Surprise! Nokia Doesn't Walk on Water

Its about-face on growth will hurt credibility

A year ago, the vision looked so alluring. As Europeans surfed the Web via their mobile phones, a new generation of speedy, data-friendly handsets would fly off store shelves. No one embraced this idea more enthusiastically than Jorma Ollila, chief of Finland's Nokia (NOK ), the world's largest and most profitable mobile-phone maker.

Then, on June 12, the company shocked investors with a profits warning, slashing second-quarter sales growth estimates in half, to less than 10%. The sell orders that followed wiped more than $31 billion off Nokia's market cap in one day. The suddenly gloomy Ollila blamed a deterioration "driven by economic uncertainty, the ongoing technology transition, and less aggressive marketing by the operators."

Translation: Europe's economy was in worse shape than expected, and mobile data transmission, the big hope of companies like Nokia and its next-door rival, Sweden's Ericsson, has so far proved a big dud. The networks to provide all the promised gee-whiz services won't be up and running until this summer at the earliest. The phones aren't coming soon. And in Europe, just about everybody who wants an ordinary digital cell phone has one.

Until Ollila's announcement, stock-pickers assumed Nokia would somehow defy gravity, despite the woes of rivals such as Ericsson and Motorola Inc. Until recently, Nokia predicted a global market of 550 million cell phones by yearend, with the Finnish company selling 40% of the haul. Now, Nokia pegs demand at 405 million phones. Analysts at Merrill Lynch & Co. reckon it will be more like 390 million.

Nokia says its earlier optimism reflected what it was seeing in the first quarter and that it didn't expect America's problems to spread so quickly. Still, the volte-face is "a blow to Nokia's credibility," says Mark Davies Jones, managing director for telecom equipment research at Schroder Salomon Smith Barney in London. Delays from Nokia are contributing to the mobile-Net malaise. The company's phones for the next stage, so-called 2.5G, are late. This leaves customers like Vodafone Group PLC (VOD ) with high-speed networks in place and few handsets to sell. Analysts see a decline in Nokia profits of 12% this year, to around $4.3 billion on sales of $26 billion.

The environment is looking grimmer and grimmer. The European market is reaching saturation, with as much as 70% of the population now owning phones. Adding to the pressure, many European cell-phone operators struggling under massive debts are slashing the subsidies that supercharged handset sales. In April, world leader Vodafone began turning off the subsidy tap. Meanwhile, the drop in European demand makes Nokia more dependent on sales in bargain-basement markets like China and Egypt.

With nearly three-quarters of its revenues coming from handsets, Nokia had big hopes that existing customers would upgrade their phones to get speedier Internet access complete with services from mobile air ticketing to driving directions. But as Europe's phone companies have been forced to scale back spending on 2.5G and 3G networks, the resultant delays are cooling a once torrid market. "The heyday years of the '90s are behind us with respect to subscriber growth and capital expenditure in mobile," says Merrill Lynch analyst Adnaan Ahmad.

BIG SHOCK. That's bad news for Nokia, which had counted on an increase in its telecom infrastructure business to offset any volatility in consumer handsets. Nokia had been steadily picking up market share in infrastructure by offering about $4 billion in loans over the past year to heavily indebted wireless operators. Now, Nokia admits its infrastructure sales will grow only as fast as the market, a big shock to investors. "They aren't taking share in the same way they have done in handsets," says Davies Jones. Another problem: As more telcos strike deals to share the cost of building 3G networks, demand for equipment is likely to fall.

Nokia is moving some production to lower-cost countries such as Mexico and China, and it will likely curtail loans to operators. But what it really needs to do is deliver the promised wonders of the mobile Net. Only then will this Finnish wonder regain its star status.

By Kerry Capell in London and William Echikson in Brussels, with Peter Elstrom in New York

— With assistance by Peter Elstrom

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