Sony Ericsson's profit warning

03 Jul 2008

Sony Ericsson has just issued its second profit warning this year, saying it now expects to ship around 24 million handsets this quarter and is likely to break even for the quarter. The company cited weak sales of its mid- to high-end phones and delays in shipping new products launched earlier this year.

These are jumpy times and people are anxiously looking for signs of a slowdown in the handset market as a symptom of the credit crunch and weakness in developed world economies.

However, we think that, as with the previous profit warning, these issues are largely self-inflicted and do not signal the start of a general slowdown.

The weak phone sales are a symptom of two things: Sony Ericsson's mid- and high-end portfolio recent launches by its main competitors - Nokia, Samsung, LG and Apple.

The issue with Sony Ericsson's portfolio today is over-dependence on the K800 and its big brother the K850. The latter was late into the market, missed out on the expected initial wave of high-price sales and has suffered ever since. This means it has generated lower average sale prices than anticipated and has brought in less profit.

Meanwhile the older K800 is still selling but is well down the price curve.

Sony Ericsson sought to address these issues with a large number of phones launched this year - nine in February, a couple in April and five more in June.

The biggest danger for Sony Ericsson now is that product delays could mean that new models suffer the same fate as the K850. And this was the second aspect of its profit warning.

Based on the announced figures, volumes would be 4% lower and revenues would be €350 million down on 2Q last year, which accounts for the entire expected drop in profits (€330 million in 2Q last year).

During 1Q this year Sony Ericsson said that its costs had risen, mostly in R&D while bringing so many phones to market at the same time and developing for a new software platform - Windows Mobile. This would imply a further reduction in profits, unless the company has carried out some cost reduction in other areas to offset it.

Sony Ericsson has announced a number of attractive models this year, and has plans for broadening its portfolio further in the entry level. Overall, these should refresh the portfolio strongly enough to get the company back on track.

But it is in dangerous territory with zero profit. It has fewer internal degrees of freedom and is more exposed to predatory competition.

In late May LG shares suffered on news that it may have to reduce prices to match some Nokia models in the US. And things happen very quickly in the handset market - remember Motorola lost 50% of its world market share in six months last year. The last thing Sony Ericsson needs now is to be dragged into a price war against a competitor with a stronger portfolio and healthier margins.

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