Microsoft Corp. will pay Nokia Oyj more than $1 billion to promote and develop Windows-based handsets as part of their smartphone software agreement, according to two people with knowledge of the terms.

Nokia will pay Microsoft a fee for each copy of Windows used in its phones, costs that will be offset as Nokia curtails its own budget for software research and development, said one of the people, who declined to be identified because the final contract hasn’t yet been signed. The agreement runs for more than five years, the people said.

If it succeeds, the partnership may benefit both sides financially while helping stave off a smartphone threat from Apple Inc. and Google Inc. Nokia shares have dropped 26 percent since the accord was unveiled Feb. 11, reflecting doubts about the move to adopt Microsoft’s operating system, which is less than six months old and has just a few percentage points of market share.

“This gives Microsoft scale and allows Nokia to rip out costs,” said Colin Gillis, an analyst at BGC Partners in New York, who recommends buying Microsoft shares. “Microsoft is getting the platform boost that comes from acquiring a Nokia for about a billion dollars.”

Espoo, Finland-based Nokia needs to cut costs to keep operating margins from narrowing further, after they shrank to 4.9 percent last year from 19 percent a decade earlier. For 2011 and 2012, Nokia may cut its budget for research and development in devices and services by about a third from last year’s spending of about 3 billion euros, said Sami Sarkamies, a Helsinki-based analyst with Nordea Bank.

Microsoft spokeswoman Melissa Havel declined to comment on the specifics of the agreement. Laurie Armstrong, a spokeswoman for Nokia, said the final contract hasn’t been signed and the company will share further details when they are complete.

Nokia’s royalty payments will help Redmond, Washington-based Microsoft make a profit on the accord even after the payments to Nokia, one person said. Some of the payment to Nokia would be made before the company starts selling the phones, meaning Microsoft bears some upfront cost in the partnership.

Microsoft shareholders want the company to salvage its mobile-software business while also reining in costs. The company doesn’t break out results for its mobile-software unit, and instead groups them with the profitable Xbox video-game business, making it difficult to evaluate the financial performance of phone software.

Chief Executive Officer Steve Ballmer has come under pressure from investors and his own board to improve sales of mobile software after the company lost market share to Google and Apple. Microsoft stock has declined 7.8 percent so far this year.

The agreement for the more than billion-dollar payment was part of a campaign by Microsoft to keep Nokia from choosing Google’s Android operating system, one of the people said. Nokia also opted for Microsoft because Windows Phone software, which is newer than Android and has a smaller number of handsets for sale, gives Nokia a better chance to stand out, one of the people said.

The agreement also has Microsoft paying Nokia for the right to use its patent portfolio, one of the people said.

As part of the deal, Microsoft will use Nokia’s Navteq mapping products for functions such as geolocation services and selling local advertising and coupons tied to a user’s position. If successful, that also could generate additional revenue for Nokia, which will share in the sales. The two companies will also divide revenue from services like search and advertising, Microsoft President Andy Lees said last month.

Peter Klein, Microsoft’s chief financial officer, said last week at an investor conference that sales from these kinds of services are important to generating profit from the deal.

“In success, it is a very mutually beneficial deal economically for both companies,” Klein said.

Such tailored user services may provide billions of dollars of revenue to Nokia over the term of the contract, one of the people said.

Days after the agreement was announced, Nokia CEO Stephen Elop said the agreement will add billions of dollars in value to Nokia, without specifying how much. Microsoft’s Lees said the agreement involves funds changing hands for royalties, marketing and ad-revenue sharing. Both companies have declined to provide specific amounts. 

(Bloomberg)