Charles Arthur 

How big are Nokia’s problems? Let’s work out how small its revenues will be

Charles Arthur: The troubled Finnish mobile maker is resilient, but our calculations show how badly it's getting squeezed and what effect that will have on revenues in the coming quarter. And then what?
  
  

How bad are Nokia's problems really?

Nokia warned on Tuesday: very bad. So bad that it might not make any money from selling mobile phones. That means that its 6%-9% margins may have been wiped out in the current quarter. It also warned that its guidance given at the end of the first quarter, or mobile revenues of between €6.1bn and €6.3bn, might be optimistic.

Well, here at Guardian Towers we have the Nokia results since mid-2006 plugged into the system. First of all, that €6.1bn figure would have been the lowest since the first quarter of 2009 (and third quarter of 2007).

We've also got the smartphone and feature phone handset average selling prices (ASP) since 2009 Q2.

For smartphones, these have been falling - from around €180-190 in 2009 to €147 in 2011 Q1. Featurephone (or "dumbphone") ASPs have been more steady at around €40 or slightly above. And Nokia has been selling about 20-24m smartphones, and 75-85m dumbphones, per quarter for quite a while. (Nokia gets about half its mobile revenue from smartphones - in fact the ratio has been edging higher over the past two years, from 46% to 50% now.)

But the numbers suggest that it's not going to hit those sales figures this quarter.

Here's why. The company said that its margins are being squeezed, all the way down to breakeven (ie zero).

So let's assume that the selling prices of its smartphones and dumbphones are being reduced by 10% to persuade the carriers to take them on, but it's still selling the same number.

That gives 24m smartphones selling at €132, and 86m dumbphones selling at €37. Do the calculation, and that gives mobile phone division revenues of €6.4bn. But Nokia has said that it's not going to hit that (upper-end) target.

OK - so the margins are being squeezed and the number of handsets is down. Let's recast to see if we can get the revenue below €6.1bn, while keeping the rough proportion of smartphones to dumbphones about the same. (This might not be the case, but it's a good enough guess.)

Playing around with the numbers, a possible scenario emerges:
Smartphones sold: 21m (Q1: 24m) @ €132 each (Q1: €147)
Dumbphones sold: 84m (Q1: 84.3m) @ €37 each (Q1: €42).

That gives revenues of around €5.88bn - which would merit Nokia's scared profit warning. It would mean dumbphone ASP was down to a level not seen since, hmm, a year ago, but that overall phone ASPs would be around half what they were as recently as this time in 2006.

Nokia profits and revenues
Nokia quarterly mobile revenues (blue) and profits (red) since 2002 Q1. Final point is Guardian estimate. Other data: Nokia.

Now, what does this mean for Nokia? Its troubles may get worse before things get better. The third quarter could see just the same pressure on sales, which will intensify at the high end (expect a new Apple iPhone and even more zillions of Android handsets), plus the same pressure at the low end from high-volume Chinese manufacturers able to make dumbphones. Nokia's lack of a niche is a weakness now: it used to be the behemoth of mobile phones, selling everywhere. There's quite a possibility that it will make a loss in the third quarter. And the 150m high-end Symbian phones that Stephen Elop, Nokia's chief executive, said it would sell? That's looking harder and harder; hitting that target with falling quarterly sales begins to look like Zeno's Paradox.

The reason Nokia is in such trouble now is that a threshold was crossed in 2006 when for the first time a billion mobile phones were sold. From there, Nokia could only really hope to be a large player in the market, rather than the ultra-dominant one. And it missed out on the smartphone market badly - dismissing Apple's efforts and unable to catch up with Android, which did do an effective multi-touch screen where Symbian couldn't. Yes, in the first quarter it sold more smartphones than any other manufacturer - but if my calculations are anywhere near correct, Apple could pass it for that in this quarter, and Samsung or HTC might not be far behind.

So Stephen Elop has jumped off the burning platform - but it seems that the sea is burning too.

Now, what does this mean for my forecast of only last week that Windows Phone will be a success? I think it's still too early to count Nokia out. It is a company that reinvents itself. But it may have to live with being smaller, at least in the mobile space; or possibly having smaller revenues and profits.

One thing that you shouldn't expect though is that the first "Nokindows" phones will be iPhone (or even HTC or Samsung) killers. What I'm hearing from informed analysts is that that first phone, to arrive some time after October, won't even be built in Nokia's own factories, but made for it by someone else. "The last thing that they should want is for people to think that that is going to be the best-ever phone, and that it will compete with the iPhone," said Carolina Milanesi of Gartner, a long-time watcher of the mobile market. "It's the device that they've had the least amount of time to work with compared to all the other Windows Phone licencees. It can't really be best in class. They need to start dialling down expectations on that ahead of time."

But with all the other bad news to be digested, the market has continued to mark it down. The shares are now trading at €6.72, down 4% on the day and from 8.2 at the end of Friday, a total 18% fall.

Nokia market capitalisation since 1999
Nokia market capitalisation since 1 Jan 1999. Source: WolframAlpha.com

(You can see the WolframAlpha output on Nokia's market cap; change the date to get different comparisons.)

Of course share price doesn't actually matter to a company; it has no effect except if it's trying to raise funds. Nokia has plenty of cash for now and could weather a few quarters of losses. But unless it can get everything in order, there's a risk of being like Sony Ericsson, which was flying high in 2006 and came crashing down into continued losses before reinventing itself (with Android).

It's instructive in fact to look at the companies that dominated mobile phones at the end of 2006. Here they are, according to Gartner's release from the time:

Nokia: 34.8% share (345m phones)
Motorola: 21.1% share (209m phones)
Samsung: 11.8% share (116m phones)
Sony Ericsson: 7.4% share (74m phones)
LG: 6.3% share (62m phones)BenQ: 2.4% share (23m phones)
Others: 16.2% (161m).

So the top four sellers had 75% of the market.

Contrast that with 2010, with 1.6bn units sold:

Nokia: 28.9% share (461m phones)
Samsung: 17.6% share (281m phones)
LG: 7.1% share (114m phones)
RIM: 3.0% share (47m phones)
Apple: 2.9% share (46m phones)
Sony Ericsson: 2.6% share (42m phones)
Motorola: 2.4% share (38m phones)
"others" made up 30.6% of sales (488m phones)

It's an almost complete change, where
• Nokia is selling more than twice as many phones, yet is perceived as under pressure
• Motorola has faded from the picture
• Samsung has thrived
• Sony Ericsson has dwindled
• LG has hung on
• smartphone-only makers have begun to infiltrate the top sellers, though only in small amounts
• the market is far less concentrated: the top four sellers only have 56% of the market.

Yet there are some who think Nokia is facing a serious - even existential - threat. Some market analysts were marking Nokia's stock down to a floor price of $4; the company's market valuation is its lowest since May 1998. Remember, while the stock price doesn't make any difference to the company's day-to-day workings, it does indicate how much profit the market reckons it will make in its life.

And research analysts too aren't optimistic, such as Horace Dediu of Asymco. Writing earlier on Wednesday, he remarked that perhaps the market is right in pricing Nokia's phone business at around $11bn (if you split off its Navteq and Nokia Siemens Network businesses).

And, he concludes

Nobody would argue that Nokia is worth more than Facebook so who's to say that Skype or Twitter aren't more valuable than a device company in crisis?

I don't try to predict the market's behavior, nevertheless, the markets are now very skeptical that there is much in Nokia to salvage. It's perhaps unfair and illogical but this is the end game of disruption. It ends much more suddenly than it begins. It's the consequence of nobody noticing the beginning that makes the end so shocking.

And Dediu knows about Nokia not noticing. He was working there when the iPhone came out and disrupted the whole smartphone - and, arguably, mobile phone - market. He tried to persuade people to listen, without success. So he left.

 

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