Crunch time for Nokia

Andy Reinhardt
10 Jan 2007

When Motorola warned late on Jan. 4 that its fourth-quarter revenues and profits would fall well below Wall Street expectations, the shock waves rippled around the world. Among the hardest-hit was No. 1 mobile-phone maker Nokia, whose shares fell 4.15% in Helsinki trading, to €15.26 ($19.84), and plunged by more than 5% in New York by mid-afternoon on Jan. 5.

It's no wonder investors were spooked. The market forces that Motorola cited for its woes"”especially a shift in sales towards emerging economies"”apply equally to Nokia.

The Finnish giant disappointed investors in the third quarter, when, despite a 20% revenue increase, its net profits fell 4.1%. At the time, Nokia pinned part of the blame on fast growth in markets such as China and India that tend to buy cheaper and less-profitable phones.

That trend appears to have continued in the fourth quarter, as the top two handset makers waged a fierce market share battle in the developing world. Motorola says it sold a record 66 million units in the last three months of 2006, up 48% from a year earlier.
But an 8% decline in the average selling price per unit vs. the previous quarter, to an estimated $121, helped limit revenue growth to between 11% and 13% for the company as a whole.

Prices on the way down

'It's déjàvu again,' says analyst Jussi Hyoty with FIM Securities in Helsinki. 'Volumes are good, prices are under pressure, and margins are coming down. That was the story last quarter from Nokia, and now it's Motorola's turn to sing the same song.'

As investors digested Motorola's earnings pre-announcement, they couldn't help but wonder how badly the same forces will affect Nokia when it reports fourth-quarter results on Jan. 25. Analysts figure the company sold north of 100 million handsets in the last three months of 2006, up more than 25% from the same period a year earlier.

But on Jan. 5 brokerage Credit Suisse issued a report predicting that Nokia's average selling prices slipped to €87 ($113)"”down from the €94 average it logged in the third quarter and 13% below the level a year earlier. That means Nokia's sizzling unit growth could translate into just a 12.4% gain in revenues.

Keeping a lid on costs

The impact of lower prices also falls right to the bottom line. Credit Suisse now figures Nokia's operating margins for handsets in 2006 were 14.6%, vs. 15.1% a year earlier. And 2006 net income, though up 12.5%, to €4.07 billion ($5.3 billion), will lag far behind revenue growth of 20%. Nokia was unable to comment due to its pre-earnings quiet period.

Still, most analysts think Nokia remains better placed than its resurgent American rival. Its market share remains around 35%, and it takes home more than half the profits earned in the entire mobile-phone industry. What's more, Nokia's huge production volumes give it an edge in keeping a lid on costs. Analyst Paul Sagawa of brokerage Sanford Bernstein figures Nokia enjoys a 3%-to-4% cost advantage in manufacturing and distribution over Motorola.

Aware of Nokia's economy of scale advantages, Motorola has scrambled in the past two years under new Chief Executive Ed Zander to grab market share and boost volumes.

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