Back in late 2007, when Nokia's (NOK) shares were close to $40 per share, the company agreed to shell out $8.1 billion for NavTeq, a leading mapping and navigation company. It was the biggest deal in Nokia's long history, and it looked like a smart one.Unfortunately, they bought near the top of the market, and in the highly competitive tech world, much can happen in a short time. Since then, Nokia has has seen its share price sink to about $13. Now, there's buzz that Nokia will take a major write-down on its NavTeq asset.
The reason: Google (GOOG). The company has been relentless in its pursuit of dominant status in the mobile arena. For example, in October, Google made its mapping and navigation offerings free on the Android mobile phone operating system. That certainly was a radical approach, and the industry had to take notice.
In response, this week Nokia followed suit, shifting to the free approach. Its belief is that its existing navigation users will upgrade to smartphones, which will help offset the revenue drain at NavTeq. But the prospects of this strategy are questionable, especially in light of Nokia's continued loss of market share to players like Apple (AAPL).
So looking back, how did this deal disaster come about, and what can be learned from it?
Founded in 1985, NavTeq built a strong platform for mapping, navigation and location-based mobile services, with a strong footprint in the automotive market. From 2002 to 2006, revenue growth averaged about 37%, and operating margins were a juicy 25%. The company also had a top-notch employee base, with more than 700 geographic analysts.
In 2005, NavTeq became a supplier to Nokia, part of Nokia's strategy to move beyond its heavy focus on device sales. As part of that effort, it decided to buy NavTeq.
Unfortunately for Nokia, there was already mergers-and-acquisitions speculation percolating through the mapping business, which meant nose-bleed valuations: Nokia wound up paying roughly 12 times revenues and 57 times earnings for NavTeq. Regardless, Nokia thought the long-term growth opportunities were enormous. If you take a look at the SEC filings, you'll find these internal projections for NavTeq: Revenue growth from $810 million in 2007 to $1.792 billion in 2011; operating income growth from $207 million in 2007 to $599 million in 2011, Nice, huh? The problem, of course, is that Nokia did not anticipate a market disruption.
Google got into the mapping business back in 2004 through its acquisition of Where2. Since then, the company has continued to innovate in the market.
But at the time, Google faced a major obstacle: It had to license mapping data from either Tele Atlas or NavTeq, which between them had a virtual lock on the market. And the fees were certainly hefty. Google picked Tele Atlas as its supplier, but to win the mapping game, it realized it needed to disrupt the market. To this end, the company set out to build its own turn-by-turn mapping database. It was probably not cheap -- involving thousands of people and cars -- but it was a brilliant move.
Once it shifted to a service based on its own Streetview data, Google had the power to offer mapping for free. In fact, the company went even further and provided advertising revenue splits to partners. How could either its partners or its customers resist?
Google's competitors were faced by the so-called innovator's dilemma: Following in Google's footsteps and making their own offerings free would wreak havoc on revenues. How could they support their infrastructure and employees? And what would shareholders do?
According to a great piece by venture capitalist Bill Gurley, this was a "disruptive play of a magnitude heretofore unseen."
Lessons Learned Too Late
Could Nokia have anticipated this? Perhaps so. But the history of the technology business is full of failed acquisitions, many of which can be traced back to disruptions in the marketplace. The irony is, now it's much cheaper to get into the mapping business, as the market values of companies like Garmin (GRMN) and TomTom (which now owns Tele Atlas) are much lower.
Small Cap Investing
Learn now to invest in small companies the right way.View Course »