Nokia Calling
The cellphone titan is poised for growth -- and its stock looks cheap.
By ERIC J. SAVITZ
IN THE GREAT 2003 tech rally, mighty Nokia has been left in the dust. Shares of the
world's top cellphone maker have barely risen 2% this year, while many big tech
stocks are up by 50% or more. Among the 30 largest hardware stocks, Nokia's gains
rank 30th. Dead last.
The Nokia bears, who obviously have the upper hand at the moment, zero in on three
related concerns. One, they are convinced that rivals will chip away at Nokia's share
of the handset market. It's certainly a big target: The Finland-based company's global
share totaled 35.9% in the second quarter, says research firm Gartner -- more than
twice the 14.6% share held by rival Motorola, and in fact larger than its three leading
competitors combined.
A second and related concern is that Nokia will see a steady decline in prices for its
cellphones, with more than 100 global players now battling for a slice of the business.
Its shares tumbled earlier this month after the company grudgingly disclosed in a
mid-quarter financial update that average selling prices in fact have slipped in recent
months.
And finally, the naysayers fear that Nokia, by far the most
profitable cellphone maker, cannot possibly continue to
crank out operating margins on handsets that routinely
exceed 20%. The bears contend that with prices falling (see
the previous worry), Nokia can't maintain its fat margins
unless it gives up some low-end business and watches
market share shrink (see the first worry).
The result of all that fretting is a seriously cheap stock, at
least by tech standards. At a recent 15.50, the American
depository shares are barely a quarter of the bubble-era
peak of around 60. Nokia trades for 19 times the consensus
estimate for 2003 of 80 cents an ADS, and 17 times the
projected 2004 estimate of 91 cents. Rarely has the stock
traded at a lower price/earnings multiple. It likewise stands
at a near-record-low multiple of sales, a bit over two times.
Game On: Nokia's N-Gage
games device, due next
month, also makes calls,
handles e-mails and surfs
the Web.
Nokia trades at a lower P/E than any major tech issue save
Hewlett-Packard. On the other hand, Nokia has a higher
dividend yield than any other large-cap tech company, just
under 2%. It has a stellar balance sheet, with more than
$10 billion in net cash, or more than $2 a share,
representing well over 10% of the company's market value.
And of late, Nokia has been buying back shares -- about 54
million since the second quarter.
Albert Lin, a San Francisco-based analyst with American Technology Research, says
the stock provides a 10% free cash-flow yield, a figure he derives by dividing free
cash flow (which adjusts for capital spending needs) by enterprise value (equity plus
net debt). "With tech companies," he says, "you rarely get a cash flow yield above the
one-year T-bill," currently 1.2%. Lin's bold conclusion: Nokia is worth close to $30 an
ADS, nearly twice the current price.
Lin may well be right. While the skeptics are fixated on average selling prices, they
are missing a shift in the dynamics of the cellphone business that has set up Nokia for
a new round of growth. The company has made big moves into some potentially
lucrative new markets, just as global demand is accelerating. To sharpen its focus on
of some of its new opportunities, Nokia on Friday unveiled a corporate restructuring
plan that zeros in on four key markets: mobile phones, multimedia, networks and
enterprise solutions. If anything, Nokia appears poised to boost its huge market
share. At a time when wireless communications is the hottest trend in the technology
sector, few companies are better positioned.
For Nokia, the trends are headed in the right direction after several years of
weakness. Cellphone adoption is growing rapidly in places such as China (already the
world's largest cellphone market), Russia and India. There's even faster growth in
earlier-stage markets like Vietnam and Bangladesh. Carriers finally are rolling out
faster networks based on so-called 2.5G and 3G technologies. To take advantage of
the speedier new networks, handset makers are cranking out new phones with nifty
features like cameras, polyphonic ring tones, Web browsers, color screens,
downloadable games, e-mail and instant messaging.
All of those things are going to lift phone sales. Market
research firm IDC sees 42% growth in 2.5G handsets in
2004, 140% growth in the nascent market for 3G phones,
64% growth in camera phones and a 111% rise in sales of
data-centric "smartphones," with keyboards for composing
e-mail.
The new gear should more than offset slowing demand in
other segments. Gartner analyst Bryan Prohm says global
cellphone sales this year should reach 460 million to 470
million units, versus 431 million last year. Nokia sees
industry-wide unit growth of 10%-plus for the nearly
completed third quarter -- and expects its own growth to
be even higher. And there's more to come. Prohm says
2004 unit sales should top 500 million phones, or one new Ollie-Pekka Kallasvuo,
phone for every 13 people on Earth.
newly named head of the
mobile-phones division, says
Nokia's high profit margins
Olli-Pekka Kallasvuo, who was Nokia's chief financial
allow for heavy investments
officer until Friday, when he was named to head the new
in new technologies.
mobile-phones division, contends the market's skepticism
about his company is understandable but wrongheaded.
While pushing to bolster its leadership in handsets, the
company is also "expanding the borders of our industry, which is sometimes more
difficult to communicate," he said in an interview with Barron's. "From our strong base
in mobility, we're extending our efforts into new domains -- imaging, gaming and the
enterprise. It's sometimes puzzling to the marketplace."
Nokia, in other words, is spending heavily on R&D to enter new businesses, an
approach that makes investors nervous; they see higher costs that endanger the
company's precious margins. But with the wireless market transforming rapidly, it's
hard to fault Nokia for spending on innovation.
Part of the problem, is that investors at the moment are not feeling charitable toward
Nokia's management team. Lin of American Technology Research says that going into
the latest conference call, the company had given the impression that results could
benefit from favorable exchange rates -- but it didn't turn out that way. The
company's complex hedging strategies muffled a top-line boost the Street had
expected from exchange rates. Says Lin: "There was a group that felt sort of cheated
on the guidance."
A more important long-term issue nagging at investors is whether Nokia will be hurt
in coming years by reinvigorated competition. Motorola, for instance, has refreshed
and strengthened its product line, and has been seeking ways to differentiate itself.
Further shifts at the former market leader could
follow in the months ahead when it selects a
successor to recently departed CEO Christopher
Galvin (see Follow-Up).
In one recent move, just weeks after selling off
its stake in Symbian, the Nokia-dominated
cellphone-operating-system joint venture,
Motorola signed a deal to make phones for AT&T
Wireless using Microsoft's rival Windows Mobile
software. Samsung, the industry's rising star, is
planning a deluge of new handsets later this year
and into 2004. And the strongest of the many
Chinese handset makers are plotting ways to
expand beyond their domestic market.
Nokia's Kallasvuo is undeterred. He says the
company still believes it can ratchet market
share up to 40% over time, though he won't say
by when. What he does say is that there are a
number of distinct opportunities for Nokia to
grow its business.
In what might be its most promising venture,
Nokia is working hard to improve its offerings for
CDMA-based cellphone networks (CDMA stands
for code division multiple access). In the more
widespread but slower-growing market for
phones based on the GSM standard (Global
System for Mobile Communications), Nokia rules
the roost. But Nokia has moved slowly to enter
the more fragmented CDMA market.
Nokia's CDMA market share is about 11%,
according to Strategy Analytics, a research firm.
That leaves the company trailing Samsung, LG,
Kyocera and Motorola. Nokia, though, contends
it can pass the others. "There is no real reason
we couldn't reach the same position in CDMA
that we have in GSM," says Anssi Vanjoki, who
had been running the Nokia mobile- phones
business until his appointment Friday to head
the new multimedia division.
Over the long haul another key opening for
Nokia will come in 3G, or third- generation,
cellular networks, which are slowly beginning to
come on stream. "The operators are launching
their networks now, ramping up their customer
acquisition," Kallasvuo says. "Mobile handsetwise, it will come to the volume phase in the
second half of next year."
Then there's the growing market for phones in
less prosperous nations. In recent weeks, Nokia
has introduced low-cost models targeted at
China, India and Russia, among other places. Gartner's Prohm thinks demand in those
new markets could drive the global cellphone-user population to two billion by the end
of the decade.
He notes, though, that reaching many of those users will require stripping away costs
to make phones affordable to the masses in large but low-income markets such as
Brazil, Nigeria and Ukraine. On that score, the company has several key advantages,
including the kind of manufacturing and component sourcing efficiencies that come
from having dominant market share, plus a strong global brand that by some
measures is among the most valuable in the world.
In more mature markets such as the U.S., Europe, Japan and Korea, where
penetration rates are already high, the opportunity lies in the market for replacing
existing phones. Here, consumers and business customers alike are being drawn to a
new generation of feature-laden phones made affordable by the rich subsidies
provided by cellular carriers. Color phones, in particular, are rapidly pushing out
monochrome models, and will make up the majority of the replacement-phone market
in 2003. Cameras are also taking hold; by the end of 2005, predicts Jane Zweig, CEO
of the Shosteck Group, a market-research group, 90% of color phones will have
integrated cameras. In a development that could provide a short-term lift to Nokia,
The Wall Street Journal reported Friday that Motorola, already behind in camera
phones, won't have its initial batch in time for the U.S. holiday selling season.
IN THE U.S., DEMAND FOR cutting-edge phones could get a lift from the cellular
carriers' looming adoption of phone-number portability, allowing customers to switch
carriers while keeping their phone numbers. When the new rules take effect Nov. 24,
there's likely to be a mad scramble by the carriers to hold on to their customers -and to poach them from rivals. One obvious way to do that would be to boost the
subsidies for otherwise pricey new phones, which would be good news for both Nokia
and its rivals.
Though Nokia has the broadest product line of any cellphone maker, there are a few
holes. Most notably, some skeptics have warned that the company's preference for
"candy bar"-style phones over "clamshell," or flip-open, models could leave Nokia
vulnerable to market share losses. Clamshells allow for larger screens on comparably
sized devices, and in the open position they're easier to use as speaker phones, an
attractive feature for business customers.
"Our data shows there are a lot of people out there who have an interest in the
clamshell-form factor," says John Jackson, an analyst with Yankee Group in Boston.
"It seems like a little thing, but they have to be nimble." Yankee Group survey data
shows that 24% of U.S. subscribers now have clamshell phones, but that more than
half say they'd like one.
Nokia does have a few specialized phones that flip open, including the brick-like
Communicator, a pioneering line of data-oriented phones that feature a wide screen
and full QWERTY keyboard, and the newer 6800, which flips open into a wing-like
design with half a QWERTY keyboard on either side of a color screen. Vanjoki says
Nokia will have new clamshell models to announce within six months.
The Communicator, less than successful on account of its sheer bulk, represented one
of Nokia's first attempts to address the market for enterprise-class phones, with links
to e-mail and other corporate applications. Nokia thinks data-centric phones will
largely snuff out the whole PDA, or personal-digital-assistant, category, which
amounts to only about 10 million units a year. "Nokia's opinion is very clear," says
Vanjoki. "Devices not connected to the network all the time are worth nothing.
Pervasive connectivity is an absolute requirement."
Along those lines, the company has licensed the Blackberry e-mail
software from Research in Motion (see "Blackberry Blues," Sept. 1)
and plans to launch a phone under that deal later this year. But
Vanjoki notes that while it will offer phones that include the
Blackberry software, Nokia also plans to sell phones with software
from other wireless e-mail companies. "We plan an agnostic and
open approach," he said.
Nokia's efforts to reach into the enterprise go beyond cellphones.
Even before Friday's restructuring announcement, Nokia had
disclosed plans for the Oct. 1 launch of a new group called Nokia
Enterprise Solutions. That unit combines what was the company's
Internet Communications division, which sells networking gear to
16,000 customers, with enterprise-oriented operations from other
parts of the company, like servers designed to allow secure access
to the corporate network. The idea, says Dan McDonald, vice
president for product management and marketing with the new group, is to offer
companies a complete solution for wireless access, not just cellphones.
Nokia's biggest expansion move in the consumer market, meanwhile, comes to
fruition Oct. 7, when the company starts shipping the N-Gage, a hand-held gaming
device. "Nokia sees life going mobile, and life extends beyond voice," says Nada
Usina, director of entertainment and media marketing in the Americas for Nokia.
Usina says the expansion into game players is an extension of what the company has
already been doing. "All our handsets come with the ability to have Java-based games
and applications," she says. The N-Gage, however, takes gaming more seriously, and
no wonder: Usina puts the global gaming market at between $25 billion and $40
billion a year.
Nokia's most obvious rival in the handheld games market is the Nintendo GameBoy
Advance (Sony has a new portable gaming device in the works, as well, dubbed the
PSP, for PlayStation Portable). But where the GameBoy largely targets adolescent
boys, the N-Gage aims at 16-35 year olds.
The device includes a long list of features you won't find on a GameBoy. For starters,
it's also a GSM-based cellphone, which suggests AT&T Wireless, Cingular and T-Mobile
will sell it in the U.S. The N-Gage includes an MP3 music player and an FM radio. It
can send and receive e-mail; it has calendar and contact features; and it can surf the
Web. It also uses the short-range Bluetooth wireless networking standard, which
allows multi-player gaming without wires.
With the N-Gage, Nokia is expanding beyond its usual distribution channel, pursuing
sales through hard-core gamer retailers, like the Electronics Boutique and GameStop
chains. But in the end, analysts say, most N-Gage sales are likely to come through
Nokia's traditional channel: cellular carriers. Nokia has been saying N-Gage will sell
for $299 at retail, but with expected carriers' incentives, the price could quickly drop
into the $99-$149 range, says Soundview analyst Matt Hoffman.
Yankee Group's Jackson says it would be a mistake to expect too much of the first
version of the N-Gage. "I expect it will achieve a level of success," he says, "but it's
an iterative process. Successive generations will become more capable."
In fact, the initial N-Gage is getting mixed reviews. Shosteck Group's Zweig contends
the "form factor isn't quite right," noting that the device requires pulling out the
battery to install a new game. She also says the N-Gage is awkward to use as a
phone, asserting, "No one's going to do it." On the other hand, the key for any new
game platform is software support, and Nokia on that score is doing quite well, with
games expected from Electronic Arts, Activision, THQ and most other major
publishers. Nokia says close to 20 titles should be available by the holidays.
On another front, Nokia has taken steps to seed development of new third-party
software for its phones. Nokia is a leading supporter of Symbian, a London-based
joint venture with Psion, Sony, Ericsson, Fujitsu and others that provides handsetoperating-system software in competition with Microsoft, Palm and others. Nokia also
has begun licensing software for a color-screen graphic user interface called Series 60
that sits on top of a Symbian operating system. Among the licensees to date are
Samsung, Siemens, Matsushita and Sendo.
WHILE HANDSETS DOMINATE Nokia's business, accounting for about 80% of
revenues, the company also operates a significant network- infrastructure business.
That segment has struggled in recent years as the telecom bubble deflated: Sales this
year will be down 15% from 2002. But that should be the worst of it. Nokia execs
expect the networking division's revenues to stabilize in 2004, with a reduction in
demand for older GSM equipment offset by carrier orders for hardware to build out
the new 2.5G and 3G networks.
One of the more remarkable things about Nokia is that it has generated those huge
margins -- 23.1% in the June quarter, up from 21.7% a year earlier -- while
continuing to do its own manufacturing, rather than outsourcing the work to low-cost
contractors. Keeping close to the production process allows the company to reap the
efficiencies that come from huge volumes -- Nokia cranks out some one million
phones every two days. In the second quarter alone it sold 41 million phones.
(Compare that to, say, the 700,000 total subscribers for Research in Motion's
Blackberry pager.) That gives the company unparalleled leverage with suppliers.
"It's a positive spiral," says Nokia's Kallasvuo. "You get more volume, you can
leverage it better, you get benefits of scale and you get more volume. This has been
very consistent." The high margins also allow intense investment in new technologies.
"You can get certain benefits in manufacturing and sourcing components, but at the
end of the day, those benefits don't make the whole difference," Kallasvuo says.
"What's not well understood is that you get volume leverage from R&D, not only
manufacturing and sourcing."
Nokia execs react with annoyance to investor complaints about declining average
selling prices. "I am not aware of any electronics business, or any consumer-durables
business, where the price will not be falling once the business reaches the maturity
phase," says Vanjoki. "I don't consider that a major issue. The main issue is, are you
able to grow your market and generate the returns that shareholders expect."
Investors might be willing to relinquish their obsession if Nokia could show some
improvement at the top line. And that might be in the offing. Matt Hoffman, an
analyst with Soundview Technology Group, thinks some of his peers may be
underestimating the contribution to revenues Nokia will see in the December quarter
from the N-Gage and growing demand for CDMA and 3G phones. He figures CDMA
handset revenues should jump from euro250 million in each of the year's first two
quarters to euro350 million in the third quarter and euro518 million in the fourth
quarter.
Meanwhile, he sees sales of phones based on WCDMA, the 3G successor to CDMA,
reaching euro65 million-euro70 million in the fourth quarter, from basically zero in the
third quarter. And he thinks the N-Gage could sell 1.4 million players in the fourth
quarter, generating north of euro200 million in additional revenue.
If Hoffman's right, investors just might stop worrying about cellphone prices long
enough to let Nokia's shares join the tech-stock rally.