Why Microsoft Corporation Sold Its Feature Phone Business

Microsoft (NASDAQ:MSFT) recently announced that it will sell its feature phone business for $350 million to Foxconn subsidiary FIH Mobile and a newly founded company called HMD Global. Microsoft originally obtained the unit through its $9.5 billion acquisition of Nokia's (NYSE:NOK) handset unit in 2014.

The Nokia 215. Image source: Microsoft.

FIH Mobile will claim the feature phone business assets, including manufacturing, sales, and distribution operations. As part of that deal, it will also acquire Microsoft Mobile Vietnam, its Hanoi-based manufacturing facility. HMD Global will gain an exclusive global license (excluding Japan) to create Nokia-branded mobile phones and tablets for the next ten years. 

The deal will close in the second half of 2016, coinciding with the expiration of Nokia's non-compete agreement with Microsoft, and enable Nokia to reenter the smartphone market with a lower-risk business model of collecting royalties from HMD.

For Microsoft, the sale represents an epilogue to one of its worst business decisions ever. Former CEO Steve Ballmer thought that buying Nokia's handset unit would give it a foothold in the smartphone market against Apple and Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google, but Windows Phones never claimed more than a low single-digit share of the global market. Under Satya Nadella, Microsoft took a $7.2 billion writedown on the business, slashed 7,800 jobs, and dramatically reduced the number of Windows Phones it would launch every year.

But why sell the feature phone business?

Microsoft's smartphones never gained much ground, but Nokia-branded feature phones are still widely used in developing and emerging markets. Microsoft spotted a glimmer of hope in that market, and introduced Internet-connected feature phones pre-installed with basic versions of its apps, like Bing Search and MSN Weather.

Microsoft believed that tethering some of those feature phone users to its ecosystem could encourage them to upgrade to low-end Windows Phones. That strategy made sense, since cheaper Windows Phones were more popular than pricier ones. According to AdDuplex's April numbers, the Lumia 535, which launched for around $135, is its most popular device, with a 12.5% share of the Windows Phone market.

Unfortunately, smartphone prices dropped too quickly for Microsoft's strategy to pay off. Google entered emerging markets like India with its Android One initiative, which emphasized the development of $100 handsets. When that price point proved too high, Google lowered its target price to around $50 last August -- effectively cannibalizing the higher-end feature phone market.

Marginalized by cheap Android devices

Microsoft's response to Google was poorly timed. Last November, Microsoft launched a $55 feature phone called the Nokia 230. That was an odd decision, since it cost just $15 less than the cheapest Lumia and about $25 more than bottom-end Android devices like the SWIPE Konnect 3 and Kenxinda K528, which cost just $30.

The Nokia 230. Image source: Microsoft.

Nonetheless, customers in certain markets still buy Nokia's feature phones, which require monthly data fees and can last for weeks on a single charge. Research firm eMarketer estimates that only about 30% of mobile users in India use smartphones. Pew Research Center estimates that almost two-thirds of people across seven sub-Saharan African nations still use feature phones.

However, new initiatives to launch free Internet services in developing nations and rural areas, like Facebook's Free Basics and Google's Project Loon, could dramatically reduce data fees and hasten the demise of feature phones.

What does this mean for Microsoft investors?

Microsoft doesn't disclose how much revenue it generates from the feature phone business. But last October, IDC claimed that Microsoft was generating more revenue from feature phones than Windows Phones. However, the margins for both businesses were likely too low to make meaningful contributions to Microsoft's bottom line.

Therefore, selling the feature phone business before it gets overtaken by low-end smartphones seems like a good way to recover some cash while streamlining its business away from low-profit businesses. Unfortunately, it also means that Microsoft's dream of using feature phones tethered to its ecosystem to grow mindshare among first-time smartphone buyers is now officially dead.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Facebook. The Motley Fool owns shares of Microsoft and has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Source: Why Microsoft Corporation Sold Its Feature Phone Business