Nokia's Not-So-Big Boost

The Finnish handset maker didn't benefit as much from Motorola's woes as analysts expected. But it was enough for investors to drive up shares

by Kate Norton

[Editor's note: This is a revised and updated version of a story that originally appeared on BusinessWeek.com on Apr. 18, 2007.]

The biggest question ahead of Nokia's (NOK) first-quarter earnings announcement on Apr. 19 wasn't how well the mobile-phone titan would do. Most analysts expected a solid performance. Of greater interest was to what extent the Finns would benefit from the woes of archrival Motorola (MOT), which turned in a first-quarter loss Apr. 18 (see BusinessWeek.com, 4/19/07, "No Easy Remedy for Motorola").

Not much so far, it turns out. Nokia reported a 6.6% drop in net profits, in line with Wall Street forecasts, on a quarterly sales gain of 3.7%, to $13.5 billion. The earnings decline was pegged to a shift toward sales of low-price phones in emerging markets. Other results were more ambiguous: Nokia's selling prices were flat—they usually fall—but that's what the market expected. And while Nokia's estimated global market share grew by one point, to 36%, analysts had expected a larger increase.

The news that carried the day, though, was a surprising improvement in Nokia's operating margins, which rose to 33.1%, up from 32.4% in the previous quarter. Investors, steeled against seemingly inexorable margin compression, reacted by driving Nokia shares up 3.8% to €18.22 in Helsinki trading, their highest level in nearly a year. (At midday, Nokia's U.S. ADRs traded at $24.78, up 3.8%.)

To that end, the first-quarter report was vindication of the strategic changes the Espoo (Finland)-based company has made since 2004, when it misjudged demand for clamshell phones and its reputation (and stock) took a knock. With the engines now running smoothly, Nokia looks to have used Motorola's recent stumbles as a chance to lock in some profits. "The company seems to have prioritized gross margin over market share," writes Jari Honko, an analyst at eQ Bank in Finland, in an investor note.

A Million a Day

The numbers speak for themselves: Nokia sold 91.1 million handsets in the quarter, a 21.4% gain on a year earlier. That's a whopping 1 million handsets a day. The biggest buyers are consumers in India, China, and other emerging markets who purchased more than half of Nokia's mobile devices last quarter. While that's been largely driven by sales of no-nonsense phones, Nokia is also introducing more jazzed-up models designed to appeal to an emerging middle class with money to spend.

Such tactics have helped Nokia, unlike rivals, achieve the same margins in its low-end range of phones as in its mid-tier models. But the focus on emerging markets can come at the expense of average selling price per phone—and profits. Amid stiff price competition in the mid-range market and higher sales of basic phones in emerging markets, average prices have headed steadily south for the past year. In the first quarter of 2006, Nokia phones sold for an average $141.27 vs. $120 in this year's first quarter. That's one reason net profits fell to $1.3 billion, from $1.4 billion a year earlier.

Clamshell Recovery

Nokia's advantage is that its sheer size means it can withstand price declines in a market where a phone is a throwaway item. In fact, economies of scale mean Nokia reaps a 3% to 4% cost advantage in manufacturing and distribution over Motorola, according to one analyst estimate.

But as phones become "multimedia devices" and fashion accessories, all the supply chain and manufacturing advantages in the world won't help if your phones aren't hip—a lesson Nokia learned the hard way after the "clamshell crisis." The slew of new models the company has rolled out so far this year to plug gaps in its portfolio—including the ultra-slim 6300—have won kudos from customers and industry watchers alike.