Olli-Pekka Kallasvuo: Nokia CFO & Balance Sheet King
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... and an interesting article about an interesting and extremely successful man who is the architect of Nokia's Balance Sheet Strategy:
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Janet Kersnar
CFO Europe
The Economist Group
April 2003
cfoeurope.com
CFO Olli-Pekka Kallasvuo is betting that Nokia's balance sheet will be strong enough to let the mobile-phone giant outflank competitors.
Recent visitors to the imposing Kiasma modern art museum in the heart of Helsinki couldn't help but be captivated by a video installation entitled "The Artist's Dilemma." Part of an exhibit examining mankind's faith in technology and other weighty matters, the short video made by local avant-garde artist Roi Vaara shows a young man frantically running in circles around a signpost placed on a vast, snow-covered plain, uncertain which direction he should travel.
It's an image with uncomfortable overtones for many CFOs these days, not least for those in the global wireless industry. After the brutal bursting of the dot-com bubble, the industry's survivors have been searching frantically for ways to put them firmly on the road to recovery. Network operators, equipment vendors, and all manner of hardware and software suppliers are chasing after the nascent technologies that will help them sell ever-more sophisticated mobile phones, loaded with colour screens, digital photography, games, music players and the like. But rolling out snazzy new products and services to grab market share is arguably much more challenging than it has ever been: what's clear now is that companies without strong cash flows and healthy balance sheets to drive growth will simply be left running in circles.
The Finnish Line
Based a few kilometres up the road from the Kiasma museum, Olli-Pekka Kallasvuo, CFO of Nokia, coolly explains why he believes the Finnish mobile-phone titan will come out of the fray in better shape than others, having already secured itself a place as an industry leader in the 1990s. Never mind that the firm's shares have lost over 50% of their value since early 2001 and a small, but vital part of its business--the network division--is struggling to find its footing. Relatively speaking, Nokia is flying high. Its main business--being the world's number one handset maker with nearly 40% market share, ahead of Motorola, Samsung and Siemens and SonyEricsson--has been growing steadily, and now accounts for over 75% of its revenue. Though group sales in 2002 decreased 4% to E30 billion from the previous year, operating profit increased 3% to E5.4 billion and operating margins increased to 18.1% from 16.8%.
"It's hard to argue about numbers like those," says Per Lindtorp, an analyst with Hagströmer & Qviberg Fondkommision (H&Q), a Stockholm-based brokerage firm.
There are other good reasons to be bullish about the future. According to Dresdner Kleinwort Wasserstein (DrKW), more than 480m mobile phones were sold world-wide in 2002; sales will grow between 17% and 18% this year and slightly less next year at around 15%. (For its part, Nokia puts the industry's worldwide handset sales figure in 2002 at a more sober--yet still healthy--405m units. And although it recently scaled back its projections for the first part of this year, it expects an industry growth rate of at least 10% in 2003.)
Until now, everything has gone more or less according to the plan that Kallasvuo helped craft with CEO Jorma Ollila in the early 1990s. The idea then was to hive off other parts of the staid Finnish conglomerate--such as its paper, aluminium and PC businesses--to focus on telecommunications. And though Kallasvuo is loath to dwell on it, the 49-year-old former lawyer has played an increasingly pivotal role as Ollila's right-hand man since their strategy meetings ten years ago. Starting his career at Nokia as a corporate lawyer in the early 1980s, he moved from various finance posts to become executive vice-president of Nokia Americas and president of Nokia's US business, before returning to his current job as CFO and joining the group executive board in 1998.
On Balance
What's made Kallasvuo stand out from his finance peers in the telecom sector over the past few years has been his conservative financial management. In 2002, Nokia's debt-to-equity ratio was -61% and it stored up an enviable pile of cash that reached E8.8 billion at the end of 2002--both are rare achievements in the poorly capitalised telecom sector today. Nokia is also delivering shareholder value--its return on invested capital was 36%.
But while Kallasvuo has won plaudits for his conservatism, the investor community is now watching anxiously to see how he plans to put that cash to use. "Nokia needs to realise that it's no longer a growth company; it really doesn't need that much cash on its balance sheet," asserts Lindtorp of H&Q.
Kallasvuo doesn't reveal much when probed about how much of that cash will go towards making acquisitions, reinvesting in Nokia's existing businesses or returning money to shareholders. But he's clearly not in the mood to go on a spending spree: "It's not the right business climate to let go of too much cash. We need flexibility and we need to be able to react quickly when new opportunities arise." (See "How much is too much?," March.)
One thing Kallasvuo isn't ruling out, however, are share buybacks. At Nokia's AGM in late March, he received approval from shareholders for a proposal to launch a new share repurchase plan that allows the firm to buy back a maximum of 225m shares worth E2 billion between now and next March.
The proposal, however, hasn't been without critics. Moody's Investors Service, for one, threatened to downgrade Nokia if it considers that any of its share repurchases are "in amounts that are sizeable in relation to its free cash generation and liquid resources." Even so, with about E5 billion free cash flow generated in 2002 before financing in addition to E1.3 billion in dividends and E9.4 billion in cash and marketable securities, Nokia can in theory pursue a fairly aggressive buyback plan without a downgrade from Moody's. But as Per Lindberg, a technology analyst at DrKW, observes: "Even though Nokia doesn't need debt--and no matter how irrational the reasoning on the part of the rating agency--Kallasvuo must be concerned about the ramifications of losing Nokia's A1 issuer rating, which could start a spiral of negativism."
Hungry Competitors
Yet while Nokia is indeed in better shape than its rivals, the landscape is changing fast. "Nokia won't be under colossal attack, but its dominance will certainly be chipped away," predicts Peter Richards, a UK-based financial analyst at Soundview Technology Group. Nokia's strength in the past, he says, has been that it was the biggest player in every part of what's known in the industry as the "value chain" in handsets--that is, everything from marketing and branding to manufacturing to logistics. No longer.
As a case in point, Richards cites the possible demise of long-standing relationships with operators like Vodafone, which have been running their services via Nokia-branded handsets. According to Richards, the operators "are now trying to gain control of the whole visual experience" by offering customers their own branded handsets and a whole new breed of "hungry manufacturers--from countries like Korea and Japan" are happy to help.
Lindtorp of H&Q sees another threat looming among the suppliers who provide the semiconductor chips that Nokia needs to run its phones. The big semiconductor companies such as Texas Instruments, Intel and Motorola have all recently rolled out integrated chips, and as Lindtorp explains, "The more standardisation and integration, the easier it is for smaller competitors to get economies of scale and have access to the same phone platforms and operating systems as Nokia on attractive terms."
All these competitive threats are what Ben Wood, a telecoms analyst at Gartner, the IT research firm, says is part of "the Microsoft phenomenon." As he explains, "It's fashionable to dislike market leaders. Everybody in mobile phones has a single focus now--to beat Nokia."
Of Cash And Competitors
In one respect, Kallasvuo agrees with Nokia's rivals--that the competitive pressures in the industry are tough and getting tougher. "Like Andy Grove [chairman of Intel] said, only the paranoid survive," he says. "In practice that means there's no room for complacency." Yet he is also quick to point out that Nokia--in its almighty handset division, at least--has several strengths that allow it to outflank rivals.
Notably, he cites Nokia's premium brand name and solid new-product portfolio. "Some industries have to choose whether they want to invest in the minds of the people in R&D or in the brand. In this industry, you can do both," says Kallasvuo. As a trade-off, however, Nokia doesn't tie up capital to manufacture its own phone chips as some rivals do. "We don't want to be a capital-intensive business. It was a conscious decision in 1992 and we continue to think that way."
Now that Nokia has become a household name, it's easy to see why Kallasvuo wants to hang on to the original strategy of the early 1990s. After all, its well-known brand allows it to sell its handsets at higher prices than its peers. What's more, behind Nokia's big brand are hundreds of thousands of loyal customers--according to research published last October by Goldman Sachs, over 40% of Nokia users in the US and over 70% in the UK say that they plan to buy another Nokia phone.
"Where Nokia differs from Motorola and so on, is its global brand-recognition value, and that's been protecting them over the past few years," comments Dan Steinbock, a senior adviser of the Institute for Mobile Market Research in the US and author of a new book Wireless Horizon (American Management Association, 2003), who adds that last year, Nokia spent over E1 billion--or 4% of net sales--on its brand management. It appears to be money well spent. In its latest annual study, Interbrand, a consulting firm, ranked Nokia as the sixth most valuable brand in the world (measured as net present value of earnings that a brand is expected to secure in the future).
Then there's Nokia's product portfolio. Unlike handset rivals such as Samsung, which focus on one segment of the handset market, Nokia's product range covers the entire gamut of low-end and high-end units. Importantly, Nokia has become very efficient at manufacturing various types of handsets by re-using the same "platform" and then adding specific features to specific models, says Richards of Soundview. One upshot for Nokia is greater economies of scale and cost efficiency, which are among the reasons why it consistently has some of the best handset margins--at around 20%--in the industry. (In the fourth quarter of 2002, margins were an impressive 24.4%.)
Nowhere To Hide
Not that any of this has made Nokia immune to the vagaries of globalisation. Kallasvuo grimaces as he recalls a dismal period in late 1995 when the fast-growing Finnish firm was hit with a series of problems, including kinks in its supply chain which prevented it from sourcing components and shipping products on time.
In response, the company began investing heavily in a global IT system that would provide them the sort of real-time, robust data that has become the lifeblood of companies like Nokia. Since 1999, the firm has been running an SAP R/3 ERP system to provide "Nokians" around the world--from logistics to treasury to sales--with "one set of numbers, one chart of accounts globally from one ‘box' set up in Helsinki," says David Blair, a 15-year veteran of the firm and director of Nokia Treasury Asia in Singapore. "Rather than maintaining multiple, crude interfaces with different ERPs, finance and related people are all focused on integrating our information into the single SAP system. For a company as big as we are, it's pretty unique to have such an enormous amount of transparency and integration."
That's all well and good, but as Lindberg of DrKW points out, "if Nokia's handsets don't sell, a new SAP system certainly won't help--ERP systems might make internal reporting and feedback more efficient, but they aren't able to instruct companies on how to be a stronger player over time."
True, and that's why Nokia is focused on several other fronts as well. From an internal perspective, for example, it re-organised its handset division last year around nine business units so that each one can focus on a different market segment, such as mobile phones, entertainment and media, and business applications. Run as individual profit centres,the units have their own R&D and marketing. Externally, it's been entering into or expanding a series of important alliances--such as the recently extended agreement with Texas Instruments to improve the chipsets and processors that it supplies for Nokia's Series 60 software platform for smartphones. There's also Symbian, a software-licensing company it helped co-found with other wireless players in 1998 to provide open standard operating system for data-enabled phones.
More is sure to come, says Jyrki Ali-Yrkkö, a unit head at the Research Institute of the Finnish Economy in Helsinki. "Nokia has reinvented itself so many times before that it's impossible to guess what sort of structure or competencies the company will have in ten, even five years from now," he says.
But with Kallasvuo's keen sense of financial direction, it's hard to imagine Nokia losing its way.
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Outside The Box
Making R&D Investment Deliver
For a finance chief of a research-intensive company, getting a handle on the impact R&D investments have on the bottom line can be a nightmare. Instill too much discipline to monitor and manage investments, the creativity and flexibility that drive research teams can be killed off. Too little, however, can lead to research teams running amok, with little awareness of why or how their projects are helping--or harming--the company.
Nokia is no exception. Ever since the company transformed itself in the early 1990s from a sprawling Finnish conglomerate to a focused, global telecoms player, CFO Olli-Pekka Kallasvuo has given the go-ahead to countless new R&D projects. And despite the market downturn, Nokia has kept R&D spending on its steady upwards trajectory. In 2002, it spent E3.05 billion on R&D compared with E2.9 billion the year before, or 10% and 9% of net sales respectively. (See chart.) Nokia Mobile Phones reaped the benefits of the firm's steady increase in R&D spending, launching 34 new products in 2002--a record number for the Finnish firm. This year, Nokia's also counting on new models--such as its five newly unveiled handsets based on the standard used in North America and its hand-held videogaming devices--to get existing customers to upgrade their mobile gadgetry while attracting new customers from Beijing to Boston.
But how does Kallasvuo know whether Nokia is getting value for money? This is where Yrjö Neuvo, a close colleague of Kallasvuo, comes in. Hired from his post as a professor in the electrical engineering faculty at Finland's University of Tampere in 1993 to become chief technology officer of Nokia Mobile Phones, Neuvo meets with Kallasvuo every few weeks at the firm's headquarters, often poring over a list of metrics gathered from the mobile-phone division's 16 research sites worldwide.
To do his job well, Neuvo says he stays focused on three things: launching products at the right time, at the right price, in the right market. That means relying on cross-functional teams to instal marketing, pricing, logistics and supply-chain insight early in the development timeline. Financial discipline, too, is key. "From day one, we're looking at costs, margins and so on--finance is right there."
Pre- and post-product launch metrics are also essential. He looks at not only traditional project-oriented metrics like time-to-market and product costs, but also profit-oriented ones such as time-to-profit, break-even time and sales performance throughout the entire two- to three-year average lifecycle of a product. Together, these metrics are taken into account when calculating annual team bonuses. "Our development teams aren't allowed to launch a new product and then just shut their eyes," says Neuvo. <<
My Notes & Comments:
After a boardroom shakeup in 1992, Jorma Ollila was named CEO of Nokia, he immediately put members of his generation in charge of Nokia's key businesses, while he and Olli-Pekka Kallasvuo, whom he named CFO, began to map a course for the company. The management team he put together is still together:
Jorma Ollila (53), Matti Alahuhta (51), Sari Baldauf (47), Pekka Ala-Pietela (46), and Olli-Pekka Kallasvuo (50) have as one journalist put it:
... have worked together for so long that they can converse in a kind of shorthand. They are seen by many at Nokia as an inseparable unit. Around Nokia, it is said, you don't hear so much talk about Jorma this or Jorma that. It's almost always Matti and Sari and Pekka and Olli-Pekka and Jorma, or some combination of the team.
Since Jorma put the team together in 1992 Nokia has grown top line from Euro 3,056 Billion (Reported IAS) to Euro 30,016 Billion
Ten Year Summary of Financials here:
nokia.com
Highlights from Olli-Pekka Kallasvuo's Q1 2003 "Balance Sheet" slides
Balance Sheet and Cash Flow – Q1 2003
• EUR 165 million released from working capital
-- Due to improved working capital rotation in Mobile Phones
• Capital Expenditure: EUR 100 million
• Expected to remain on the same level as in 2002
• Net operating cash flow: EUR 1.4 billion ($1.55 million USD)
• Net cash position: EUR 10.5 billion ($11.6 billion USD)
• Gearing ( net debt-to-equity ratio): -71%
Annual General Meeting Resolutions: March 27, 2003
• Approved share buy back program
-- Up to 225 million shares
-- Up to EUR 2 billion
• Approved 2002 dividend of EUR 0.28 per share, to be paid
during Q2 2003
* The referenced share buy back program commenced several weeks ago.
* Through Q1 03 Nokia remains King of Handsets with ~37% market share and properly ~2.3x their next nearest competitor (Motorola), and their market share is continuing to grow.
- Eric - |
