The big 3GSM World Congress mobile phone show in Barcelona this week was filled with nifty product announcements, cutting-edge technology demos, and portentous strategic alliances. But perhaps no event carried quite as much symbolic value as a one-two punch of revelations from the world's largest cell-phone maker, Nokia.
For the Finnish giant, it was out with the old and in with the new. On Feb. 13, it planted a stake firmly in the future by unveiling its first-ever phone that works on both the so-called "GSM" cellular networks that are common in the U.S. and most of the world, as well as the wireless fidelity, or Wi-Fi, high-speed Internet zones popping up almost everywhere. Such phones will save users money by letting them place cheaper voice-over-Internet calls from their homes, offices, or hotspots.
UNEXPECTED TWIST. At the same time, Nokia (NOK) reinforced its ambitions for bringing broadcast TV to the small screen by announcing a collaboration with rival Sony Ericsson on technical standards for mobile TV. Both moves could vastly widen the usefulness and ubiquity of mobile communication and entertainment.
The next day came a different story. Nokia unexpectedly disclosed plans to exit the business of making phones for CDMA, the second most widely used mobile standard in the world. Instead, Nokia will tackle CDMA through a joint venture with Sanyo (SANYY). Despite years of effort and hundreds of millions in R&D spending, the king of mobiles has always lagged behind in CDMA, which is controlled by San Diego-based Qualcomm (QCOM). The rival technology is used by about one-fifth of the world's mobile-phone subscribers, mostly in the U.S. and Asia.
Nokia enjoys roughly 38% market share in handsets for GSM, which it helped create in the early 1990s. In 2005, that amounted to sales of about 230 million phones. By comparison, its share in CDMA -- which dominates Korea and also appears in and Japan, Brazil, India, and other countries -- is only about one-third that size.
MONEY GOBBLER. Why the poor showing? Nokia has long resisted buying CDMA chips from arch-enemy Qualcomm, preferring to develop its own using patents licensed from Qualcomm and others. That meant it was continually scrambling to keep up with the latest enhancements to the technology -- and producing phones that didn't wow customers. Things have gone downhill recently as Qualcomm rolled out so-called "EV-DO" phones with faster data access, a technology Nokia doesn't yet have.
Worse, CDMA is a perennial money-loser for Nokia. With high R&D costs spread over fewer than 20 million units annually, Nokia's long, tortured effort to grab share in CDMA is a drag on earnings. CDMA phones have lower gross margins than the rest of its product line. Add research and marketing expenses, and success in CDMA looks positively quixotic.
Enter Sanyo. Nokia will transfer its entire CDMA business unit, including about 1,000 employees in San Diego, to the joint venture. The diversified Japanese electronics maker also makes CDMA phones and has struggled to get traction and make money in the business. Sanyo's 7% share puts it well behind rivals such as Samsung, LG, and Motorola (MOT). "We think by putting the two together we can get better than one-plus-one equals two," Nokia CFO Rick Simonson says.
"WIN-WIN SITUATION." A marriage of two also-rans doesn't sound like a recipe for success, but the combination actually makes sense. If they hold on to their customers, the two companies combined will have about 20% market share, making their ventures a strong No. 2 behind Samsung.
Equally important, they bring complimentary strengths and product lines. Sanyo has enjoyed success with U.S.-based Sprint (S) and Japan's KDDI, while Nokia is stronger in India and Brazil. Sanyo's portfolio is tilted to high-end models, whereas Nokia is more of a bottom-feeder.
"We view this as a win-win situation," says Albert Lin, an analyst with American Technology Research in San Francisco, who rates Nokia a buy and is neutral on Sanyo. The two companies haven't released financial terms of the deal, which is expected to close in the second quarter. But the industry is already buzzing about its potential. The joint venture, to be based mostly in Osaka and San Diego, will start out with around 3,500 employees, though eliminations could soon cut that down to 3,000.
Brand identity hasn't been disclosed, but it's likely to include both names for their respective market value. The Nokia moniker will bring visibility and respect to Sanyo's CDMA line, especially in the developing world, while the Japanese connection could help the rest of Nokia penetrate a market where it has been largely shut out.
MIXED PICTURE. On the operations end, Nokia's wide access to distribution channels could help drive Sanyo's beefier CDMA phones into new markets. And the joint venture's greater scale will help it negotiate better prices for components than either company could get alone, while spreading R&D and marketing costs across a broader sales base.
"In this business, bigger is always better," says equity analyst Richard Windsor of Nomura Securities in London. One curious twist: The deal will likely be a boost to Qualcomm, because the venture is more likely to buy its chips to get the latest technology.
Will it work? Previous history offers mixed guidance. The Sony Ericsson joint venture, which also united two struggling handset players, has turned into a major success after some initial bumps. Over time, it has delivered on the promised synergy of Ericsson's (ERICY) telecom expertise and Sony's (SNE) media and marketing sizzle. But when Alcatel (ALA) dumped its troubled handset line on Chinese upstart TCL, the venture turned into a mess. Analysts figure Nokia and Sanyo stand a better chance.
Equally interesting is the effect the divestiture will have on Nokia. Losing its CDMA sales could lop as much as $1.5 billion off its annual top line. But overall gross margins and net profits should improve, though analysts haven't yet run the numbers. Results from the joint venture won't be consolidated into Nokia's results, but rather added as a contribution to earnings from "associated" companies.
UNCHARTED TERRAIN. Perhaps more importantly, moving off CDMA will free up Nokia to focus greater attention on more promising -- and forward-looking -- activities, such as a continued push into third-generation (3G) networks and new ventures such as Wi-Fi phones and mobile TV. After all, even Qualcomm is fast moving beyond plain-vanilla CDMA in favor of new avenues such as its MediaFLO mobile TV technology.
The Valentine's Day bombshell was vintage Nokia: pragmatic, strategic, and unsentimental. You have to hand it to the Finns. In the middle of the world's biggest GSM trade show, they shoved CDMA into the past and stepped into an uncharted future.
Reinhardt is a correspondent in BusinessWeek's Paris bureau
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