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