By Andy Reinhardt Some companies seem to do everything right. Helsinki-based Nokia Corp. (NOK) is one. From its century-old roots as a maker of everything from cables to rubber boots to TVs, Nokia made a huge strategic shift in the early 1990s under CEO Jorma Ollila, betting its entire future on the nascent mobile-phone business. The rest, as they say, is history.
Nokia grew in less than a decade to be far and away the largest cell-phone maker in the world, with nearly 40% of the global market last year -- more than its next three rivals combined. It blew past mobile-communications pioneer Motorola (MOT) in 1998 and never looked back. Along the way, Nokia became a profit machine, thanks to its superefficient operations and economies of scale. Last year, it churned out $3.4 billion in net income, putting it solidly among the top money-makers in the world, and lofting it to No. 5 on BusinessWeek's 2003 Info Tech 100 list.
None of this means Nokia can rest easy. It's staring at a mobile handset market that's a lot less bubbly than it was in the go-go 1990s. After years of double-digit growth, the industry actually shipped fewer phones in 2001 than the year before -- that first time that had ever happened. Last year provided a modest return to growth, and in 2003 analysts figure unit sales will edge up about 10%.
ASIAN THREAT. However, with continued pricing pressure, revenues could stay flat for the industry as a whole. In Nokia's midyear strategy update in Helsinki on June 11, Ollila said he's "very confident" the industry will grow 10% this year, reported Reuters. "It's a slow return to economic upturn, but we'll get there," Ollila said.
Against this backdrop, mobile phones remain a fiercely competitive business. Motorola, for one, may be down but not out. Like the proverbial punching clown, it keeps bouncing back to take another shot, and it remains a solid No. 2, with 14.7% of the world handset market in this year's first quarter, according to market researcher Gartner in Stamford, Conn.
More worrisome to Nokia is the continued growth of Korean's Samsung, which has leaped into the No. 3 slot in the last two years on the strength of its huge product line, strong presence in Asia and the U.S., and aggressive marketing (see BW Cover Story, 6/16/03, "The Samsung Way"). Samsung increased cell-phone unit sales by nearly 34% from the first quarter of 2002 to this year's first quarter -- far and away the fastest among the top-five handset makers. Nokia's shipments, by comparison, grew by 21%, while both Motorola's and Sony Ericsson's saw declines.
"LIMITED UPSIDE." Given these market dynamics, how do analysts rate Nokia? As a rule, they remain impressed by its execution and financial performance. London-based Merrill Lynch analyst Adnaan Ahmad figures Nokia's profits will grow 9.6% this year, to $4.34 billion (3.7 billion euros), even as sales decline by less than 1%, to $34 billion. But Ahmad lowered his rating on Nokia from buy to neutral on June 11, the day after it lowered its second-quarter handset sales growth estimate to between zero and 4%. Nokia's American depositary receipts closed down 1 cent on June 11, to $17.70.
Nokia blamed the combined effects of slow global economies, the falling dollar, and the impact of SARS in Asia for the downward revision. Its announcement came just a day after Motorola said it would miss its second-quarter targets. That was enough to spook analysts -- not because they think Nokia is headed down the tubes, but because they worry that the stock is overpriced given current long-term growth prospects.
"We see only limited upside to the current share price," said Ahmad in his June 11 report. He has some reason to be concerned. While the company has delivered again and again on strong numbers, the world it faces is tougher than ever before.
WEAKENED EUROPE. And Samsung isn't the only competitive threat. In mainland China, where Nokia is the No. 2 handset seller, growing competition from local vendors such as TCL Holdings and Ningbo Bird could hurt it as much as they threaten market leader Motorola. In the first quarter, reports Taiwan-based Market Intelligence Center, Chinese vendors broke above the 30% market share barrier for the first time -- up from nearly nothing just four years ago. Their rise is also pulling down average prices for handsets in China.
Then there's the generally weak state of Europe, where Nokia gets 54% of its sales. European carriers, still struggling to work down massive debts taken on from overpriced acquisitions and the cost of licensing spectrum for so-called third-generation (3G) mobile services, have cut capital spending and slowed the rollout of both 3G and interim data services, known as 2.5G. Plus, Europe's mobile-phone market is already pretty well saturated, with penetration in some countries now above 75%. All of this has slowed demand for new handsets.
To stimulate growth, Nokia has diversified its product line into nine market segments, including business devices, games and entertainment devices, and entry-level phones for developing markets. So far, its most successful new initiative has been in camera phones, which have a simple digital camera built into the handset. Nokia's popular model 7650 and a less-expensive follow-on called the 3650, have sold millions of units and help drive demand for wireless "multimedia" messaging services that can transmit voice, e-mail, and photos.
NAGGING PROBLEM. One area where Nokia hasn't made much progress yet is in phones using the so-called code division multiplexed access, or CDMA, standard. This is the standard pioneered by San Diego-based Qualcomm (QCOM), and it's gaining big traction in North America and Asia. But Nokia is only a bit player in the CDMA market, with less than 10% share. So it's now mounting a major push into CDMA, even agreeing to license CDMA technology it developed itself to chipmakers Texas Instruments (TXN) and STMicroelectronics (STM). So far, analysts say, Nokia hasn't managed to wrestle CDMA phone market share away from Samsung and LG Electronics. That's a critical need, because CDMA is growing faster than any other mobile-phone standard.
Nokia has one other nagging problem. In addition to its huge handset business, it's also a player in the mobile telecom-equipment sector, where it competes with Swedish giant Ericsson (ERICY) and North American companies Lucent Technologies (LU), Nortel Networks (NT), and Motorola. Problem is, that market has been plunging for years, thanks to the capital-spending cuts by telecoms.
Nokia has been as hard-hit as anybody, and it continues to post losses in its equipment division, which contributes about 17% of total revenues and should post operation margins of -5.1% this year, estimates analyst Richard Windsor of brokerage Nomura Securities in London. One concern about the Nokia Networks division, Windsor says, is that its success is tied to acceptance of one particular flavor of 3G, while rivals are also pitching a Qualcomm alternative that appears to have more momentum.
All told, these are trying times at Nokia. Investors have huge faith in the company, which has defied doubters many times before. But for the time being, that faith -- represented in a high price-earnings multiple -- is being tested. Next year, if the market turns back up, as expected, investors might be more comfortable pricing Nokia as a growth stock. Reinhardt covers European technology from BusinessWeek's Paris bureau