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Microsoft Bets On Nokia; Wall St. Sees Desperation

Microsoft (MSFT) believes acquiring Nokia's (NOK) mobile phone business will accelerate its transformation to a devices and services company. But investors were pessimistic Tuesday, sending the PC software giant's stock down nearly 5%.

Microsoft said late Monday that it will pay 5.44 billion euros ($7.2 billion) to buy Nokia's cellphone business and to license its patent portfolio.

Nokia is by far the main maker of smartphones that use Microsoft's Windows Phone operating system. But Windows Phone badly lags in a market dominated by Apple's (AAPL) iPhone and devices running Google's (GOOG) Android.

Analysts speculate that Microsoft bought Nokia's struggling handset business because Nokia was preparing to make devices running on Android.

Microsoft also made the case for buying its leading smartphone hardware partner by saying it can make more on device gross profit margin than on just licensing Windows Phone to Nokia.

Elop Heir-Apparent?

The acquisition also will bring Nokia CEO Stephen Elop back to Microsoft, where he is considered a leading candidate to replace CEO Steve Ballmer, who last month said that he'll step down within a year. Elop ran Microsoft's business software division before taking Nokia's top job in September 2010. Elop stepped down as CEO on Monday to become Nokia's head of devices and services, a title he will retain with Microsoft when the deal closes, likely in Q1 2014.

In February 2011, Nokia and Microsoft announced a broad alliance around Windows Phone. Nokia's Lumia smartphones using Windows Phone have won positive reviews, but haven't had much market impact.

Microsoft is trying to carve out a place for a third major operating system in the smartphone market. It now competes with BlackBerry (BBRY) and others in the also-ran category.

Microsoft said it is targeting 15% market share out of the estimated 1.7 billion worldwide smartphone shipments in 2018.

In Q2, Nokia ranked No. 9 in the global smartphone market with 7 million handsets shipped, a 3.1% share, research firm Gartner said. Samsung was first with 31.7% share, followed by Apple with 14.2%.

'Backs Against The Wall'

FBR Capital Markets analyst Daniel Ives doubts the acquisition will give Microsoft much of a smartphone edge. "Their backs are against the wall on mobile," he said. "They had to make a move. But in our opinion, acquiring Nokia's device business is not the answer. Since this partnership has been around a few years, it's been a tepid success.

Only 10% of Nokia's phone shipments in Q2 were smartphones; the majority were low-cost feature phones. It still ranks as the world's No. 2 cellphone maker, with a 14% share, thanks to those low-end devices. Samsung leads with 24.7% of the total cellphone market, Gartner said. Finland-based Nokia has been losing share as consumers switch from simple feature phones to smartphones.

Microsoft's Windows Phone accounted for 3.3% of the smartphone market by operating system in Q2. It edged out BlackBerry's 2.7%. But Android dominated with 79%, followed by Apple's iOS at 14.2%, Gartner said.

Buying Nokia's phone business is part of Ballmer's effort to transform the PC software maker into a devices and services company. In July, he announced a sweeping corporate reorganization to support that new strategy.

Ballmer said he remains committed to working with other hardware partners on Windows Phone devices. But those vendors, including Samsung, HTC and LG, might be less likely to support the platform now because of conflicts of interest, ABI Research analyst Jeff Orr said.

The combination of Microsoft and Nokia's phone unit also doesn't address the critical shortfall in software apps, Orr said.

"At the end of the day it comes down to what apps you have," he said. "Windows Phone comes from a disadvantage there."