Mobile Phone Bonanza

Makers of handsets are seeing sales and profits soar. And it doesn't look as if lower-priced units for emerging markets will bring them down to earth

After a blowout year in 2005 for the mobile phone business, when sales soared 21%, to more than 800 million handsets, investors were justified in worrying that momentum could run out this year. Ever cautious, market leader Nokia (NOK) predicted that industrywide unit sales might climb just 10% in 2006.

But that was before consumers' insatiable appetite for phones became clear. By the end of the first quarter, an increasingly confident Nokia raised its industry forecast to 914 million units, up 15% from its calculation of last year's total, thanks to booming demand in fast-growing markets such as China and India.

Even that prediction could prove too conservative: With first-quarter results starting to come in, analysts are expecting most top-tier makers to report strong sales and strong profits.

Sony Ericsson Mobile Communications, No. 5 in the market, started the earnings season off with a bang on Apr. 13 by announcing first-quarter sales of $2.4 billion, up an eye-popping 55% from the same period last year. Profits for the London company, a 50-50 partnership of Sony (SNE) and Ericsson (ERICY), grew threefold, to $132 million. "Growth in the global handset market continued to outpace earlier expectations," it said in a statement.


  What makes the picture even brighter is that some phonemakers have reversed the seemingly inexorable decline in average selling prices that has dogged the industry for years. Sony Ericsson's average prices rose 4% in the first quarter, to $180. And on Apr. 11, Nokia surprised investors by announcing that its first-quarter average handset revenue clocked in at $125, up $5 from the last quarter of 2005, thanks to a richer mix of sales.

Translated, that means Nokia sold more high-end handsets -- the kind loaded with digital cameras and music players -- relative to rock-bottom phones. Its stock rose 4% in one day on the news and is now trading in New York at around $21, up 17% since the start of the year. Archrival Motorola (MOT) also is expected to report increased average prices when it releases earnings on Apr. 18, thanks to strong demand for its premium-priced RAZR phones.

Analysts see a broader trend behind the numbers. Thanks to the emergence of third-generation (3G) mobile networks and relentless waves of new feature-packed phones, more buyers appear to be trading up to pricier models.

"There's no doubt that in mature markets, sales of more enhanced phones and new 3G models are increasing," says Carolina Milanesi, mobile handset analyst for researcher Gartner, near London. "Even in emerging markets, you see people looking to replace their first phone with something a bit more sophisticated."


  Handset makers are using every weapon they can to entice buyers to these more expensive -- and profitable -- models. Nokia has brought out a new high-end line, called the N-Series, decked out with multimedia capabilities such as good-quality digital cameras and MP3 music players with ample space to store songs. Motorola has played the design card with its slender RAZR, which has now become the single best-selling model on the market, even on Nokia's home turf of Europe.

And Sony Ericsson is luring customers in part by borrowing storied brands from its Japanese co-parent -- the Walkman name for its music phones, and Cyber-shot for its camera phones.

The strategy is paying off. Nokia, which reports on Apr. 20, could see revenues soar 21% in the first quarter, to $10.8 billion, predicts equity analyst Richard Windsor of Nomura Securities in London. Credit a strong lineup of phones for banishing the crisis Nokia faced two years ago, when a spotty portfolio cost it six points of market share in a single quarter. Nokia's Multimedia division, which sells everything from camera and music phones to a hot new palm-sized Internet tablet, should do especially well, with revenues up 48%, to $2 billion, Windsor predicts. The core mobile phones unit will grow 26%, to $6.9 billion.


  The picture at Motorola is even more upbeat. Brokerage Bear Stearns raised its rating on the company to "Outperform" on Apr. 12, citing expected first-quarter handset revenue growth of 42%, to $6.3 billion. Like Nokia, Motorola is benefiting from a better portfolio mix. JP Morgan analyst Ehud A. Gelblum estimates average selling prices were up 2.9% in the first quarter, to $143, thanks to a continued shift to more expensive models such as the RAZR.

The question, of course, is whether the upward pricing trend can last. Analysts suspect it won't, mostly because sales of low-cost phones in the developing world are growing so fast. "Competition is just so relentless that the long term-trend still points down," says Neil Mawston, senior wireless analyst for researcher Strategy Analytics in Milton Keynes, England. The positive impact of 3G and multimedia gizmos may not be enough to counteract the downward pull from low-end models.

Indeed, it was the growth in emerging markets that socked Samsung, the world's No. 3 phonemaker, when it announced results on Apr. 14. The Korean giant sold a record 29 million handsets in the first quarter, up 7% from the fourth quarter of 2005. But phone revenues declined by 6%, to $4.57 billion, and average selling prices fell 7%, to $171.


  Some of the blame falls on inventory management and distribution issues. But Samsung has also long had among the highest average selling prices in the business, thanks to a product portfolio skewed to feature-rich models. That leaves it vulnerable to market share losses and price-cutting in developing countries, where Nokia and Motorola are stronger.

Another player likely to have suffered in the first quarter is Taiwan's BenQ, which acquired the mobile phone unit of Siemens (SI) last year. A rash of product delays could cause market share losses for the company, which ended 2005 ranked No. 6 in the market, according to Gartner.

In the end, though, what really matters to investors isn't average prices, but profits. And there, the trend looks more enduringly positive. Samsung senior vice-president Chu Woosik forecast on Apr. 14 that the company's handset margins would hit 13% to 15% in 2006, up from 10% in the first quarter. Nomura's Windsor sees Nokia's average selling prices drifting down by 5.8% over the course of this year but figures profit margins will climb from 16% now to 17.4% in the fourth quarter.


  And JP Morgan's Gelblum figures that operating margins for Motorola's mobile devices unit will climb from 11% in the first quarter to 12.8% in the fourth, even as average selling prices drift down 4.8%, to $136.

No question, sales are on a tear this year. Phonemakers are shipping record units and enjoying an added boost by taking home higher average prices. But the best news is that even if prices fall back into their historic downward trend, top tier players are managing to squeeze costs even faster. If they can keep convincing buyers to snap up the snazziest and most expensive models, profits could head to the stratosphere.

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