The Nokia-Microsoft Transaction: Further Thoughts on Strategy and Valuation

Fellow blogger Mike recently discussed ("Microsoft Acquires Nokia Handset Business and Licence-Related Patents"), here, the high-profile acquisition by Microsoft of Nokia's handset business. Permit me to offer my own view of certain aspects of this blockbuster transaction. To remind readers, Microsoft paid 3.79 billion EUR for the mobile phone and smart devices business units plus certain support assets and activities (the business "itself") and an additional 1.65 billion EUR for a 10-year non-exclusive licence (subject to possible extension in perpetuity) to use certain Nokia patents. I scratched my head and did a lot of on-line digging in search of a previous example where multiple billion dollars were paid for a non-exclusive licence, but my efforts came up empty. Whether or not these licence arrangements, having regard to the sums paid, are indeed without precedent, the more interesting question still remains: what do we make of these licence arrangements, given that the previous mega-patent transactions of recent years have focused in whole, or nearly in whole, on the acquisition of patent ownership of large patent portfolios? Two reports of this transaction offer somewhat different perspectives.

First, let's consider the 3 September Reuters report by Dan Levine ("Why Nokia didn't sell its patents to Microsoft"), here. Until the transaction, it is claimed, Nokia had not widely licensed its handset-related patents, instead using its patents as a shield against competitors. That will change, said a Nokia spokesman, "[o]nce we no longer have our own mobile devices, following the close of the [Microsoft] transaction, we would be able to explore licensing of those technologies." That is well and good, but it takes two enter into a non-exclusive licence arrangement, so why did Microsoft agree to take such a licence rather than to acquire the patents?

One answer may simply be that, when compared with several of the mega-deals for patents, most notably the Google-Microsoft Mobility transaction, Nokia simply did not receive an offer for the amount that it wished to receive for sale of its patent portfolio to Microsoft. Maybe yes, maybe no, given all of the second-guessing about the amount actually paid by Google that are attributed to the patents. The better answer, as suggested in the article, is not simply a case of the licence arrangement being the best available option. Rather, the licence was part of a strategy for the exploitation of the company's patents.

In particular, it is connected with Microsoft's attack on Android manufacturers. Thus, it turns out that Microsoft has already succeeded in convincing approximately 20 Android manufacturers to pay royalties, thereby adding a further cost to the overall Android system. The argument is that, by leaving the patents in the ownership of Nokia, the company can separately sue the same Android manufacturers, with the intention of obtaining a royalty and further adding to the cost of the device. The article called this step a "pincer movement" made possible by the ownership of Nokia in the patents. If this be correct, we can expect to witness, over the next several months, multiple law suits for patent infringement and filed by Nokia.

A somewhat different approach is offered on the FOSS patents blog post of 3 September ("1.65 billion euro patent licensing portion of Microsoft-Nokia validates Nokia's portfolio"), written by the perceptive Florian Mueller, here. Of particular interest are two slides set out in the post, taken from a "strategic rationale" document furnished by Microsoft (Mike's post provides a link to the document). Most notable are the following claims by Microsoft:

1. Microsoft is taking an assignment of more than 8500 design patents;

2. The utility patent portfolio that is the subject of the Nokia licence to Microsoft consists of more than 30,000 granted patents and pending applications and is described as one of the most valuable portfolios in the wireless connectivity industry.

3. Microsoft will taken an assignment of the benefits of more than 60 third-party patent licenses.

Mueller observes that Microsoft, unlike Google, already has a strong patent position (witness its success in smart-phone litigation and convincing 20 Android device manufacturers to take a licence with recourse to litigation). Thus it had no interest in acquiring the Nokia patents, but merely in ensuring that it would be free from interference based on these patents, whoever ultimately owns them. The blog also suggests (and others have apparently discussed more directly), that Nokia now is in a position to assert its patents against other parties for the purpose of obtaining royalties (and thereby becoming a "patent assertion entity" or even a "patent troll"?).

Despite the stark differences between the Google-Motorola Mobility transaction, in which the portfolio was acquired by Google, and the Microsoft-Nokia transaction, which emphasizes the grant of licences by Nokia, there are still some common nagging questions: (i) how did Microsoft reach the 1.65 billion EURO valuation for the licences; (ii) how did Microsoft assign a value to the design patents acquired; and (iii) how did Microsoft reach the conclusion that the Nokia portfolio is a particularly strong one?

More generally, Florian states that "Google grossly overpaid for Motorola's patents", apparently based on the thin record of successful litigation resting on these patents. Maybe yes, maybe no. Perhaps Google assigned a large value to the fact that in acquiring the patents, it precluded acquisition by someone else. Perhaps Google has other metrics by which it is valuing the success of its patent acquisition. As for Microsoft, the entire acquisition may make sense only if the company can make a go of it in the smartphone industry. If Microsoft fails, then not only can it be claimed that it "overpaid" for the Nokia patents, but in doing so, it precluded these amounts from being utilized by the company to develop other product categories. Seen from this vantage, the ultimate strategic concern is not the potential benefits flowing from the grant of the licensed rights, but rather the very transaction itself. As such, the issue of the licensing is at most a matter of high level (and expensive) tactics. Without being trite—"only time will tell."

Do the Movie Studios Have a Strategy for the Online World?

I recently paid my annual visit to what is reported to be one of Borders' most successful stores, located in an upscale suburb of a Midwestern US city. When I reached the CD department, I had to do a double-take to confirm what I was witnessing. It seemed to me that the department had been downsized by probably over one-half since February 2009, both in terms of floor space and stock. The feeling that I had entered into a CD ghost town ran through my thoughts.

The recurring theme of the movie industry, and more specifically the DVD business, is that it will do (or try to do) whatever it takes to ensure that it will not suffer the fate of the CD music business. This struggle was well-summarized in an article that appeared in the Strategy & Competition section of the October 19th issue of Business Week. Entitled "Squeezing Every Dime from DVDs", the article discussed the efforts by the content providers to garner greater profits from DVD products. The reality is there for all to see--DVD sales are declining and there is little or no expectation that this trend will be reversed. In the words of Peter Chernin, the former president of News Corp., "[t]he days when you [could] get anyone who wants to see a movie to pay $15 at a Blockbuster, Best Buy or Wall-mart are in significant decline."

Against this backdrop, Hollywood is reported to being taking the following steps to improve its position in the dwindling CD market:

1. Cooperation between studios to combine certain activities, such as distribution and the back-off, in order to cut costs and improve CD margins ("Those talks have since bogged down because hoped-for savings might not materialize quickly enough.")

2. Improve their business terms with the rental company Netflix, whereby the studios want to increase their share of subscription revenues and/or to furnish Netflix with releases only several weeks after they go on retail sale at Wal-Mart et al.

3. Improve their business terms with Redbox, which specializes in $1 DVD rentals at kiosks located in supemarkets, by threatening to withhold titles unless Redbox agrees to certain restrictions, such as limiting the number of titles available at a given kiosk, sharing rental fees and imposing a 45-day wait period from the commencement of retail sales (Not surprisingly, Redbox has filed suit to challenge such restrictions.)

CD as a Dodo Bird

There seems to be a two-pronged approach of sorts going on here, against the backdrop that the studios have internalized that sooner or later there will be a future without DVDs. First, in at least the short-term, squeeze more income out of the existing, if ultimately declining DVD market. Secondly, figure out a way to monetize movies in a non-DVD world.

Experiments abound. For one, Warner is trying to roll out a small number of online rentals in a test market, whereby the in-store sales will take place only four days later. The thought is that the online capability will encourage in-sale purchase of the DVD (though in my humble opinion that reminds me of the failed rationale for making music available on-line.) For another, Fox is offering a three-disk package for the movie X-Men Origins: Wolverine, containing a Blu-ray disk, traditional DVD, and one that can be stored in a computer hard drive. And then there are the online subscription experiments. ranging from Disney, with its proprietary list, to YouTube, with its platform open to all content providers.

I have several thoughts here:

1. For 300 years, content providers have migrated from distribution platform to distribution platform as technology changes. Thus, the effort to increase studio revenues from CDs is an attempt to make the financial best of a bad (and getting worse) situation. Here, the studios are seeking to earn a bit more change while in transition. For the distributors, however, such as Netflix and Redbox, there is the potential double whammy of a declining revenue share and ultimate obsolescence as a distribution platform.

2. The studios (and potential distribution platforms) are far from formulating a successful strategy in the post-DVD world. One advantage of movies over music is the commercial advantage of the movie theatre over the concert and music halls. But the revenues from movie theatres is not enough. Despite a half a decade of talk, the jury is still out whether the movie studios will fare any better commercially than their music colleagues in the online space. In the words of Barton Crockett of Lazard Capital Markets, "They've been practicing for some of these dance steps for a long time. It's time they hit the dance floor."

3. The strategic options available to the movie industry should take into account the wider world of emerging markets. Hardly a day goes by without a business pundit observing that emerging markets will be the focus of economic growth for the foreseeable future. Hollywood, Bollywood, and Nollywood may each have its own core market, and the DVD market is hardly the same for all of them. Indeed, I am not sure the extent of the DVD market for emerging market film industries. But down the line, all will have confront the challenge of online distribution. I, for one, would like to see more discussion of the challenges of online distribution in this broader context.

It's Time to Hit the On-Line Dance Hall