SMARTPHONES: Microsoft Puts Smartphone Bets on Xiaomi

Bottom line: Microsoft probably took a 10-20 percent stake in Xiaomi as part of the pair’s new alliance, and could use the Chinese company as its primary vehicle for participating in the mobile devices market.

Xiaomi lines up with Microsoft

The high-tech world is buzzing today with news of a major new tie-up between Microsoft (Nasdaq: MSFT) and struggling smartphone maker Xiaomi, in a pairing that has interesting implications on many levels. At the biggest level, this alliance looks strikingly similar to an earlier one that ultimately saw Microsoft purchase the core smartphone business of former global leader Nokia. At another level, the alliance could give Xiaomi a powerful ally to help revive its fading fortunes, including a partner that could help it to move into the lucrative but difficult US market.

Word of this alliance comes just a day after media reported that Microsoft CEO Satya Nadella was in China this week to discuss Beijing’s 3-year-old anti-trust investigation against his company. (previous post) That led me to predict a final verdict in that investigation could be coming soon, and I continue to stand by that prediction. But Xiaomi is also based in Beijing, and it now appears that Xiaomi’s headquarters was an important stop on Nadella’s latest China trip.

According to the latest reports, Microsoft will sell some 1,500 patents to Xiaomi as the initial first big step in what the pair are calling a major long-term partnership. (English article; Chinese article) No more detail is provided, but it’s probably safe to say that many of the patents are for mobile technology and come from Microsoft’s purchase of the Nokia cellphone business in 2014.

Microsoft last month announced it was selling its smartphone business after failing to gain any traction. But this new Xiaomi tie-up appears to indicate the US software giant retained many of the patents it received as part of its earlier Nokia purchase. Google (Nasdaq: GOOG) followed a similar strategy when it purchased the fabled but faded Motorola smartphone brand for $12.5 billion in 2011, and then sold it 3 years later to Chinese PC giant Lenovo (HKEx: 992) for a much smaller $2.9 billion.

Equity Swap?

There are no financial terms in the latest reports of the Microsoft-Xiaomi tie-up. But based on the previous Google experience, we can probably estimate the patents in this latest exchange were worth at least $1 billion. I doubt that Xiaomi paid any cash in the deal, as it’s currently in a cash conservation mode as it tries to revive its fortunes. That would imply that Microsoft probably took an equity stake in the company in exchange for the patents, meaning it may now own around 10-20 percent of Xiaomi.

In addition to the patent sale, the newly announced tie-up also includes cross-licensing agreements that will see Xiaomi install Microsoft’s Skype instant messaging service and Office software on Xiaomi smartphones. If we were put this tie-up into a bigger context, it would appear that Microsoft has decided to abandon actual smartphone manufacturing and sales, and instead move that part of its business into a major partner like Xiaomi.

The news comes at a critical time for Xiaomi, whose sales in its home China market plunged in this year’s first quarter and whose recent globalization drive has also hit a major obstacle in Brazil. (previous post) Analysts are pointing out that the new Microsoft alliance could give Xiaomi important ammunition as it tries to differentiate its phones from the many similar Android-based models now on the market. That does indeed seem true, though we’ll probably need to wait until at least the end of this year before we start to see some interesting new models come from Xiaomi.

We’ll close with a look at the intriguing question of whether this new alliance could mark the first step towards an outright acquisition of Xiaomi by Microsoft. The earlier Nokia deal followed a similar path, starting with an alliance that ultimate turned into an outright purchase by Microsoft. But in this case a repeat of the past seems less likely, following Nadella’s decision to get out of the smartphone business last month. Instead, this kind of strategic tie-up that probably includes an equity stake looks like Nadella’s preferred way to stay closely tied to the mobile device market. Accordingly, it’s quite possible we could see Microsoft increase that stake over time.

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