 281,067<br />

New Firm Value without synergies 281,067<br />

Operating Income (EBIT) 30,574 23,869 27,132 25,552 25,916 26,972 28,064 29,544<br />

Income taxes 7,657 6,242 6,877 5,390 5,472 5,708 5,973 6,271<br />

Depreciation & Amortization 4,336 5,077 5,170 5,444 5,935 6,600 7,192 7,686<br />

CAPEX + Replacement Investments -4,436 -3,868 -2,934 -3,885 -5,148 -6,825 -7,192 -7,686<br />

Free Cash Flow to the Firm (FCFF) 18,608 23,576 21,285 20,649 21,061 19,993 21,045 22,097<br />

FCFF 18,608 23,576 21,285 20,649 21,061 19,993 21,045 22,097<br />

1,00 0,93 0,87 0,81 0,75<br />

Discounted Cash Flow 20,649 19,599 17,314 16,959 16,571<br />

Explicit Value 91,092<br />

Terminal Value 189,975<br />

Firm Value 281,067<br />

Net Debt 5,756<br />

Appendix 29: Historical <strong>and</strong> Expected Income Statement <strong>of</strong> the Merged Entity with<br />

Revenues 131,908 116,518 122,600 121,832 122,349 126,967 132,060 137,707<br />

Windows & Windows Live Division 16,865 14,712 18,491 18,302 18,761 19,228 19,710 20,202<br />

Server & Tools 13,171 14,126 14,866 15,014 14,714 14,42 14,131 13,849<br />

<strong>Nokia</strong> Siemens Networks 21,586 17,729 17,852 17,670 17,317 17,663 18,016 18,376<br />

Total Revenues 131,908 116,518 122,600 121,832 122,349 126,967 132,060 137,707<br />

Cost <strong>of</strong> Revenues (without D&A) 54,267 46,163 49,002 46,083 45,242 46,400 47,864 49,354<br />

Gross Pr<strong>of</strong>it 77,641 70,355 73,598 75,749 77,107 80,567 84,196 88,353<br />

Research & Development 16,579 17,341 16,981 16,965 17,059 17,707 18,425 19,222<br />

Sales <strong>and</strong> Marketing 19,215 18,424 18,680 19,422 19,689 20,463 21,335 22,321<br />

Total Operating Expenses 101,334 92,649 95,468 94,668 94,827 98,341 102,288 106,397<br />

OPERATING INCOME (EBIT) 30,574 23,869 27,132 27,164 27,522 28,626 29,772 31,310<br />

EBITDA 34,910 28,946 32,302 32,609 33,457 35,226 36,964 38,996<br />

INCOME BEFORE INCOME TAXES (EBT) 32,119 22,953 27,645 27,763 28,205 29,392 30,570 32,240<br />

Provision for income taxes (or Income Taxes) 7,657 6,242 6,877 5,691 5,782 6,025 6,267 6,609<br />

Total Provision for income taxes 7,657 6,242 6,877 5,691 5,782 6,025 6,267 6,609<br />

NET INCOME 24,462 16,711 20,768 22,072 22,423 23,367 24,303 25,631<br />

Appendix 30: Historical <strong>and</strong> Expected Balance Sheet <strong>of</strong> the Merged entity with<br />

Cash <strong>and</strong> Cash Equivalents 12,744 7,686 8,256 9,384 11,234 13,521 15,274 16,347<br />

Short-term investments 20,534 36,272 45,840 52,358 62,819 75,762 85,673 91,713<br />

Total cash, cash Equivalents <strong>and</strong> short-term investments 33,278 43,958 54,096 61,742 74,053 89,283 100,947 108,060<br />

Accounts receivable (total receivables, net) 34,904 29,346 30,423 30,336 30,342 31,468 32,696 34,047<br />

Inventories 4,556 3,346 4,297 3,942 3,906 4,046 4,193 4,352<br />

Total current assets 77,744 82,574 93,950 101,154 113,435 129,931 142,970 151,593<br />

Accumulated depreciation -10,746 -13,486 -14,980 -15,062 -16,105 -17,347 -18,814 -20,534<br />

Deferred Income Taxes 2,768 2,125 2,250 2,250 2,250 2,250 2,250 2,250<br />

TOTAL ASSETS 106,410 128,277 141,274 152,246 168,277 189,656 208,547 224,211<br />

Accounts Payable 11,401 10,303 12,627 10,847 10,651 10,865 11,189 11,514<br />

Other Current Liabilities 18,626 34,712 35,158 38,386 44,993 51,210 59,203 65,697<br />

Total current liabilities 36,393 48,448 50,877 52,325 58,736 65,167 73,484 80,303<br />

Long-term debt 1,214 9,995 10,920 15,907 18,110 21,102 20,599 20,275<br />

Other Long-Term Liabilities 9,238 9,480 10,417 12,497 18,240 27,009 35,317 42,042<br />

Total non-current liabilities 10,452 19,475 21,337 28,404 36,350 48,111 55,916 62,317<br />

TOTAL LIABILITIES 46,845 67,923 72,214 80,729 95,086 113,278 129,400 142,620<br />

Total Stockholders' Equity 59,565 60,354 69,060 71,517 73,191 76,378 79,147 81,591<br />

TOTAL LIABILITIES AND SHAREHOLDER EQUITY 106,410 128,277 141,274 152,246 168,277 189,656 208,547 224,211<br />

Long-term Debt 1,214 9,995 10,920 15,907 18,110 21,102 20,599 20,275<br />

Total Debt 7,580 13,428 14,012 18,999 21,202 24,194 23,691 23,367<br />

Cash <strong>and</strong> cash equivalents 12,744 7,686 8,256 9,384 11,234 13,521 15,274 16,347<br />

Net Debt -5,164 5,742 5,756 9,615 9,968 10,673 8,417 7,020<br />

Total Receivables 34,904 29,346 30,423 30,336 30,342 31,468 32,696 34,047<br />

Accounts payable 11,401 10,303 12,627 10,847 10,651 10,865 11,189 11,514<br />

Net Working Capital 28,059 22,389 21,911 23,249 23,415 24,467 25,518 26,703<br />

Change in NWC 4,209 -4,740 1,206 1,338 166 1,052 1,051 1,185<br />

Appendix 31: Merged Entity CAPEX with synergies<br />

Appendix 32: Valuation <strong>of</strong> the Merged Entity with synergies<br />

Equity Value 278,008<br />

Enterprise Value 286,368<br />

Upside Potential 9%<br />

D/E Ratio 2,07%<br />

Levered Beta 1,0945<br />

D/(D+E) 2,0280%<br />

Re 7,57%<br />

WACC 7,45%<br />

Terminal Growth rate (inflation + IMF prospects) 4,90%<br />

New Firm Value with synergies 286,368<br />

Operating Income (EBIT) 30,574 23,869 27,132 27,164 27,522 28,626 29,772 31,310<br />

Income taxes 7,657 6,242 6,877 5,691 5,782 6,025 6,267 6,609<br />

Free Cash Flow to the Firm (FCFF) 18,608 23,576 21,285 21,694 22,324 21,323 22,454 23,516<br />

FCFF 18,608 23,576 21,285 21,694 22,324 21,323 22,454 23,516<br />

Discounted Cash Flow 21,694 20,776 18,469 18,100 17,642<br />

Explicit Value 96,681<br />

Terminal Value 189,687<br />

Firm Value 286,368<br />

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<strong>Mergers</strong> & <strong>Acquisitions</strong>: <strong>The</strong> <strong>Case</strong> <strong>of</strong> Micros<strong>of</strong>t <strong>and</strong> <strong>Nokia</strong> Luís Franco Hilário Advisor: Peter Tsvetkov Dissertation submitted in partial fulfillment <strong>of</strong> requirements for the degrees <strong>of</strong> MSc in Business Administration, at the Universidade Católica Portuguesa SEPTEMBER 2011 1

  • Page 2 and 3: Abstract Due to the financial downt
  • Page 4 and 5: Table of Contents 1. INTRODUCTION .
  • Page 6 and 7: 8. THE ACQUISITION PROCESS ........
  • Page 8 and 9: 2. Literature Review Being the main
  • Page 10 and 11: value based on these benchmark mult
  • Page 12 and 13: Despite the distinction mentioned a
  • Page 14 and 15: across firms within an industry (Ka
  • Page 16 and 17: Indeed, this formula is composed by
  • Page 18 and 19: two categories of cash-flows: the r
  • Page 20 and 21: According to Luehrman (1997), APV i
  • Page 22 and 23: are more accurate for large (Alford
  • Page 24 and 25: etween firms competing on the same
  • Page 26 and 27: short-term factors can also live on
  • Page 28 and 29: Indeed, the decision of using cash,
  • Page 30 and 31: information about the takeover bene
  • Page 32 and 33: Nevertheless, the current unstable
  • Page 34 and 35: Figure 3: Top 5 Mobile smartphone m
  • Page 36 and 37: Additionally, the mobile sales have
  • Page 38 and 39: positioned between a laptop and a s
  • Page 40 and 41: applications for distributed comput
  • Page 42 and 43: Moreover, as a way to diversify the
  • Page 44 and 45: operations, and service-oriented ar
  • Page 46 and 47: Google, Yahoo! and a variety of web
  • Page 48 and 49: is also responsible for retail sale
  • Page 50 and 51: For this reason, a merger with Micr

On the other hand, Nokia has a sign

systems, Internet-based mapping app

4. Performance of both companies in

The financial downturn has led comp

6. Performance Forecast As it was r

In addition, revenues have decrease

Concerning to Research & Developmen

investments, which is reflected on

6.1.7. Sensitivity Analysis Despite

through WACC and Multiples valuatio

Regarding to Research & Development

6.2.6. Financial Leverage and Cost

7. Valuation of the Merged Entity F

fact, the combined enterprise shall

the combination of both investments

elongs to the revenue synergies. Co

segments as the smartphones OS, it

9. Conclusion The constant technolo

Appendix 3: Nokia’s SWOT analysis

US Industry NºFirms Appendix 8: Mo

Appendix 11: Historical and Expecte

Appendix 14: Microsoft Base-Case Va

Appendix 17: Historical and Expecte

Working Capital Appendix 19: Nokia

DCF Calculation Explicit Value 9,12

Appendix 26: Historical and Expecte

Damodaran Data USA Weighted Unlev.

Appendix 30: Historical and Expecte

James, M. and Koller, T. (2000) Val

Other sources: Damodaran’s websit

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  • Company Forensics

Why Microsoft acquired Nokia (and then sold it)

David Marin

Nokia is a Finnish multinational corporation that goes all the way back to the nineteenth century and started with wood mills that produced mainly paper. Yes, the same Nokia that a hundred years later created cultural icons like the 1110 phone model a lot of you probably rocked at some point, back in the early 2000s. It became a mainstay in mobile phones for some years, and it was interesting enough for Microsoft, who bought Nokia. The story, however, is much more complicated than that.

Nokia was an icon in mobile phones

If you’re older than 20, you most definitely know Nokia for leading the telecommunications market back in the early years of cellular phones, producing some of the first commercially successful handsets that sold hundreds of millions of devices and lead the industry for more than ten years straight, paving the way for the rise of companies like BlackBerry or Motorola. 

But all that was only the beginning of the mobile phone era and a few years into the 21st century came smartphones. Surprisingly, after the first decade of this new millennium, Nokia found itself fighting to keep up with the web 2.0 environment, the deadly competition of the iPhone and the swift development of Android. 

Unbelievable as it seemed then, Nokia sales started plummeting after mainly going only up. So, after having been making business for a few years with them, in 2014 Microsoft stepped in and acquired all Nokia mobile phone operations for no less than €3.79B, plus another €1.65 billion to license its portfolio of patents. It was kind of a lifesaver for Nokia but it was also Microsoft’s big bet on entering the feature phone game, to deliver both software and hardware. 

The challenge was a huge puzzle for Microsoft and it needed to be figured out quickly, as the competition of iOS and Android became ruthless.

Yeah, the glory of Nokia and the roaring success from old times had just vanished and things continued going south to the point where Microsoft ended up re-selling Nokia’s phone operations to HMD, again a Finnish subsidiary of the giant Foxconn Technology Group, in 2016.

So, despite still being alive, Nokia as a phone brand is not even the shadow of what it once was and the kingdom they built when they put cell phones in everyone’s hands, is just gone for good. 

How Nokia started

Let’s get nostalgic now. Nokia was born in Finland, in 1865, so it has lived over the transition of two centuries. Yes, it was during the final years of the industrial revolution when Nokia was created by Frederik Idestam and Leo Mechelin, two owners of wood mills in the Finnish towns of Tampere first and later in Nokia, a town named after the Nokianvirta river. 

The two businessmen decided to partner up and created a shared good, named the Nokia Company. By the end of the nineteenth century, they decided to step into the electricity generation business but just then came the first World War. By the end of it in 1918, Nokia was struggling to survive. No surprise there... But then it formed a partnership with the Finnish Rubber Works and the Cable Factory, all companies based in these Finnish lands.

Later in 1967, the three companies merged into what we know as the Nokia Corporation, after having been manufacturing electronics from cables to radio communicators, computers, and many other products like rubber boots or respirators. It was in the early 70s that they started getting into the network and telephone industry. 

The spirit of merging was in Nokia’s DNA and in the following years they acquired a series of companies, including several of the main television manufacturers from Finland, Sweden, and Germany, turning into the third-largest TV maker company. Similar story with radio communicators, that they even manufactured for the army along with other products.

These acquisitions and mergers were considered a significant shift in Nokia’s business and were mostly orchestrated by Kari Kairamo, the Finnish CEO that arrived in 1977 and that sadly committed suicide ten years later, by the time the company’s revenue base was hitting 3B. Under his administration, Kairamo executed several acquisitions that increased the company’s portfolio in the modern market. One of the companies they acquired was Mobira, an early cellular phone manufacturer that ended up being the foundation of Nokia’s future business in telephony. 

In 1981, Mobira launched the Nordic Mobile Telephone or NMT, as a solution to the increasing demand and saturation of the old manual phone networks, and it was the first one to allow international roaming. The network was opened in 1981 in Sweden and Norway, and soon in more countries like Denmark, Finland, and Iceland.  

But it was the Mobira Cityman 900 that really started Nokia’s race for fully mobile phones, being way smaller and lighter than the Senator, although it had a very high price tag at the beginning. Nokia had been winning from Finland’s open trade with Russia, and the Cityman 900 phone model became iconic after the Soviet Union president Mikhail Gorbachev used it to make a call from Helsinki to Moscow during a press conference in October 1987. Yes, with the Cold War at its peak, Nokia is reported to have managed successful business with both Russians and Americans. That’s how big it was. 

Nokia created a wide catalog of devices

Let’s keep the nostalgic vibe and remember some of the most popular Nokia phones that have a rightful place in the history books and in the memory of those in their mid-late twenties or more. But before that, we need to say that the amount of phone models in Nokia’s catalog over the years is ridiculous and there are many series and models that were successful. 

Sure, most of them are discontinued today, but still going through the full list can be stunning. Let’s remember some of the most iconic ones.

They also experimented with all-in-one type models that may have very well been the first approach to smart devices. The Nokia 900 Communicator from 1996 was a mini-laptop looking device that could do fax, email, spreadsheets and some other stuff. It wasn’t necessarily a commercial success, but it’s worth mentioning as one of their first attempts to have phones do more than calls and messaging. 

That first Communicator seems to have been the one that brought Microsoft’s attention in. Nokia executives at that time tell that a Microsoft recon team brought Bill Gates himself to see the device and have a demo of it, in a big tech conference in Las Vegas. Microsoft reportedly bought a good amount of them and this started a business relationship that would end up being critical.

Later in 1998, came yet another commercial hit and the first to successfully introduce the idea of gaming on a phone. Yes, the first one to feature the Snake game in it: the Nokia 6100. It’s very likely that you or someone you know had one of these in the early 2000s. In a way, Nokia can be remembered as the phone of the people, as they always delivered great durability and value for accessible bucks; whereas brands like Blackberry pursued a more sophisticated, executive audience. 

Nokia entered the 21st century still as the undisputed king of cell phones, having surpassed the 100th million manufactured phones in 1998. In that year alone, they had a sales revenue of $20 billion making $2.6 billion profit. By 2000 it employed over 55,000 people around 140 countries and had a market share of 30% in the mobile phone market, almost twice as large as its nearest competitor, Motorola. 

Before Microsoft acquired Nokia, the giant was already struggling

But just then, the first decade of the new millennium brought a real game-changer: in 2007, the iPhone was released to the world, quickly setting a new industry standard. Just switching from keyboards to an all-touchscreen the way Apple did it back then, was revolutionary, and with the implementation of iPhone OS, there was no doubt that Apple had defined a new era. 

The iPhone almost instantly dethroned Nokia and any other runner-ups. The director of user experience management at Nokia during that time has reported himself to have been explicitly tasked with creating an “iPhone killer” for the next year. Yeah, imagine being charged with that… So, shipments of iPhones were received and analyzed in Nokia’s headquarters, but something was just off now. The iPhone may have been the drop that spilled the glass.

Several former Nokia executives have shared their thoughts on the overwhelming transformation that the company went through with the overflowing success of their phones. Cause let’s remember the Nokia foundations from those wood mills and rubber factories and how its culture pretty much came from those humble days. Former employees have testified how all the crazy success and the tons of money that came through the years impacted on Nokia’s cultural foundations and principles. 

There are many testimonials of this and even one curious story to illustrate it, told by the former head of development and senior vice president from the 90s themselves. Yeah, whenever they had a problem or needed to solve a complex issue, management would climb up the top of their building to meet, just not in your regular meeting room but in saunas, surrounded by a spectacular rooftop view that helped ideas flow, according to them. It sounds extravagant, but if you think about it, it’s a very personal approach to problem-solving, maybe a little too personal, but ultimately an expression of trust.

With the outrageous growth came a new lineage of executives and managers that didn’t have time for any of that, as the company seemed to have become a monster hungry for more success and more money at all costs. The internal competition within the teams and divisions became ferocious and different management styles were confronted in what former employees have called a madhouse. 

Also, the killer competition didn’t stop with the iPhone. In 2008, the Google recently acquired Android mobile OS, was featured for the first time commercially in the HTC Dream phone.  

We all pretty much know how the story went from there: Android became the main mobile operating system on virtually every phone that is not an iPhone. Big manufacturers like Samsung or even Huawei raised through Android and claimed their rightful place in the Market too. 

Who Bought Nokia?

Cut to - the end of 2013, Microsoft announces the acquisition of all Nokia phone operations for more than 5B euros. It was Microsoft’s move to take part in the mobile market after having underestimated it and focused mainly only on its PC business. It was an ambitious bet and a bigger challenge for Microsoft. 

The dimension and complexity of the acquisition were such, that the deal was several months overdue after its announcement, due to legal and administrative challenges that involved manufacturing facilities in Asia, along with a mix of licenses and operating systems. By the time the deal was closed, some financials had of course changed and Nokia ended up receiving something around the 7B euros.

Image for: Why Microsoft acquired Nokia: a Nokia conference shows several speakers on the stage, with the words Nokia acquisition, and 7 billion Euros on the right

Nokia also had to remain in charge of operations in Korea and India, due to tax-related legal constraints, but they would manufacture for Microsoft and all phones would now be Microsoft branded. 

It was just the beginning of the massive puzzle that Microsoft had got itself into. For a reference, by 2013, Nokia sold nearly 251 million handsets, a mixture of feature phones and smartphones.

The Lumia lineup of Windows Phones only accounted for 30 million and Microsoft had to plan how to handle the other 220 million other devices that Nokia produced not on Windows Phone. It was a big worldwide business in which Nokia was in second place behind Samsung, as the top mobile phone manufacturers. Microsoft was now the world's second-largest phone manufacturer by sales.

With the hardware muscle now, some argue that Microsoft’s right move should have been to make the Windows OS free in all their smartphones. Of course, that’s easier said than done and ultimately, Microsoft wasn’t successful in figuring out the licensing puzzle or inserting itself as a phone brand. But just thinking about it, free adoption of Windows Phone would’ve definitely placed more direct competition on Android. It would’ve given them the chance to control their own app store, push its own cloud-based services, and many other possibilities. 

But instead, the firm’s efforts to elbow into first-party hardware received a massive setback. Long story short, in 2015 Microsoft writes off $7.6 billion as a consequence of the Nokia acquisition and lays off 7,800 employees and a roughly $800 million restructuring charge, writing down the vast majority of the phone business purchase price.

In 2016, Microsoft Mobile announced the sale of its feature phone business to the Finnish HMD Global and FIH Mobile. The sale included design rights and its rights to use the Nokia brand on all types of mobile phones and tablets worldwide until 2024. The total sale to both HMD Global and FIH Mobile amounted to US$350 million.

After Microsoft acquired Nokia, what happened to it? 

In this new stage, back again in Finnish hands, Nokia seems to have been recovering some of its roots and it now produces straight forward devices for the mid-lower end of the market. However, it’s been diminished to almost being unknown for the new generations. 

So, that’s how a company that once was reigned over the mobile phone industry became a runner-up and ended up maneuvering just to keep its head up. Now, if we learned something today, is that when a company reaches the global magnitude that Nokia reached, it’s virtually impossible for it to go down to the point of disappearing. Just think of something equivalent nowadays, like Samsung or Apple going out of business… it’s just hard to imagine, it would probably require a global calamity. 

But remember, we also learned that success can sometimes hit hard and shake a company’s foundations just as much as a failure. Having a solid base and principles to stick to can end up being critical for a company’s endurance over time, regardless of its size.

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Microsoft And Nokia Partnership Case Study

microsoft nokia merger case study

Show More Microsoft and Nokia Partnership The paper’s theme is an analysis to determine whether the Microsoft and Nokia partnership was a success or a failure, although the termination of the partnership occurred when Microsoft acquired Nokia. Currently, Microsoft is rightsizing the Nokia staff. The analysis will explore the forces leading to the partnership, each partner’s partnership objective, reasoning for the partnership, approach creating the partnership, effective and ineffective decisions resulting from the partnership, and the issues each company’s CIO needed to address to support the venture. On February 11, 2011, according to a press release from Microsoft, "Nokia and Microsoft intend to jointly create market-leading mobile products and …show more content… Nokia is bleeding market share to Apple and Google 's Android partners. From Nokia’s viewpoint, Microsoft with its deep pockets is the perfect partner because the firm is not achieving market penetration from hardware vendors (Hickie, 2013). The two reasons for the partnership opportunity is 1) Nokia requires financial and marketing resources to invest, while the company re-invents itself, 2) Microsoft requires a committed hardware vendor with a recognizable brand name to provide a platform for the Windows Media operating system (Hickie, 2013). Resulting from the two objectives, Microsoft gains 1) Nokia adopting Windows Phone as its principal smartphone strategy; 2) Nokia would help drive the future of Windows Phone; 3) Nokia would contribute its expertise on hardware design, imaging, mapping, and language support; 4) Nokia would help bring Windows Phone to a larger range of price points, market segments, and geographies; and 5) Nokia’s extensive operator billing agreements would make it easier for consumers to purchase Nokia’s Windows Phone services in countries where credit-card use is low (Microsoft, …show more content… The CIO also must keep track on how the interaction of the technologies, methods, and increasing production can help or distract the technology aspects of the business lines. Finally, the CIO should ensure the transfer of optimum intellectual property and secure the assets of the venture. Summary Microsoft and Nokia established a strategic venture to develop smartphones. Both parties possessed the technology and intellectual property to provide the venture. The key question is whether the venture achieves its goals and is the results of the venture are a success? The answer to this issue is difficult to determine because of Microsoft 's 2014 purchase of Nokia. Although in the meantime, with the Microsoft CEO replacement, the strategy of the company may be changing. According to Souppouris, (2015), the company announced in 2015, Microsoft will reduce 7,800 positions over the next several months. Much of the reduction will come from Microsoft 's phone business, which joined the company 's newly formed ‘Windows and Devices Group’ in June. As part of the merger announcement, Microsoft also revealed it would say goodbye to the last two major Nokia executives still at the company (Souppouris, 2015, p.

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Devices & Services for $7.2 billion, a bold move by the software giant aimed at strengthening the position of Windows Phone in a smart phone market that continues to be dominated by devices running Android and iOS. This deal is expected to close in Q1 2014 subject to shareholder and regulatory approval. In this analysis, we look at the strategic rationale for the acquisition, focusing on the next wave of mobile growth driven by demand for data services in fast-growing markets, and assess how well Microsoft-Nokia is positioned to benefit from it. The Companies are very excited about the proposal to bring the best mobile device efforts of Microsoft and Nokia together. Our Windows Phone partnership over the past two and half years has yielded incredible work -the stunning Lumia 1020 is a great example. Our partnership has also yielded incredible growth. In fact, Nokia Windows Phones are the fastest-growing phones in the smart phone market.

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Case Study: Microsoft Acquisition of Nokia

The merger between American and US Airways to form the world’s biggest airline has captured the headlines in recent days (Rushe). However, it is likely to affect less people than the acquisition of Nokia by Microsoft. More people in the United States and across the globe use the two products as compared to the services provided by the ‘two’ airlines. This paper delves into the case of the acquisition of Nokia, and some of its consequences.

Circumstances that Resulted in the Acquisition

Although Nokia was once the leading mobile phone manufacturer in the world, times changed to point where the once giant was struggling to remain relevant in the market. The downfall of the mobile phone manufacturer is extensively attributed to the inability of the company to come up with superior operating systems that would match up to others such as the Android, or the IOS (Rigby).

The purchase of Motorola by Google, and the news that Samsung was going to introduce its own operating system meant that each hardware maker would have to find a guaranteed OS, and the other round as well. Since Microsoft was reliant on manufacturers such as Nokia, HTC, and Huawei to run its Windows Phone OS, it took the chance to acquire Nokia since it was well established globally and was also lacking in software expertise; which happens to be Microsoft’s forte. The continuous decline in Nokia’s market share also made it desperate for a way to change its fortune.

Positive Effects of the Acquisition

An acquisition such as this is backed by the numerous possibilities of positive outcomes. From a very neutral perspective and one that is aimed at the general welfare of the industry, one of the positive outcomes is that there will be competition between the key players in the mobile phone market. Competition between giants such as Microsoft, Google, and Apple is bound to nurture an atmosphere of lower prices and better products (BBC). This is welcome news since it means that civilization makes strides forwards in the field of technology.

Nokia was also inclined towards further decline in the global market. The acquisition by Microsoft drastically changed this. Its 32, 000 employees would no longer have to fear about the fate of the company. A consequence of a merger or an acquisition is that the influence of one company is acquired by the other. In this case, the influence that Microsoft has in the global platform was acquired by Nokia. This helped it to avoid collapse, if it indeed got to this stage.

Changes to the Organizational Structure

After Microsoft acquired Nokia, one of the initial statements that it made was that it had no plans of restructuring the company in any major ways. The only notable development was that Stephen Elop, who was the chief executive at Nokia, was going to join Microsoft. Microsoft maintained that all other aspects of Nokia would remain the same (Winfield).

Unlike the case of American and United States Airways, the operations of Microsoft and Nokia are a bit different. The two airlines have no need to have two identical structures, the fact that the merger makes it a large organization may require it to restructure. Organizational structure in most mergers change because organisations are very similar, but the case of Microsoft and Nokia is different. Microsoft is a software giant while Nokia is a hardware giant, the two organizations cannot synchronize because they do not handle the same sought of functions. Detrimental outcomes are likely to occur if Microsoft took the initiative to shape Nokia since Nokia is more experienced in hardware making than Microsoft is.

Modification of Human Resources Management Practices

Like in the case of the organizational structure, Microsoft allowed Nokia to continue as it was before with only minor changes. Stephen Elop changed sides from Nokia to Microsoft. This is notably the most significant changes in the human resource set up as a result of the acquisition. The other thirty two thousand employees of Nokia retained their positions (Worstall). The structure of Nokia with regard to its human resource is very different from that of Windows. For instance, Nokia’s operations are mainly carried out in Finland and others in the Asian continent.

On the other hand, Microsoft carries out most of its operations in Seattle and ships its products out of the country. Production of software and hardware necessitates two very distinctive sets of human resource teams. Again, the case of American and U.S. Airways is different in that they both undertake very similar functions and the operations of one can be executed by the human resource team of the other.

BBC. Microsoft to buy Nokia’s mobile phone unit . 03 September 2013. Online.

Rigby, Bill. Microsoft swallows Nokia’s phone business for $7.2 billion . 03 September 2013. 

Rushe, Dominic. American and US Airways officially merge to create world’s biggest airline . 9 December 2013. Online.

Winfield, Nick. Microsoft to Buy Nokia Units and Acquire Executive . 03 September 2013. Online.

Worstall, Tim. The Real Reason Microsoft Bought Nokia. Transaction Costs . 08 October

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Good How To Evaluate Mergers And Acquisitions: Microsoft Acquisition Of Nokia Devices Case Study Example

Type of paper: Case Study

Topic: Telephone , Google , Windows , Software , Market , Microsoft , Nokia , Marketing

Published: 04/02/2020


1-Strategic rationale: what are the primary reasons for the acquisition?

In September 2013, Microsoft acquired Nokia at a cost of $7 billion in a bid to strengthen its (Microsoft) position as one of the leading players in the mobile universe. The strategic rationale was in response to the fierce competition in the industry. Microsoft desires to enhance its market competitiveness. Before the partnership with Nokia, Microsoft was virtually irrelevant in the mobile market but its acquisition of Nokia has enabled the company makes inroads in the lucrative smartphone industry. Nokia smartphones run on Microsoft’s Windows Phone 8 operating system. Sale of Nokia smartphones has gradually increased, and Microsoft would benefit from the positive indicator if it had direct control of Nokia resources. Microsoft aspires to leapfrog iOS in the next 3 years, and this would be possible if Nokia were acquired by a competitor. Indeed, if Nokia was acquired by a rival, Microsoft would have been kicked out of the smartphone industry. Microsoft will be able to unify hardware and software implying better integration of the handsets with the Windows Phone operating system thus increasing the company’s market competitiveness.

2-Integration plan: how effective is the plan to integrate the two organizations?

The acquisition has integrated key Nokia personnel into its management and technical team that have maintained the working rhythm. Nokia sales team is still intact, but the supply chain, as well as the marketing of the two companies, has been consolidated to increase efficiency. 3-Implementing the merger/acquisition: How quickly if there is not a plan to achieve and use them early in the merger/acquisition process.-Are planned market advantages being achieved? Why or why not? -Is the right cost structure in place? How long did it take to achieve the cost structure? How effectively have the strategic advantages been preserved through the cost-cutting process? etc Already, the acquisition has proved fruitful with Nokia smartphones controlling an over 10 percent market share in 9 markets and outperforming Blackberry in 34 markets to become the third most popular OS in the world. Window-powered Nokia phones year on year sales have gone up by 78 percent. With all operations under one roof, innovation will hasten. The acquisition has increased the economies of scale that has led to an improved unit economics increasing profitability. The acquisition has also increased royalty gross margin from less that $10 to more than $40. The company will break even when smartphone sales are above 50 million.

Google Acquisition of Motorola

Google Inc. announced, in August 2011, its desire to acquire Motorola Mobility for $12.5 billion although the deal was subject to approval by the relevant authorities. At the time, Motorola has posted losses for five straight quarters. The acquisition deal was finalized in May 2012, and Google appointed Dennis Woodside who served as its senior vice-president as the new Motorola Mobility CEO. 1-Strategic rationale: what are the primary reasons for the acquisition? Google acquired Motorola to reinforce its patent portfolio (access to licenses for intellectual property) since Motorola enjoyed a massive 10000 patents with 7500 patents awaiting approval. Google’s Android operating system has been facing patent infringement allegations from its competitors Apple, Microsoft and Oracle. By acquiring Motorola, Google would drastically reduce cases of patent infringement. 2-Integration plan: how effective is the plan to integrate the two organizations? Google promised to maintain Motorola as an independent business. Motorola would take charge of innovation in the Android platform while Google would continue with its core advertising business. Motorola management team is under CEO appointed by Google. Nonetheless, experts believe that, in the long run, the talent in both companies will be combined to form a powerful highly innovative team such that Google will have the capacity to control both software and hardware just like Apple. 3-Implementing the merger/acquisition: How quickly if there is not a plan to achieve and use them early in the merger/acquisition process.-Are planned market advantages being achieved? Why or why not? -Is the right cost structure in place? How long did it take to achieve the cost structure? How effectively have the strategic advantages been preserved through the cost-cutting process? etc Google acquired Motorola when the latter was struggling financially; recording massive losses due to its inability to adapt to the digital technology. In a bid to streamline its operations, Google announced it would reduce Motorola’s workforce by 4000 and terminate operations in a third of its locations located outside the US. Google would benefit through reduced tax liability since it will claim tax deductions’ for losses made by Motorola. The acquisition of Motorola has not been successful, and the company is yet to make any mark in the market. Indeed, in December 2012, Google sold the Motorola Home business to ARRIS Group, Inc. in a deal worth $2.35 billion.


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