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Still Bullish on Nokia

Posted on Monday, Jul 21st 2008

On July 17, Nokia Corporation (NOK) posted strong Q2 results that topped analyst estimates, driven by 21% growth in mobile device sales to 122 million units, an average of 1.35 million units per day. In the converged mobile device section, sales grew 10% to 15.3 million units, much more than the iPhone’s target for the year. But then, Nokia is the giant here with a 45.2% smartphone market share, and Apple has just 5.3% of the pie. And with Nokia’s touchscreen device, Tube, expected to reach the market later this year, the convergence device race is heating up further. My earlier post on Nokia’s convergence device strategy is available here.

Nokia, which had a 48% stake in the handset software firm Symbian, recently spent $410 million to buy the rest of the company and form the open-source Symbian Foundation with other industry leaders including Sony Ericsson, Motorola, AT&T, and Vodafone. Last year, Symbian had 67% of the global smartphone market but less than 10% of the US market. Here’s a detailed analysis on how this move changes the smartphone game.

Basically, the iPhone has reaffirmed that the differentiation in the smartphone business will be in software. Apple has also been hinting at vertical integration. Nokia, to get some control over the software side, needs to beef up Symbian.

For Q2, net sales grew 4% y-o-y and q-o-q to €13.2 billion, exceeding analyst estimates of €12.8 billion. Diluted EPS, excluding special items, was up 13% y-o-y to €0.36, in line with analyst estimates. In Q2, Nokia bought back shares worth €1.5 billion. And last week, it completed its acquisition of Berlin-based Plazes to extend its context-based service offering.By segment, Nokia recently clubbed Mobile Phones, Multimedia and Enterprise Solutions into the Devices & Services segment, which had net sales of €9.1 billion, down 1% y-o-y and 2% q-o-q, with ASPs down 18% y-o-y and 6% q-o-q to €74. Nokia Siemens Networks net sales grew 18% y-o-y and 20% q-o-q to €4.1 billion. Navteq will be a reportable segment in Q3. As for market share, Nokia estimates that Q2 Mobile Device market share grew to 40%, up from 38% last year and 39% last quarter.

By region, sales grew 10% y-o-y and 73% q-o-q in North America. Europe was flat y-o-y and grew 5% q-o-q; Latin America grew 39% y-o-y and 28.6% q-o-q; the Middle East and Africa grew 23% y-o-y and 4.5% q-o-q; Greater China grew 11% y-o-y but was down 16.2% q-o-q; and Asia Pacific showed the highest y-o-y growth at 42.2%.

Nokia does not expect its market share to change in Q3 but aims to increase market share for 2008. It expects global mobile device volumes to grow 10% in 2008. Nokia is currently trading around $27 after a 52-week low of $23.58 on July 1, which was a great buying opportunity into the convergence device movement.

Chart for Nokia Corp. (NOK)

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I made the claim that Apple will blow past RIM in short order. RIM is a one-hit player in North America that will become a footnote. They’ll struggle for years, as Palm did. They have a very nice business email franchise that will pay dividends for years, but their growth acceleration should slow somewhat over the next year or two.

Like I’ve said here before, Nokia will prove to be a more formidable competitor. The iPhone will still be the phone to beat; that will not change. Nokia will make a lot of money trying to hit that target. They’ll never make anything as good or as elegant. But over time they will continue to approximate the iPhone, at least within one generation. Apple will never stand still.

Nokia’s problem is that they have too many phones, too many platform, too many parts, too many everything. They’ll need to streamline; the sooner the better. Their margins will come under pressure otherwise and surprisingly from Apple.

Look at it this way. If Apple can sell, arguably the best phone around, the iPhone3G profitably for $199; what can they put together for $200 less. Right now, Apple is too busy bulding up their iPhone 3G franchise and keeping their iPod and Mac cash cows flowing, updating regularly. But soon the iphone 3G will be literally everywhere, and Apple will still want to grow their phone business.

Like in their iPod business, they’ll naturally want to get the larger market at lower price points with less fancy gear. Notice the iPod mini, then the iPod nano and the iPod shuffle. Then, when sales of those slowed a bit at huge gross margins, they cut the prices.

Mark my words. It will happen in the cell phone industry also. Imagine what Apple will do in the cell phone business, (1) given their brand, (2) with FREE feature phones (subsidized by the carriers of course), (3) that have a great user interface (albeit different than the touch Internet interface of the iPgone) (4) with great margins, they always have great margins, and (5) with great reliability.

Nokia has been warned. If and when Apple chooses to go after its’ market, it will get bloody. It is not as easy to defend Nokia’s position as everyone thinks it is. You certainly fall into that camp. I hope for Nokia’s sake that they have no hubris, and will clean up shop and fight tooth and nail.

Apple will have few very but very well designed phone models. The iPhone (as we know it today) will be the flagship model, with the internet access and games and apps, etc. They’ll likely eventually decide they can make a shuffle/nano type cell phone with much curtailed abilities, but with a great interface and a great price (FREE). Many people around the world, even taxi drivers in India can afford a FREE Apple cell phone, even if it isn’t as fancy as the iPhone. That move will be market changing.

Nokia enjoys pretty decent margins now, but their product roadmap is all over the place. Apple also has great margins, but Apple has the additional benefit of enjoying a intentional streamlined product mix. Once they build up the volume, their economies of scale and pricing power will beat Nokia, even though Nokia will be making more phones.

Apple will be able to price their phones lower than Nokia. In practice, Apple will likely just enjoy better margins. But in a price war, Nokia will feel the pain more than Apple.

A few recent launch execution missteps aside, it is clear that the Apple brand will bring more value to the table. This means that most people would be willing to pay more for an Apple product. More interesting, at the same price point, the company with the perceived value proposition wins. In this case, it would be Apple.

Nokia’s a great company. I even advocated that your readers buy their stock. They have some of the best margins in the business. But no one is talking about this issue, at least not outside of the board rooms at Nokia and/ or Apple.

I’ve followed them for years that I know how their management thinks. They’ve had this conversation. No insider information, just an intimate understanding of how the think and act in the marketplace. They do what they do well. When they go after a market they do so aggressively.

Bottom line: Nokia has great margins. So does Apple. Nokia has economies of scale. Apple not so much. Apple’s business model allows it to scale to economies of scale faster with fewer sales. When both have large cell phone businesses, the advantage will shift to Apple.

Nokia has a scattered product mix. They have a lot of good phones, but a very unfocused product array. Nokia has a window of opportunity to clean up their mess, before the tsunami hits.

If Nokia just concentrates on chasing the iPhone, they will lose. They have to develop the backbone, the OS and use it everywhere. They have to decide on a browser and use it everywhere, they have to figure out a great interface and use it everywhere.

They are doing the same things differently on different phones with different technologies. They have their engineering resources scattered and unfocused.

Apple will use one OS and one browser and one interface. Nokia will have several of each, but none equal to or better than the Apple offering.

Nokia has the engineering talent and resources for this fight, which is why I’m bullish on them. But they must change. They must focus. Fast.

Realtosh Wednesday, July 23, 2008 at 3:08 PM PT

One more thing.

The FREE iPhone would be cheap enough that even taxi drivers in India could afford. How would that change your predictive modeling for the cell phone industry?

Yes, I know; not all phone are sold with contracts and subsidies. It’s called hyperbole.

But even those Indian pre-pay iPhones could be cheap enough to negate predictions about Nokia having some kind of nebulous advantage because they’ve been selling phones previously in those markets.

Think of it this way.

Taxi driver in Mumbai, Delhi, Kolkata, Bangalore or any other large or small city in India,”I know Nokia phones. I’ve been using them for years. They are what they are. But that one there, selling for the same price, is an iPhone sibling. Look, it even has the little shiny Apple on it. All my best customers are using the iPhone. They nearly all, to almost the very last one, say how much they love their iPhone, plus they say the reception is the best they’ve ever had on any phone. It’s so easy to use, they say. I need a new phone, so let me try that iPhone sibling. It’s not as expensive as the regular iPhone, but it still looks so nice. I hope the quality is as good. Yes, let me try this one. I’ll take an iPhone sibling, please. How much can you take off for me? Come on, Hamid, I’ve bought 5 Nokia phones from you already. Make me a good deal. Maybe this will last longer than those other phones you sold me.”

This could be a realistic exchange in about 12- 18 months time. How would that change your cell phone industry forecast modeling?

Realtosh Friday, July 25, 2008 at 9:53 AM PT

I don’t buy your forecast of this phenomenon in the next 12-18 months. Apple doesn’t do FREE. They’re a luxury products company.

Sramana Mitra Friday, July 25, 2008 at 10:24 AM PT

The economics of the cell phone industry is different, and will change all that.

As long as someone is paying Apple their fat margins, they’re happy. Apple preferred it to be the end user, but it didn’t work out that way. It looks like they are going after the cell phone market aggressively, and are accepting carrier subsidies to pay their nice margins.

There are only 2 questions.

1) Will Apple branch their cell phone product mix. One need only look at the iPod business to get an answer. They will have a small number of models to cover EVERY price point in the market.

2) After that question is answered positively, necessarily, then the only other question is when. Again, one can look at the iPod business for some answers. However, in drawing on the iPod, one must remember that Apple is a different company today than they were in 2001-2002. The iPhone has ramped up much more quickly then the iPod could have back then. Also the cell phone business is much more mature than the media player business was back then. All that means that the iPhone ramps up will be much faster, as evidenced by the sell through rates of iPhones today vs iPods in the first couple of years.

So in answer to question #2, Apple will continue to update and/or add to the iPhone every year over the next 3-5 years until their iphone is larger than their iPod business.

My prediction is that in less than 3 years, iPhone will in part surpass, and in part supplant the iPod business. The high-end iPods will all be Internet communicator devices that will be part of the broader iPhone economy. The lower end iPods will remain albeit in updated form factors to cover the lower price points and need for small cheap single use media players.

So, when will Apple release the iPhone sibling. Two options 12-18 months or 24-30 months. Those are the only two options. I’ve gone with the earlier of the 2 time frames. The iPhone business ramp up is going on at a much faster rate the the iPod business ramp up. Apple is attacking this market more confidently than they did the media player market. They fell into that media player market after developing the iPod as a defensive play. The iPhone, however, is all offense. The defensive in that they want to protect their media player revenue. They’d rather cannibalize the iPod business then allow someone else to do it. plus the cell phone business is a much larger business than either media player business or the PC business.

Don’t expect Apple to slow the assault until they as dominant in the cell phone business, as they are today the media player business.

That’s why I post my warnings for Nokia. I believe that Nokia is up to the challenge; they are in the best position to compete with Apple going forward. But they need to change drastically and fast.

Apple has a very granola, hip and cool image. Their business however is all about excellence, precision, and (albeit the recent missteps) execution. The Apple people are very focused on the products and markets that they address. Jobs has said that the products that they don’t do are as important as the ones they do.

I predict that Apple’s iPhone business will surpass Nokia’s entire business in 5-7 years, maybe sooner. Apple will do it. The timeframe depends on Nokia; how quickly they get their act together and create more focus to more effectively compete with the assault that Apple has already mapped out in the board room and executive offices. You will never hear anyone from Apple speak publicly of their plan or timetable. But we’ll all see it play out in the marketplace.

Nokia did it to Motorola; Apple will do it to Nokia. The incumbent company is coasting along with record revenue, record margins and record profits. They’re fat, they’re happy. They’re on top of the world.

Their management underestimates the risk to their business of new technologies on their doorstep. In Motorola’s case they defended analog technology against the new digital cell phone technologies that were emerging. Motorola was slaughtered so bad from this misstep and poor strategic direction that they have not recovered since. Motorola has been dropping like a lead balloon ever since. They’ve even had to sell off other profitable businesses just to raise capital.

Nokia has a choice. They can either become Motorola or they can choose to recognize the real threat is Apple entering and growing to domination in the cell phone business.

My gut feeling is that Nokia at highest levels of management is already cognizant of the magnitude of the threat. However, they may be trying to play down the threat to not alarm their employees, business partner, carriers, consumers. That is a mistake.

Nokia’s assessment of their situation needs to be honest. They need to gauge their competitiveness against the assault that is the Apple iPhone. Apple will not be content with just 5% of the cell phone business, even if it is the most profitable segment with the fattest margins. Nokia needs to acknowlede that fact and run their business accordingly.

Nokia’s communication with their employees needs to be open and frank. They need to rally their troops. They need to get everyone on board, buying in to the real threat that Apple will pose to their business. They will need to focus. They will need to execute like they never have before.

Nokia will need to do what they’ve done well, even better. They designs will have to be amazing; all of them. Their phone’s build quality will have to be excellent and consistent; all of them. The interfaces on their phone’s will have to be impressive; on all of their phones.

Nokia will need to focus their resources and engineering talent to make fewer phones, but all with excellence. If they don’t, Apple will regardless. It’s Nokia business to lose more than Apple’s to gain.

Apple already knows what they’re going to do next year, the year after that, and the year after that one. They are too busy making great phone to woory about making it personal. For Nokia, they may have no other choice. Their attitude until now is that everything is OK, and there is nothing to worry about. I don’t how much of that is about saving face and protecting the stock price in the short-term.

They better start worrying something awful about their situation. They better start doing something about it. They need to focus. they need to ask some very tough questions and get to work. They need to decide whether Symbian is the OS that will take them into the next decade. My guess is that answer is no. If not, they better forget about how much they’ve already invested in Symbian and start creating it’s replacement. My guess is that they won’t fast enough, and will fall into Google’s arms out of necessity and get stuck with Android. Android eventually will probably not be too bad. But even so, how will using the same OS as many other call phone makers allow Nokia to differentiate their offerings.

Wake up Nokia! Wake up fast!

About the FREE iPhones. The margins on Apple’s FREE iPhones (with carrier subsidy) will be greater than the margins on the iPod shuffle. The iPod shuffle exists out of necessity. The FREE iPhone will also come about out of the same necessity. It won’t be the same phone as the premium iPhone. It probably won’t even do the Internet, nor have a touch screen; unless the dynamics of the costs involved change drastically over the next 2-3 years. But it will be an Apple phone, it will have a great design, great build quality, great interface, and will be affordable to entire mass of people that would never be candidates for the premium iPhone.

Apple is a premium brand. They do offer premium goods. After they tie up mindshare at the top, they after a larger swath of the market. They did it with the iPod, they’re doing it currently with the Mac (stay tuned for future announcements), and they’ll do it with the iPhone.

The synergies between Apple’s various businesses are real and make it much harder for any one competitor in any one industry to compete as effectively as Apple in their own marketplace, as Apple can in various industries.

It took many years of hard work, but the dividends (figuratively) will pay out like crazy as Apple revenues keep growing at unheard rates for any company producing tangible goods (hardware, consumer electronics, computer, cell phone, etc.) Microsoft sells the same software code over and over many times, so the dynamics of the intangible software business are a bit different. But what Apple is doing with hardware is impressive.

One might get concerned about the law of large numbers. However Apple is growing in various different businesses that each have much potential for future growth. For example, Apple’s share of the PC and cell phone markets are growing fast, but still just a tiny sliver of each. Apple may be the largest distributor of digital music, but there i still so much physical distribution of CDs and DVDs, that Apple still has many years of growth there too.

As long as they don’t have to lower their design and quality standards, Apple does indeed offer products in multiple price points, including lower ones.

I don’t mean to talk about Apple so much as I’m making a point about Nokia, but I felt a need to justify my positions above. Somehow don’t believe that we’ll have FREE iPhones.

I knew we’d have a new iPhone 3G this summer, and I knew that eventually Apple would deliver a phone to reach down to lower price points. I never guessed that Apple would do both with the same phone.

But if Apple’s flagship phone is only $199, then they can certainly offer a simpler feature phone for FREE, but with Apple’s characteristic great design, great interface, and great build quality.

Watch out Nokia. You’re a better position that most to do battle with Apple. But Apple is in a much better position than anyone, including Nokia. They already have the technologies and people in place to dominate one industry after another.

Apple doesn’t need most of the market share in an industry to do well. They’ll just go after the best and most profitable segment, whether it’s 25%, 50%, or 75%. Others can fight over the crumbs that remain.

BlackBerry has no chance to compete independently, and can’t even see the train coming straight at them. Nokia has a better chance. Maybe even a Nokia-RIM or a Nokia-Palm. None of them alone has what it takes to compete against Apple. Palm is working on a next generation OS that has promise. Let’s see how it works out. If it lives up to its’ promise it would be better than anything Nokia has in the works. Blackberry is strong in the North American market where Nokia is weakest, and they have many established relationships with many large businesses. But RIM lacks the technology that Nokia needs to compete.

You heard it here first. Nokia buys Palm and merges with RIMM, although the HQ and control will remian in Finland, and the combined entity will be known as Nokia, although some of their phones will be carry the BlackBerry brand.

I don’t know if any of it will help. It might if done soon as part of a proactive plan. It won’t help much if it’s done in 3-4 years as a defensive move against Apple who by that point is the number 2 cell phone maker behind Nokia and closing the gap fast.

Realtosh Friday, July 25, 2008 at 12:17 PM PT