Will New Phones Boost Nokia's Signal?


By Olga Kharif After the telecom sector's two years of woe, Nokia sees some sunshine. At its analysts' conference on Dec. 2, the world's largest cell-phone maker said it expects worldwide demand to pick up 10% next year, to 440 million units. While some analysts found that estimate disheartening after the 35% annual growth rates of the go-go '90s, Nokia execs said their outfit should grow faster than rivals. The reason: It'll get a boost from its lineup of new phones, some of which will debut in the U.S. on January 1, 2003. They'll carry state-of-the-art features, such as color screens and embedded cameras.

Nokia (NOK) plans to release more new models next year than in any in its history. Last spring, the Finnish giant broke up its mobile-phone business, which contributes 78% of total revenues, into nine divisions. Now, each unit makes phones for a different market segment, similar to what GM does with cars. With its equipment business likely to have another tough year (it contributes the remaining 22% of Nokia's sales), the handset maker still sees "significant market-share gains" in the fourth quarter. By the end of 2003, Nokia hopes to boost its worldwide market share to 40%, from 36% in the third quarter of 2002.

REASON TO CHEER? So far, Nokia's plan has gotten a warm reception on Wall Street. Several investment banks -- including Salomon Smith Barney and Morgan Stanley -- have recently upgraded the stock to buy. Nokia's shares now trade at $18, up 71% from their 52-week low of $10.50 in July. The upgrades were partially based on Nokia's headway with wireless service providers. T-Mobile, which carries the Nokia 3390, will add several other models next year.

And on Dec. 2, Sprint PCS (PCS), the No. 4 U.S. wireless service provider, which hasn't offered any Nokia phones for more than two years, has begun retailing the Nokia 3585, a compact, candy-bar-size phone that includes games, a calendar, and an organizer.

Still, celebrating Nokia's good fortune might be a bit premature. For one, its investment in new products designed to grab market share might be excessive, worries analyst Richard Windsor at investment bank Nomura in Britain, and that could eat at its margins next year.

NO SLAM-DUNK. What's more, some analysts say Nokia's single-digit earnings growth doesn't warrant the high stock price. "There has been a continued trend for missing top line and hitting the bottom line," says WR Hambrecht analyst Peter Friedland. "They've had strong operating margins, but this is going to catch up with them." Friedland believes that Nokia's shares are already fully valued.

Nokia's quest for more market share isn't a slam-dunk. It's counting heavily on gains in phones using a new technology called code division multiple access (CDMA). The Finnish concern has only a 10% share of this market now, partly because of technological glitches several years ago that caused service providers like Sprint PCS to dropp Nokia phones altogether. The problems have finally been worked out, and Sprint recently announced that it would carry one Nokia phone.

However, even Nokia's most up-to-date CDMA phones are behind those from players like Korea's Samsung, says analyst Jay Slattery, with high-tech consultancy Technology Business Research in Hampton, N.H. "They don't offer the full-featured, full-color phones you would expect from Nokia," he notes.

"MORE COMPETITIVE." The Nokia phone Sprint is using has a black-and-white screen -- at a time when the service provider is promoting color-screen models that allow multimedia services such as e-mailing photos. Not to worry, says a Nokia spokesperson: "Our phones are very focused on our target market." Although no announcements have been made, Nokia will come out with more advanced products sometime next year, he says.

Making further inroads in a crowded field will be challenging. Nokia faces rivals like Samsung, Sanyo (SANYY), and Kyocera (KYO). And more could show up soon: Some of the 19 cell-phone makers in China are ramping up their production and could start shipping worldwide shortly. That could make it tough for Nokia to sustain its market share, much less increase it. "It's no more competitive than any other market," counters Nokia's Bill Plummer, a vice-president for strategic and external affairs.

Meanwhile, the push for market share might be using up a hefty chunk of Nokia's resources. Take its new CDMA phones. The manufacturer announced that in two years, models based on this technology, which allows for high-speed Internet access, will account for 15% of its advanced phones. Nokia has shipped a few million of these products so far and plans to increase sales next year. But the resources it lavished on the CDMA project makes sense only if Nokia expects handsets with this standard to account for 35% of its product mix, says Windsor. All the competitors in this market space could make that a hard number to hit.

MARGIN SQUEEZE? Many analysts also question Nokia's decision to develop its own chips for its CDMA phones. Some, like Windsor, believe that chips from wireless powerhouse Qualcomm (QCOM), which supplies the rest of the players, would have come cheaper, simply because Qualcomm's volume is so high. Others worry whether Nokia's chips can match the performance of those from Qualcomm, which invented CDMA and has been in the business for years.

Nokia says it's confident that its products are as good. And Sprint PCS, which has tested Nokia's CDMA phone, seems to think so as well. Still, like the rest of the handset makers, Nokia will likely see its margins squeezed next year as component suppliers raise prices and competition intensifies, says Windsor.

Lehman Brothers analyst Tim Luke agrees, predicting that Nokia's operating margins -- earnings before taxes and various charges -- will slip from around 25% today to around 21% next year. And they could get squeezed further in the long term as carriers migrate to new technologies, where Nokia is either behind its rivals or on par with them. "Fundamentally, we're not convinced that they're going to continue to enjoy the same cost advantage [they've enjoyed before]," says John Bucher, a Gerard Klauer Mattison analyst.

ANTI-MOTOROLA. Moreover, Nokia will likely incur extra costs from managing its inventory of more phones and helping its telecom customers sort through the growing variety of models, says analyst Bryan Prohm, with market consultancy Dataquest. The Finnish outfit's strategy is the reverse of No. 2 mobile-phone maker Motorola (MOT), which is to slim down its product line. "Most customers simply want a phone that makes a good phone call," says Greg Santoro, vice-president for Internet and wireless services at carrier Nextel (NXTL). Still, T-Mobile and Sprint PCS believe that variety offers them a competitive advantage.

Nokia has much work ahead of it. U.S. carriers have to be persuaded to carry more of its phones. Today, many go for the funky looks of models from rivals such as Samsung and Sanyo. The Finnish company also wants to make headway in the corporate cell-phone market with its new Nokia 6800, a flip phone with a full keyboard, replacing the bulky and less stylish Nokia Communicator.

However, this new product alone won't win the battle for Nokia, says Technology Business Research's Slattery. Increasingly, corporations turn to tech consultancies and services firms for all of their technology needs. And Nokia distributes its phones only through consultancies IBM Global Services (IBM) and Cap Gemini Ernst & Young. That's not enough to get big deals with businesses, Slattery figures.

PAST GLORY. Despite these challenges, Nokia remains highly profitable, recording $959 million in income in its third and latest quarter. Its sales then grew 2%, to $7.2 billion. In the fourth quarter, Nokia expects sales of $8.9 billion to $9 billion. And many on the Street are betting that Nokia will navigate many of these difficulties. The $800 million Dreyfus Premier Technology Growth Fund (DTGRX), which has held the stock for five years, will stick with it, though it's not a top holding. Says portfolio manager Mark Herskovitz: "They're at the beginning of a new product cycle, which is often followed by a strong period of growth."

Still, Herskovitz admits, "You're not going to get the same kind of growth [as before]." And that's the sad truth. Investors need to decide whether they're in with Nokia for the long term, growing pains and all. Kharif covers technology for BusinessWeek Online and is a frequent contributor to Street Wise


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