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If Microsoft Had A Wish, It May Be No More Big, Stupid Deals

This article is more than 8 years old.

When one crawls through Microsoft's latest 10-K filing with the Securities and Exchange Commission, there is an unstated theme. The company is going to be very wary of big deals  -- unless it's really good.

This despite the speculation that the company actually talked to Salesforce.com about a possible merger earlier this year.

But the talks broke off because Mister Softee balked at the price, reportedly as much as $70 billion. Good for Satya Nadella. He'd apparently offered roughly $55 billion.

Wall Street looks to be comfortable a deal didn't come together. Investors prefer careful, smart deal-making from Microsoft. While the stock has been flat this year, it was up nearly 6% in July and has held its own in the face of recent volatility. The stock finished up 11 cents, or 0.2%, to $46.81 on Monday, a day when stocks generally moved lower.

The fact is, however, the 2014 Nokia hardware deal, all $9.4 billion of it, was a big stupid deal, and the internal opponents, which reportedly included Nadella, were probably right to fight former CEO Steve Ballmer over it.

The Phone Hardware business, as Microsoft calls it, probably has not been a fun experience. In the 2015 fiscal year, the business generated $7.5 billion in revenue and a gross profit of $701 million, says the 10-K, filed late Friday.

That means a gross profit margin of 9.2%. But that's not much, especially compared with the 92.3% gross margin for consumer licensing (basically Windows, Office, the Windows Phone operating system and the like) and a 17.6% margin for its computer and gaming business (Xbox, Surface and related accessories).

Those numbers don't tell the whole story. Not even close. The 10-K does, however: "In the second half of fiscal year 2015, Phone Hardware did not meet its sales volume and revenue goals."

In the third quarter, the segment showed a gross margin of -$4 million on revenue of $1.4 billion. Yes, that means it lost money making and selling its phones.

In the fourth quarter, the Phone Hardware's segment reported sales of $1.2 billion, down 38% from a year earlier. The gross margin was -$104 million. Both sales and gross margin were a whole lot worse than the third quarter. That's may be because potential buyers wondered how long Microsoft would support their purchases.

When Microsoft's financial folks did their annual tests for asset impairment on May 1, according to the 10-K filing, Phone Hardware failed. It failed first when the company analyzed the business on a discounted-cash-flow basis. The carrying value was larger than the estimated fair value. And when the analysis went on to look at the values of each of the components in the business -- tangible assets, existing technology, patent agreements, and contractual arrangements -- it still failed.

The result should not have surprised. In its fiscal-third-quarter report, the company signaled the Phone Hardware business was troubled and might require a write-down.

So, in the fourth quarter, Microsoft wrote off $7.5 billion in a combination of goodwill and asset impairment just for the Phone Hardware business. It was the largest write-off in company history, beating a 2012 write-down of $6.2 billion of its purchase of online ad services company aQuantive in 2012. That deal, made in 2007, cost Microsoft $6.3 billion.

Stephen Elop, who returned to Microsoft with the Nokia deal and was once believed to be a potential Ballmer successor, is gone. Ballmer has retired and now runs the NBA Los Angeles Clippers.

Microsoft had already laid off about 19,000 employees during the fiscal year; most were with Nokia. An additional 7,800 still face the axe.

Microsoft is still investing in new things. It reportedly is making a big investment in ride-hailing company Uber.

It is also still buying companies, just not big companies right now. It announced the purchase of Incent Games on Monday. Incent develops software called FantasySalesTeam that operates sales contests for employees. Price wasn't disclosed, but the Austin, Tex., company has just 20 employees. In January, the company raised $1.5 million in a series A funding round.

In fiscal 2015, Microsoft bought 15 companies for a whopping $892 million, the 10-K says. That translates into an average price of $59 million.

For most of us, $59 million is a lot of money. But we're talking Microsoft here, a company that generated sales of nearly $94 billion in the 2015 fiscal year, up about 8% from a year ago. From that perspective, $59 million is small. But it may be smart.