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JULY 15, 2004
By Andy Reinhardt Is Nokia Really So Bad Off? Although its second-quarter report was hardly confidence-inspiring, investors may be overreacting -- at least a little The news out of Finland looks pretty grim. Mobile phone giant Nokia, which shocked investors three months ago with a sudden downturn in sales, failed to reassure the market on July 15 when it announced results for the second quarter. Revenues fell 5%, to 6.64 billion euros ($8.0 billion). And operating margins for its all-important mobile-phone unit -- which provides 63% of revenues -- fell from 27% a year ago to just 19%. Investors bolted for the exits: Nokia (NOK ) shares, already 40% down from their Mar. 8 peak of $23.52, plunged more than 12% on July 15, to close at $12.45. Is the king of mobile phones is serious trouble? No question Nokia is going through a rough patch. After a decade of nearly flawless execution, it's clearly off its game. Rivals such as Motorola (MOT ), Samsung, Siemens (SI ), and Sony Ericsson are gaining on their much larger rival, while Nokia is making uncharacteristic stumbles. OODLES OF CASH. In fact, investors fret that Nokia's glory days could be over forever -- that pressure from resurgent rivals and low-cost Asian competitors will permanently drag down its profit margins and squash any prospects of stock growth. "It looks like a rout," says analyst Richard Windsor of Nomura Securities in London. However, a bit of perspective is in order. Despite lower sales in the second quarter, Nokia managed to improve its overall operating margins from 11.7% a year ago to 13.7% last quarter, thanks to gains in divisions other than mobile phones. And net income climbed 14%, to $860 million. No other phone maker comes close on those two scores. Besides, Nokia spins off oodles of cash -- $1.7 billion in the quarter -- and has managed to hold onto nearly a third of the global handset market despite an aging model portfolio. What's more, some parts of Nokia are thriving. The mobile-networks division, responsible for 24% of revenues, reported a 6% sales increase and improved margins. And the multimedia division, which makes camera phones and other "convergence" products, booked $839 million in revenues, 24% higher than a year ago. MORE PAIN THAN GAIN? That raises the question of why investors were so upset by the second-quarter report. After all, Nokia had already conceded after its first-quarter disappointment, when sales fell 2% and it lost about 5 points of market share, that it had product weaknesses that would likely take several quarters to rectify. It cautioned that in the second quarter, it would cut handset prices to hold or regain market share, a tactic likely to harm margins in the near term. That's exactly what happened. Nokia says it ended the quarter with 31% market share, down from 32% in the first quarter. (Outside market researchers have pegged the first-quarter figure a little lower, between 29% and 30%.) The hit to margins, though, prompts analyst Albert Lin of American Technology Research in San Francisco to wonder whether the "pain" was worth the "gain." Nokia also has moved quickly to fill the gaps in its lineup, especially in the midrange, where phones cost $150 to $250. It has unveiled a half-dozen new phones since the end of the first quarter that experts predict will help regain lost ground. And it's moving to offer more "clamshell" models -- as popularized by Motorola and Samsung -- which represent a growing share of the business and where Nokia was completely absent until last year. "Nokia will reemerge with a competitive product portfolio," says analyst Bill Lesieur of Technology Business Research in Hampton, N.H. BUZZ MAY BE COMING. What worried the market on July 15 was Nokia's forecast for the third quarter. It said it expects revenues to be flat to slightly down from last year under continued pricing and profit-margin pressure. That will drive earnings far below what analysts had predicted. Investors had been hoping to see quicker signs of an upturn, especially because forecasters think the handset market overall will reach a new high of 600 million units this year. Nokia now looks likely to miss out on some of that growth unless it has a rock-'em-sock-'em fourth quarter. The longer-term worry is that a vaunted business model is coming unravelled. Windsor notes that Nokia's cost structure, including R&D and marketing expenses, is starting to look high. Its low-cost manufacturing advantage is being eroded by Asian competition. And increased price pressure from mobile operators may be forcing down Nokia's wholesale prices. Still, Nokia could stage a turnaround in the fourth quarter. The new models on tap, including higher-resolution camera phones and sleek models for third-generation mobile networks, should add buzz. And Nokia continues to thrive in developing markets in China, India, and Russia, where it has placed renewed emphasis in the last year. "We believe the giant will rebound," says American Technology Research's Lin. Whether Nokia will ever again see mobile-phone operating margins in the high 20s still remains to be seen. Some analysts also doubt it will regain enough lost market share ever to approach its long-stated goal of 40%. Investors are clearly feeling skeptical and pessimistic right now. The ball is now in Nokia's court to prove them wrong.  Andy Reinhardt is a correspondent in BusinessWeek's Paris bureau
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