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Looking Beyond Nokia's Bad News

By Andy Reinhardt Have Nokia investors, once enamored of a company that could seem to do no wrong, lost their ardor? If so, they could be making a big mistake. No doubt, there'll be some sleepless nights in Helsinki -- and they won't just be due to the midnight sun. Nokia (NOK) shocked the markets on Apr. 6 with a warning that its first-quarter sales won't meet expectations due to weakness in its product lineup.

The mobile-phone powerhouse had earlier advised Wall Street that first-quarter revenues would likely rise 3% to 7%. Instead, they dropped 2%, with profits coming in at the low end of the predicted range.

The explanation was simple but worrisome. While the handset market overall surged 25% from last year's first quarter, Nokia says, its own units grew 19%. That could trim two points off its global market share, taking it down to just over 33%. It blames the shortfall on weakness in the midrange of its cell-phone product line, exacerbated by distractions from its recent reorganization.

"A LOT TO DO." This wasn't just about slower unit sales. The average price Nokia took home for the 42 million phones it sold in the quarter fell by 21% from a year earlier. So even though it pushed 7.2 million more phones out the door than it did in early 2003, revenues fell 6.3%. That shift to lower-price models, in turn, hurt operating margins and net profits. "This is bad news," says analyst Richard Windsor at Nomura Securities in London. "Nokia has a lot to do to make it up."

Investors were nearly panicked by the announcement. Nokia shares fell 16% in Helsinki and 19% in New York on Apr. 6, and kept heading down on Apr. 7, closing at $16.92 on the Big Board. The stock is now selling at about the same price as it did at the start of the year -- and it suddenly looks underpriced relative to its sector, trading at about half the price-earnings ratio of the communications-equipment industry.

Take note, however: While the first-quarter results are certainly worrisome, Nokia is otherwise giving off the signs of doing everything right. One quarter doesn't make a strategy, and looking far into the future, Nokia is remaking itself into much more than a mobile-phone company.

3G FUTURE. The first sign of that was a return to growth for Nokia's long-suffering networks division, which provides about one-fifth of overall revenues and grew 16% in the quarter, to about $1.7 billion. That reflects an upturn in orders from the world's wireless operators, which are finally reinvesting in their networks and rolling out delayed third-generation (3G) mobile services.

Nokia has staked its future on the acceptance of 3G -- and especially of its favored flavor of the zippy wireless voice-and-data technology known as wideband-CDMA. When the networks are switched on, demand for newfangled 3G handsets also will pick up, and Nokia could enjoy years of strong replacement sales from customers trading up to the newest handset.

Another positive sign was better-than-expected results for Nokia's new Enterprise Solutions group, which is trying to hook large organizations on using mobile communications in new ways. Headed by newly hired American executive Mary T. McDowell, who joined Nokia from Hewlett-Packard (HPQ) in January, the group will be based in New York's Westchester County to be nearer big American customers.

MORE CLAMSHELLS NEEDED. The Enterprise group's success is just one facet of Nokia's larger plan to move upstream from the commodity phone business. In effect, CEO Jorma Ollila and his team are repositioning Nokia to become a provider of all manner of electronic gizmos -- from digital cameras to handheld computers to portable gaming machines -- which share in common only that they all communicate over wireless networks.

In one of Nokia's most significant shifts, those networks don't even have to be traditional telecom systems: The latest model in Nokia's line of Communicator phone/PDA hybrids also can link up via Wi-Fi connections. And the company is doing good business selling plug-in cards for laptops that connect to both Wi-Fi and mobile networks using the GPRS standard.

This doesn't mean all is rosy under the Scandinavian sun. The biggest problem in Nokia's current lineup is apparently a matter of design. For a half-decade, while rivals spun out a growing variety of popular "clamshell" or "flip" phones that hinge at the back, the Finnish giant stuck exclusively to "candy bar" designs. When Nokia blamed its first-quarter sales shortfall on a poor selection midrange phones in Europe and America, analysts interpreted that to mean a lack of clamshells.

"They misread the market and made the wrong handsets," says Nomura analyst Windsor. That's giving an edge -- especially in the U.S. -- to Korean clamshell kings Samsung and fast-rising LG Electronics.

SHARP LESSON. Nokia is finally starting to fight back. Its first-ever flip phone, the 7200, is now available in Europe and Asia, but not the U.S. Later this year, it'll ship a CDMA camera flip-phone for the U.S. and other markets. But both are pretty top-of-the-line. To regain its edge, Nokia may have to dig deeper into clamshells. Overall, it promises 40 new models this year to fill the gaps and entice buyers. But it won't catch up quickly from its late start.

Still, writing off Nokia isn't a good idea. It enjoys huge economies of scale and manufacturing efficiencies, and its brand recognition and distribution channels are second to none.

If a lesson is to be learned from the first-quarter fiasco, however, it's that Nokia can't afford to let its pursuit of a grand future interfere with the present. On its way to becoming a maker of communicating electronics products, Nokia still has to stay on top of its game in plain old phones, or it could suffer a lot more rude sell-offs from skeptical investors. Reinhardt covers technology from BusinessWeek's Paris bureau

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