Ibex,
Nokia, Qualcomm, and Wireless In 2002
By Eric Jhonsa
For much of the past eighteen months, as growth in the mobile handset and networking markets has slowed dramatically due to the saturation in the markets for wireless voice services in developed nations, and due to delays in rolling out next-generation data services, Nokia and Qualcomm have managed to act as bellwethers of sorts for the industry, with their core businesses (handset and infrastructure sales for Nokia, chipset and licensing sales for Qualcomm) posting strong quarterly profits even as the majority of the industry’s other stalwarts – including but not limited to Motorola, Ericsson, Siemens, Texas Instruments, and RF Micro Devices – have seen their balance sheets dip into the red. Their latest earnings reports, both of which were released on Thursday, continued this trend, with each firm generating solid amounts of operating cash flow, and delivering pro forma earnings per share of $.22 and $.23, respectively. Considering that these numbers represent a drop from the $.24/share and $.26/share reported by Nokia and Qualcomm last year, they definitely aren’t spectacular; but in the present industry climate, it’s difficult to ask for too much more.
In Nokia’s case, the company’s 4th-quarter performance can, to a large extent, be attributed to the market share gains made by its handset division. After closing out the first quarter of 2001 with an all-time-high handset market share of roughly 35%, the company gave back a couple of those percentage points in the next two quarters, the result of a somewhat-stale product line and extensive price cutting on the parts of some of its rivals. However, with the price war having partially abated in the 4th quarter - mostly as a result of the fact that Motorola and Ericsson couldn’t stand any more bleeding – and with the product line having been rejuvenated with the release of the 5510, 6310, and 8310 models, Nokia managed to recover all lost ground – and then some. Citing an internal estimate of 380 million handset sales for the industry on the year, the company claims it possessed a 37% market share for 2001, which would imply a market share of nearly 40% for the 4th quarter. If an Ericsson estimate of 390 million 2001 handset sales were to be used, these numbers would come down to 36% and 38%, respectively; but nonetheless, regardless of which estimate proves to be the more accurate one, it appears that Nokia is set to come out of this industry downturn with its handset market share at a new high.
Going forward, it doesn’t look like the handset division is going to be resting in the manner that it effectively did in the first half of last year. The next few months should see the release of the 5210, 6510, and 7650 models, the last of which is Nokia’s first mass-market, GSM 900/1800 handset (aimed at Europe and Asia) to possess a color screen, a built-in digital camera, and support for the Symbian Epoc operating system and the J2ME (Java 2 Micro Edition) development platform. With most users still viewing their phones as nothing more than voice and text messaging platforms, devices like the 7650 will be crucial in driving consumer interest for more advanced data services, which in turn is essential both for increasing “replacement” handset sales and driving 3G network deployments. Nokia will also be active in releasing new handsets for the Americas, with its first 1xRTT and GSM/TDMA dual-mode handsets slated to arrive in the second quarter. The GSM/TDMA model, known as the 6340, is a particularly important launch for the company; a number of major TDMA operators, including AT&T Wireless, Cingular, Rogers (Canada), and TelCel (Mexico) are planning to spend billions of dollars to upgrade their networks to GSM-1900. Dual-mode phones will be critical in guaranteeing a relatively smooth migration, and since Nokia’s GSM-1900 market share is somewhat lower than its TDMA share (although still much higher than the competition’s), it’s crucial that the company plays a leading role in bringing them to the public.
Meanwhile, in contrast to the handset division’s work, the performance demonstrated by Nokia’s networking business wasn’t particularly endearing. Whereas Nokia Mobile Phones managed to post flat annual sales growth and a slight increase in operating profit margin (22.0% compared with 21.5%) at a time when industry-wide sales fell meaningfully, Nokia Networks reported both a 17% drop in revenues and a 24% drop in operating margins (13.0% compared with 17.2%). Likewise, while the handset division is forecasting only a 3-7% sequential decline in revenues for the 1st quarter of 2002 (normal, given the seasonality of the handset business), the networking division is expecting to see a 16-20% drop. To a large extent, this weakness can be attributed to a decline in demand from Nokia’s traditional GSM customers in Western Europe and the Pacific Rim; while Nokia has managed to obtain significant orders from customers in developing nations, and from TDMA “converts” in the Americas, they haven’t been able offset the weakness in spending on the parts of those older GSM operators who are now operating out of nations with mobile penetration rates well above 50%, and thus no longer need to make major capacity upgrades in order to satisfy the voice communications needs of their respective subscriber bases. However, this phenomenon only tells half the story – the decline in plain vanilla GSM orders has been long expected; what wasn’t expected, on the other hand, is the delay that’s taken place in 3G W-CDMA network rollouts on the parts of those same, older operators. This delay owes itself both to technological issues that have pushed out the release of W-CDMA/GSM dual-mode handsets by several months, and to reductions in capital expenditures that have come about as a result of a present lack in consumer demand for wireless data services. While we remain fairly optimistic about the ability of these issues to mostly resolve themselves over the next 9-12 months, we also think it’s quite likely that Nokia Networks will continue to face choppy waters until they do, something that could have an effect on Nokia’s stock price until signs of a recovery become more evident.
Qualcomm, like Nokia, has had its near-term prospects adversely affected by the delays related to W-CDMA rollouts, as they have pushed back the payment of some of the infrastructure royalties the company might have otherwise begun receiving during the next couple of quarters. However, a much larger problem, at least for the near-term, has come about as a result of delays in 1xRTT deployments on the parts of three of the world’s five largest CDMA operators. While 1xRTT has been deployed with much success in South Korea – there are now over four million 1xRTT subscribers, and 1xRTT models presently constitute over 80% of all handset sales – the two largest CDMA operators in the world, Verizon Wireless and Sprint PCS, and the only major CDMA operator in Japan, KDDI, have all pushed back their 1xRTT rollouts, initially slated for the fall of 2001, to various points in the first half of 2002. As stated in a previous column, 1xRTT deployment is important for Qualcomm on a number of levels, as it stands to bring with it greater handset sales, higher chipset selling prices, higher handset selling prices (thus higher royalties), and the potential for CDMA operators to take market share from GSM competitors offering technologically inferior GPRS services. Without a doubt, 1x pushbacks played a large role in the lowering of Qualcomm’s guidance for the next quarter from a profit of $.24/share to one of $.19-.21/share, and the revising of its estimate for 2002 CDMA handset sales from 85-95 million to 80-90 million. Nonetheless, at least from a handset and chipset sales perspective, this issue should only be a near-term blip - 1xRTT has already been commercialized on a large scale in South Korea, and there’s no reason why the same shouldn’t soon happen in North America, Japan, and elsewhere. When combined with the potential rollout of 1xEV services in South Korea by summer, and the rollout W-CDMA services in developed GSM markets by the 4th quarter, Qualcomm could witness the beginning of a sharp acceleration in earnings growth as the 2002 calendar year nears its end.
All of this, of course, depends on the expectation that consumers around the world will want the advanced data services afforded to them by the rollout of these technologies. And, without a doubt, the same holds true for any hopes held regarding Nokia’s networking division’s chances at staging a quick recovery, and Nokia’s handset division’s chances at staging a quick return to fast growth. Highly profitable bellwethers though they may be, Nokia and Qualcomm can’t be granted high valuations for their shares without the growth that can only come from the mass adoption of wireless data services. It is for this reason that the development of compelling mobile data applications, whether they happen to deal with WAP browsing, Java applications, multimedia messaging, or something else altogether, will be an issue of primary importance for the wireless communications industry during the course of the upcoming year. Should the right applications be created, and properly priced and marketed, it won’t be long before millions of mobile users worldwide will be lining up to replace their existing, voice-oriented handset models with newer, data-oriented ones. Should this happen, it won’t be long before operators find themselves compelled to finally begin making large-scale 3G deployments, something that, in turn, could spur additional handset sales, thus creating a virtuous cycle that could last for quite a while, a cycle very similar to the one that led to an explosion in demand for 2G wireless voice services during the second half of the 1990s, one which helped take Nokia and Qualcomm to their present positions of industry prominence, and rewarded the companies’ shareholders considerably along the way.
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