The Bad News for Nokia: The Good News Is Wrong
By ERIC J. SAVITZ
Barron's
The way Per Lindberg sees it, the market for cellular phones is both considerably larger and growing significantly faster than most of the handset makers predict. Good news for cellphone stocks, right? Well, not exactly.
An analyst with Dresdner Kleinwort Wasserstein in London, Lindberg has staked out a maverick position on what seems like a simple question: How big is the cellphone business?
To understand the complexities of the question, and why it matters so much, consider what happened last week. Monday, Merrill Lynch raised its forecast for 2003 mobile-phone shipments from 410 million to 474 million, a gain of 18.5%, and concluded that Nokia would be the biggest beneficiary of the brightening outlook in the sector. Most estimates for 2002 are running at about 400 million phones.
In particular, Merrill cited strong interest in Europe in new phones with color screens and built-in cameras. Nokia's stock moved up nearly a buck on Merrill's hearty endorsement. Then, at an analyst meeting in Dallas the next day, Nokia forecast a 10% increase in global mobile-phone sales in 2003, which implies 440 million phones, or a lot less than Merrill predicted. Nokia shares gave up the previous day's gains.
For some time now, Lindberg has been asserting that the mobile-phone market is about 20% larger than the numbers typically used by most big players in the industry. Lindberg projects the market next year will be more like 569 million units, up from 488 million this year, for a gain of 16.6%. While that sounds bullish for Nokia, it isn't. Lindberg's view is that Nokia and the other leading U.S. and European manufacturers tend to understate the market to their advantage, since it has the effect of making them look as though they have a bigger market share than they actually do.
Thus, Lindberg figures Nokia's market share is 31% to 32% and sliding, rather than 37% to 38% and rising, which is what the numbers used by Nokia and some rival analysts suggest.
One factor cutting against Nokia, Lindberg says, is that the addition of features like color screens, cameras -- and even television tuners -- in cellphones plays to the strength of the Asian consumer-electronics manufacturers. And in fact, Asian handset companies are gaining market share, in part due to an explosion of sales in China and other Far Eastern markets, but also from better acceptance of Asian-produced phones in Western markets.
On Friday, Qualcomm, which supplies chips used by phones based on a technology called CDMA, boosted its fourth-quarter sales forecasts, due in part to strength in sales of CDMA-based phones in South Korea, Japan and China. In the third quarter, Lindberg notes, Nokia posted a 2.5% increase in third-quarter units sold over the second quarter, while Korean manufacturers Samsung and LG posted sequential gains north of 20%. Indigenous Chinese handset makers, he says, have been growing even faster.
The upshot: Lindberg says Nokia faces the unhappy prospect of losing market share -- unless it wants to cut prices and reduce its margins. Last week, he dropped his rating on Nokia to Hold from Buy, re-asserting his belief that the company is "doomed to lose market share and pricing power in its flagship handset operations." A better than 50% rebound in the stock since early June has "more than fully discounted" a sustained recovery in the mobile-phone market, he contends.
So a funny thing happened on the way to the recovery last week: The Street lost its nerve. From Oct. 9 through the end of November, a tech buying panic broke out, resulting in gains of 50% to 75% by the tech-oriented stock indexes, and triple-digit percentage gains for many individual issues. In part, the rally reflected a strategy shift by portfolio managers who went into the year's final quarter underweight tech stocks and feared missing a fourth-quarter rally. Some encouraging anecdotal signs of stabilization in technology end-demand also bolstered investor courage, at least for a while.
Last week, it became increasingly apparent that the rally's underpinnings had two major flaws. One, despite the optimism, the tech-spending outlook remains weak. And two, the rally has inflated stock prices to bubble-era valuations.
From a fundamental perspective, last week brought some new data points, not all of them bad. The good news came from the chip sector: Both Advanced Micro Devices and Intel boosted fourth-quarter revenue guidance last Thursday. Good news, but not unexpected. Analysts lately had been saying optimistic things about Intel's ability to meet its previous forecast for the current quarter, driving its shares up 40%.
But let's not get carried away. Intel Chief Financial Officer Andy Bryant said in a conference call that the company was seeing a seasonal pick up in business, with most of the improvement coming from sales of microprocessors and related parts in Asia. Bryant said the strength seemed more tied to consumers than businesses, observing that there had been "no takeoff" in corporate tech spending. That was no surprise, of course. Earlier in the week, Cisco Systems repeated its previous forecast that current quarter revenue would be flat to down 4%. Meanwhile, Hewlett-Packard reduced its revenue growth expectations for the quarter to a range of 2% to 4%, from 4% to 6%. Gateway said it might not meet its fourth-quarter revenue target, due to weak PC sales and aggressive pricing. Corning said telecom spending probably won't recover before late 2004.
On a macro level, the latest Goldman Sachs IT spending survey found chief information officers still anticipating only 2% to 3% budget growth next year. Respondents continued to see long-term IT spending growth at 6% to 7%, which is better than 3%, but still sharply lower than the 10% to 13% growth in the pre-bubble days. The survey also found that "expense control remains the top priority." That's consistent with the just-released 2003 Worldwide IT Benchmark Report from Meta Group, which found that the top corporate IT priority for next year is "reducing costs."
Given all that, the question of the moment is, How much do you want to pay for tech stocks? Morgan Stanley raised that question last week, and they answered it, too, chopping ratings on stocks in four major groups: chips, semiconductor equipment, contract manufacturing and enterprise hardware. Donald Luskin, chief investment officer with Trend Macrolytics, in Menlo Park, Calif., contends that the recovery has left tech stocks extremely overvalued relative to the rest of the market -- more so than at any time in the last 18 years, aside from the March 2000 bubble-market peak. He's advising clients to short the Nasdaq 100 and buy the Standard & Poor's 500.
Pip Coburn, technology strategist at UBS Warburg, says the valuation question is coming up more frequently as he talks to portfolio managers. Technology stocks, he says, are trading at about 32 times 2003 earnings estimates -- estimates that are still too high. Consensus has the S&P 500 tech stocks growing 7% to 8% at the top line, and 39% at the bottom line; he thinks 4% to 5% revenue growth and 20% earnings improvement is more likely. Coburn thinks chip stocks, in particular, are due for a comeuppance. He notes that Jerry Sanders, chairman of AMD, said recently that long-term chip industry growth will be 8% to 10%, a far more sedate pace than in the boom years. "He's onto something," says Coburn. "Look at the growth rates for the end markets for next year. Handsets 10%, PCs 5%, servers 5%, communications equipment, negative. Those markets cover 70% of where semiconductors go. The heart of the explosion is over."
Last month, I chronicled this year's big run in J2 Global Communications, parent of Efax, a service that translates fax transmissions into e-mails ("Partying Like It's 1999," Nov. 11). Among other things, the story noted that insiders had begun unloading shares. They're still at it: On Nov. 26 and 27, Chairman Richard Ressler sold one million shares, about 9% of the shares outstanding, at $22 to $24 a share, chopping his stake to 2.5 million shares. J2, which started the year a tad under $5 and traded a smidge under $27 before our story, last week closed at about $18.
E-mail: eric.savitz@barrons.com
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