Nokia: High Profits in Low-End Phones 1

By Jennifer L. Schenker

Maybe there is high profit potential in low-end phones. On Oct. 18, Nokia (NOK) announced that third-quarter profit soared 85%, to $2.2 billion, handily beating analysts' estimates and sending its stock surging.

The strong showing is something of a surprise, not only because it comes just as telecom equipment makers Ericsson (ERIC) and Alcatel-Lucent (ALU) are struggling, but also because Nokia is the first mobile-phone company to show it can make healthy operating margins on entry-level phones. "The profitability is stunning considering the sales in the low end of the market," says Richard Windsor, a financial analyst who tracks Nokia for Nomura Securities (NMR).

Nokia reported that third-quarter revenues rose 28%, to €12.9 billion, or $18.3 billion. Net income increased to €1.6 billion, or $2.2 billion, which works out to 40 eurocents, 6 cents more than analysts had been predicting. The report came just two days after Ericsson reported third-quarter earnings that fell far short of expectations (BusinessWeek.com, 10/16/07), wiping out some $17.5 billion in market capitalization.

Helping Nokia is the continuing strong demand for mobile phones. The company shipped 112 million units for the quarter, a record for the industry. Nokia now predicts that 1.1 billion mobile devices will be sold this year, up from 978 million in 2006. The company's results follow strong profit reports from mobile-phone rivals LG, Samsung, and Sony Ericsson in the third quarter. Michael Walkley, a wireless technology analyst at Piper Jaffray (PJC), says the fact that so many of the handset makers are doing well underscores the robust demand for mobile phones, even in a relatively benign pricing environment. Motorola (MOT), another top rival, is slated to report results on Oct. 25.
Healthy Margins

But Nokia is the only manufacturer that's managing to do well even as it pushes aggressively into the low end of the market. The company impressed financial analysts by reporting healthy operating margins, despite a sharp drop in the average selling price of its phones. The average price dropped to €82, or $116, in the third quarter, from €90, or $127, in the previous quarter. Nevertheless, the company's operating margins in its mobile-phone business increased to 22.6% in the third quarter, up from 21.2% in the second quarter. The decrease in average selling price was the result of a sharp uptick in the number of phones it sells for less than €30, or $42.54.

With the widest range of phones of any handset maker, Nokia is managing to do well in low-end phones, top-of-the-line, and pretty much everything in between. "We can make money on a €300 phone, a €150 phone, or a €30 phone, and nobody else has been able to do that last part," says Rick Simonson, Nokia's chief financial officer in an interview. "Even when we are selling a €30 device, we are making gross margins in the high 20% range," he says.

Nokia now holds 39% of the mobile-phone market globally, more than all three of its closest rivals—Samsung, Motorola, and Sony Ericsson—combined. The company predicts it will be able to match that market share in the fourth quarter, which would boost its share for the year from last year.