A Wrong Call on Nokia?


By Olga Kharif

Dour announcements are nothing new from Nokia. Reporting in July on second-quarter results, the world's largest cell-phone maker said next quarter's figures could be flat to slightly down, due mainly to exchange-rate fluctuations. Nokia's shares promptly dropped 20%, to $14.38. Then, on Sept. 9, midquarter guidance squashed hopes of higher sales as Asia put the SARS scare behind it and got back to business.

The stock, which had been gaining steadily after the July slump, immediately sagged 6%, to $16, on the day of the announcement, and by the closing bell on Sept. 23 it was down to $15.56. "It's not often that a stock loses its value after a company raises its earnings per share," says SoundView Technology analyst Matt Hoffman, who lists Nokia (NOK) as a top pick and notes that the third-quarter earnings-per-share forecast of 17 cents was an improvement on previous guidance of 15.6 cents.

CURRENCY HICCUP. What's an investor to make of the recent declines? One possibility: Disappointment is unwarranted, especially since Nokia's current problems stem largely from the greenback's weakness -- not operating performance. Currency fluctuations have been responsible for 60% of the decline in revenue per phone in the second quarter, estimates Peter Hofstra, senior investment analyst at the AIC Diversified Science & Technology fund. Instead of running away, investors may want to consider jumping in today, at what may eventually prove to be a depressed price.

Nokia's cell-phone business, which supplies 79% of revenues, is ramping up and likely to see record unit sales in the fourth quarter, traditionally the strongest, says Sanford Bernstein analyst Paul Sagawa, who notes that Nokia is gaining market share and should control 40% of the global market by yearend. What's more, as Sagawa and other analysts note, its money-losing wireless infrastructure business, responsible for about 20% of total sales, should become profitable in the fourth quarter. Evidence that Nokia's fortunes are turning could come as early as Oct. 16, when its third-quarter earnings report is due.

Some mutual funds haven't been waiting. Hofstra, who purchased Nokia in July at $14.50, says the stock now represents 6% of his fund's $113 million in holdings. "We got a real bargain," he says. At a price-to-2004 earnings ratio of 17, Nokia is trading well below No. 2 cell-phone maker Motorola (MOT), with a p-e of 26.5, and wireless-equipment maker Ericsson (ERICY), with a p-e of 63. SoundView's Hoffman believes Nokia could hit $22 within 12 months -- a 42% gain on today's price.

TAKE IT WITH YOU. General market trends also seem to be working in Nokia's favor. Cell-phone sales are rising. In 2003, worldwide shipments should grow 16%, to 465 million, estimates Niel Strother, a senior analyst with tech consultancy Cahners In-Stat. (Nokia expects a more conservative 10% growth in handset sales this year.) In 2004, they'll reach 500 million, he says.

Actual growth might come in even higher, thanks to the wireless number portability rule, which begins in November and will allow U.S. cell-phone users to retain their old numbers when changing carriers. When that switch occurs, users won't be able to keep their old carrier-specific phones. As a result, Nokia could sell an extra 10 million handsets, estimates Michael Mahoney, portfolio manager with EGM Capital hedge funds, which doesn't own Nokia shares.

Many of those phones will be high-end models, Mahoney estimates, since service providers -- which buy the majority of Nokia's handsets -- plan to lure users into signing up for one- to two-year service plans by offering expensive units featuring cameras and color screens.

CAMERA AND RADIO. Nokia could also see a sales spike as the largest U.S. wireless services provider, Verizon Wireless, introduces two of Nokia models in the fourth quarter, says Pekka Vartiainen, senior vice-president for Nokia Mobile Phones, Americas. And Bell Mobility, the wireless services unit of Bell Canada, should start selling at least one Nokia handset in early October, he says.

While demand is climbing for lower-priced phones, Nokia is convinced that it can attract customers for all 28 models it has released so far this year. Seven more are expected before yearend, and nearly all of them are in the middle to high end of the market, says Vartiainen. One example is the Nokia 6225 camera phone, released on Sept. 12, which sports a color screen and integrated FM radio. Carriers will pay around $200 for the unit, vs. around $100 for Nokia phones with fewer options, estimates RBC Capital Markets analyst T. Michael Walkley.

And Oct. 7 will mark the debut of the much-anticipated N-Gage portable gaming console that also functions as a cell phone -- Nokia's first foray into the gaming-hardware market. Each device should cost carriers about $299, with the line contributing $7 million in sales this year, estimates Erik Zamkoff of Independent Research Group, a New York-based equities-research firm that's a subsidiary of TheStreet.com.

NEXT-GENERATION BOOST. Next year, Nokia should start seeing some volume from so-called next-generation wireless phones, which allow for advanced data services such as video streaming. A slew of these models is expected to be launched in the first half of 2004, says Vartiainen, as the market grows at a triple-digit rate. And each handset should be priced at more than double today's average of $150.

Nokia might also benefit from less competition in China, the world's largest mobile-phone market. According to recent press reports, Beijing is considering capping its phone manufacturers' domestic output because the market is suffering from too much inventory. Such a cap could put the weakest of the local manufacturers out of business -- and give Nokia a boost.

For now, though, overproduction in China remains a threat. And in many regions, such as the fast-growing Latin American market, low-price models constitute the overwhelming bulk of Nokia's sales. That has been the case for years, however, and it has been one phone maker able to keep its average selling prices relatively steady.

RESURGENT RIVALS? Rivals Motorola and SonyEricsson (the electronics giants' joint venture) will be stepping up the competition as well. The latter, which has been losing market share for the past two years, is releasing new models that analysts like. And Motorola has teamed up with software giant Microsoft (MSFT) to produce smartphones -- hybrid cell phone-personal digital assistants -- a tiny market that Nokia dominates and which Strother estimates will grow from the 11.6 million units shipped this year to 25 million in 2004.

Finally, Nokia has to prove that some of the newest wireless-network technologies its infrastructure business sells work well, says Richard Windsor, an analyst with investment bank Nomura in London. Nokia has struggled with technical glitches in the past, but "those [problems] have been solved," responds a Nokia spokesperson in an e-mail. So too, perhaps, will the problems that have been holding investors back. Kharif covers technology for BusinessWeek Online in Portland, Ore.


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