Recent Acquisition of Nokia by the Microsoft Corporation - Case Study Example

Multinational Acquisition: Case Study By Multinational Acquisition: Case Study Introduction The high intensity of competition is increasingly affecting the survival of modern businesses. Hence, organizations today rely on business expansion strategies like mergers and acquisitions with intent to strengthen their market position and to gain competitive advantages over the rivals in the marketplace. Business acquisition can be simply defined as the process of acquiring a running business so as to build on the strengths or weaknesses of the acquiring company. The business acquisition strategy may assist the acquirer to increase his/her geographical coverage and to raise strong competition challenges to small scale firms. However, a thoughtless business acquisition would weaken the organization’s profitability and incur huge financial losses. This paper will evaluate the recent acquisition of Nokia by the Microsoft Corporation. Description of the Acquisition On 2nd September 2013, the Microsoft Corporation announced its plan to acquire the mobile hardware unit of Nokia in a deal amounting to 3.7 billion Euros, along with another 1.65 billion to license the patent portfolios of Nokia (Kovach, 2014). The then Microsoft CEO Steve Ballmer opined that the proposed deal was a ‘bold step into the future’ for the firms, considering their recent collaborations. The deal was closed on 25th April 2015 after completing all the formal regulatory stuff (Ibid). Although the final price has not been revealed, the two companies announced that the takeover was completed for slightly more than the original announced price of $7.2 billion. With the closing of the deal, Nokia’s mobile hardware unit and tablet business will begin to run as a division in Microsoft called the Devices Group. The former Nokia CEO Stephen Elop will lead this division as its executive vice president (Ibid). Nokia was the world’s biggest seller of Windows Phones and arguably the only company that took the platform seriously. Although other mobile device manufacturers such as Samsung and HTC took efforts to make Windows Phones, they could not capture the market effectively. Once Nokia was the world’s largest smartphone maker but the company failed to adapt to the new generation devices that were introduced after the original iPhone launch in 2007. As a result, Windows Phones eventually lost its market share to Android phones but Nokia still decided to continue the use of Windows Phone software for its top-tier devices. Currently, Windows Phone has a tiny market share of 3% - 5% compared to the 80% share of Android in the global smartphone market (Kovach, 2014). Microsoft’s former CEO Steve Ballmer played an important role in making the deal a reality. He strongly supported the deal and had some hot arguments with the company’s board over the deal. Although Ballmer wanted to acquire the whole Nokia, including its mapping service, the board was unwilling to support his plan. Finally, the board agreed to buy Nokia’s devices business only. As a result of the tensions over the deal, Ballmer decided to retire earlier than expected. Accounting Requirements and Challenges The process of business acquisition involves a series of complex accounting procedures for the effective business combination by bringing all the income and expenditure/receipts and payments under common heads of accounts. Since the chosen acquirer (Microsoft Corporation) follows US GAAP, it is necessary to record the acquisition in accordance with this accounting framework. The accounting requirements mainly include five steps including measuring tangible assets and liabilities, measuring intangible assets and liabilities, measuring the amount of non-controlling interest, measuring the mount of consideration paid, and measuring the amount of goodwill or other transaction gains. The tangible assets and liabilities must be measured at their fair market value as of the acquisition date – the data on which the acquirer gains complete control over the acquiree (Kapil 2013, p.829). Similarly, intangible assets and liabilities, non-controlling interest, consideration paid, and goodwill should be measured as of the acquisition date. However, it is important to note that lease and insurance contracts must be measured as of their inception dates. Generally the process of fair value evaluation is performed by a third party firm. Measuring intangible assets and liabilities seem to be a challenging task for the acquirer because the acquiree may not have recorded many of these items on its balance sheet. In addition, Nokia followed the IFRS accounting practices but some intangible assets recorded under IFRS cannot be recognized as assets under GAAP. In the case of non-controlling interest, the fair value may be derived from the stock market price of the acquiree. There are different types of consideration that the acquirer may be paid to the acquiree, including cash, stock, debt, or other types of assets. The consideration should be also measured at its fair value as of the acquisition date regardless of its type. In the consideration calculation, the acquirer must include the amount of future payment obligations (if any) such as earnouts. The amount of goodwill or gain on a bargain purchase can be estimated using the following calculation. Consideration paid + Non-controlling interest – Identifiable assets acquired + Identifiable liabilities acquired If this calculation gives a bargain purchase, then it can be assumed that Microsoft has paid less for the Nokia than the fair value of its assets. If the accounting treatment of acquisition is likely to delay the preparation of final accounts, the acquirer may report his/her best estimates in the relevant accounting period. Those figures may be adjusted later based on facts and circumstances as of the acquisition date. Values Derived from the Transaction While analyzing the Microsoft-Nokia deal, it is identified that this business acquisition slightly increased the amount of goodwill and other intangible assets of the combined business. Considering the size of this business acquisition, it is clear that the business deal contributed poorly to the goodwill or other intangible assets of the Microsoft Corporation. Although Nokia was the world’s most recognized and reputed mobile device brand a few years back, today the company is extremely struggling to address the intense competition raised by the Android phone. It is unfortunate that Nokia still depended upon its Windows Phones even when the company began to lose its market share to competitors. In other words, the company was unwilling to adapt to the wave of new generation devices due to its overconfidence on the Windows platform. Hence, the market demand for Nokia phones consistently declined over the last few years and the company is yet to regain its growth momentum. In this context, a poor brand image of Nokia cannot contribute much to the goodwill or other intangible assets of the Microsoft. In addition, Nokia recently announced a new family of cheap Android devices called Nokia X when the Microsoft is all about Windows Phone. The Nokia’s decision to make an Android Phone would raise doubts about the reliability and functionality of Windows Phones and the situation in turn may lead to a further decline in the brand value of Windows Phones. Furthermore, Nokia had already used the Windows operating system even before the acquisition and hence this business deal has probably nothing new to add to the goodwill of the company. However, economies of large scale may assist the organization to cut down its operating expenses and the large size would benefit the business to spread risks. To sum up, the business combination did not result in a notable value creation. Business Consolidation Issues Evidently, change in ownership is a special issue related to the business consolidation under discussion. It is important to note that the whole Nokia company has not been acquired by Microsoft but the mobile hardware unit and tablet business only. These two business divisions will be collectively called the Devices Group and operated as a wholly owned subsidiary of Microsoft Corporation. Nokia is a Finnish based company and Microsoft is an American multinational company, and hence cultural barriers may become a challenge for the combined business in the context of change in ownership. Nokia and Microsoft had practiced different customer relationship strategies, and therefore it would be really a difficult task for the consolidated business to integrate those strategies and to deliver efficient services to existing and new customers. In addition, the change in ownership resulting from the takeover of Nokia by Microsoft may adversely affect the operational strategies of both the firms. To illustrate, Nokia has recently introduced a new family of cheap Android devices called Nokia X when the Microsoft is still dependent on the Windows platform. As a result, the consolidated business is less likely to continue its Nokia X services, and this situation would negatively affect the interests of existing customers. Similarly, the process of reorganization resulting from this business acquisition may also raise some potential challenges to the effective consolidation of two firms. For instance, the organizational culture, marketing mix, and other policies of Microsoft and Nokia are different, and hence the managements may find it difficult to develop a common set of operational policies that would meet the needs of smartphone customers effectively. Probably, employees at Nokia may be resistant to the changes introduced by the Microsoft, and they would be unwilling to adapt to a new worksite culture. This situation may lead to severe employee conflicts, and the creation of a hostile worksite environment, which is detrimental to employee performance and profit maximization. Acquisition Reporting under IFRS and US GAAP The acquisition reporting rules are different under US GAAP and IFRS. Under US GAAP, the non-controlling interest rate is measured at fair value, including goodwill. Under IFRS, “non-controlling interest components that are present ownership interests and entitle their holders to a proportionate share of the acquiree’s net asset in the event of liquidation may be measured at: (1) fair value, including goodwill, or (2) at the non-controlling interest’s proportionate share of the fair value of the acquiree’s identifiable net assets, exclusive of goodwill” (Ernst & Young, 2012). Referring to the favorableness of the terms of an acquiree’s operating lease relative to market terms, the acquirer recognizes an intangible asset or liability under US GAAP regardless of the lessor/lessee status of the acquire (Ibid). In contrast, under IFRS, an intangible asset or liability should be recognized separately only if the acquiree is a lessee. If the acquiree is a lessor, then the fair value of the asset subject to the lease should be estimated based on the terms of the lease. Here, separate recognition of an intangible asset/liability is not required (Ibid). While treating the combination of entities under common control, the US GAAP system requires the receiving entity to record the net assets at their carrying amounts in the transferor’s accounts (historical cost). The IFRS system either follows an approach similar to the US GAAP or uses the acquisition method (fair value) (US GAAP versus IFRS) (Ibid). Hence, it is clear that the Microsoft would follow a different acquisition reporting approach if IFRS was used instead of US GAAP, and the difference in the acquisition reporting may be material to the profitability of the combined entity. Conclusion From the above discussion, it is clear that the former Microsoft CEO Steve Ballmer played a significant role in making the Nokia takeover plan a success. The deal involved an announced price of $7.2 billion. For reporting a business acquisition, there are number of accounting requirements such as measuring tangible assets and liabilities, measuring intangible assets and liabilities, measuring the amount of non-controlling interest, measuring the mount of consideration paid, and measuring the amount of goodwill or other transaction gains. While analyzing the Microsoft-Nokia deal, it seems that this takeover did not contribute much to the goodwill or other intangible assets of the combined business because currently Nokia maintains a poor brand image. Furthermore, Nokia had been using the Windows platform even before this business acquisition. The change in ownership and the business reorganization would raise a range of potential challenges to the consolidated business because both the firms had been following two different corporate approaches. Finally, the accounting treatments required for acquisition reporting are different under US GAAP and IFRS, and the difference would be material to the profitability of the combined entity. To sum up, the takeover of Nokia by Microsoft would not add to the prosperity of the consolidated entity in the short term. References Ernst & Young (2012) US GAAP versus IFRS. Available at: http://www.ey.com/Publication/vwLUAssets/IFRSBasics_BB2435_November2012/$FILE/IFRSBasics_BB2435_November2012.pdf Kovach S (April 25, 2014) Microsoft Closes Its $7.2 Billion Purchase Of Nokia. Businessinsider. Available at: http://www.businessinsider.in/Microsoft-Closes-Its-7-2-Billion-Purchase-Of-Nokia/articleshow/34206369.cms Kapil S (2013) Fundamental of Financial Management. New Delhi: Pearson Education India. Read More