Nokia and Ericsson: A Tale of Two Telcos

Like a one-two punch, the two Nordic giants of telecom equipment reported results on Apr. 22 and 23 that fell short of analyst estimates. Nokia’s first quarter revenues announced on Apr. 22 grew 3% from the same period a year earlier, to €9.5 billion ($12.7 billion), and net income nearly tripled from 2009’s tough first quarter, to €349 million ($466 million). But the earnings were about €61 million shy of analyst estimates, and Nokia’s shares plunged 13.3% on Apr. 22 and another 2% on Apr. 23. It wasn’t so much the profit miss that spooked investors but falling average selling prices for phones, flat market share, and a slightly lowered forecast for operating margins this year.

Ericsson’s results announced Apr. 23 were in many ways worse. Revenue dropped 9% from the same quarter in 2009, to 45.1 billion Swedish kroner ($6.28 billion), about 3 billion kroner ($418 million) short of analyst predictions. Net income fell 27%, to 1.26 billion kroner ($174 million), nearly 38% ($103 million) below analyst estimates. The company blamed tepid operator investment in network equipment and continued sharp price competition from rivals. Yet Ericsson shares soared 10.3% on Apr. 23, largely because its results included a near-doubling in North American sales.

Is there an illness at the heart of Nordic telecom? No question, the first quarter was a comedown from the results posted by both Nokia and Ericsson in the final quarter of 2009. But aside from that, the companies are facing quite different situations. While the reaction from investors in both cases may have been overdone, the basic direction of movement reflects diverging realities.

Nokia, whose shares have fallen 1.4% this year against a backdrop of generally rising telecom stocks, can’t seem to catch a break these days. Long the leader in mobile handsets, and still hanging on to one-third of the overall market, Nokia has been sent reeling by the success of the Apple iPhone. Sure, Nokia sold 21.5 million “converged mobile devices,” or smartphones and mobile computers, in the first quarter, up 57% from a year earlier. Apple, by comparison, sold just 8.75 million iPhones. But Apple snagged an average of $622 in product and service revenue for each iPhone, whereas Nokia’s devices sold for an average price of $207 (€155). Translation: Apple made 22% more revenue on 60% fewer units—and its profit margins were even more dominant.

It's not as if the Finnish giant hasn't been developing smartphones for years, or hadn't spotted the trend towards mobile services. Indeed, it was ahead of the rest of the industry for many years in both areas. Recall that the original palm-top Communicator with a QWERTY keyboard came out in 1996(!), and Nokia made waves—and annoyed jealous mobile operators—a decade ago with its Club Nokia download center for ringtones, screen savers, and other phone enhancements. But Apple, with its snazzy design, great timing, and unparalleled ability to rally software developers, has walked away with the market buzz in state-of-the-art smartphones and downloadable (and revenue-producing) apps.

It's this perceptual gap that inclines investors to sell Nokia on any signs of weakness in its results. Overall, the company's performance remains enviable. It sold a solid 107.8 phones in the first quarter, up 16% from a year earlier (against a market that Nokia predicts grew 11%) and it still enjoys 12.1% operating margins in its handsets and services business. Its operating cash flow in the quarter was a cool €1 billion, and its somewhat troubled Nokia Siemens Networks joint venture gratified analysts with a small pro-forma profit for the quarter. Even the forecast decline in 2010 operating margins—from an earlier estimate of 12% to 14%, to a revised range of 11% to 13%—doesn't amount to much.

A bigger worry is that Nokia still hasn't come up with a blockbuster answer to the iPhone, and the time horizon is slipping. CEO Olli-Pekka Kallasvuo told analysts Apr. 22 that Nokia's first device using a new open-source version of the Symbian smartphone operating system, known as Symbian^3, won't ship until the third quarter of this year. It had earlier been expected in the second quarter. A follow-on Symbian refresh is now expected in 2011.

What about Ericsson? Far and away the dominant seller of mobile network equipment and services, the Swedish company has been on a roll since it bounced back from the horrorshow of the dot-com and telecom crash in the early part of this decade. But stiff competition in its business, especially from rising Chinese rival Huawei, is keeping prices down at the same time that recession-strapped mobile operators are holding back on spending.

Ericsson has bulked up by buying other companies, including some of the assets of failed Canadian telco gear-maker Nortel. It was the addition of those assets, plus a well-timed deal with AT&T, that helped Ericsson lift its North American sales 99% in the first quarter, to $1.3 billion, making the region now its largest in the world.

The proximate reason investors bid up the shares of Ericsson even as they hammered Nokia is, ironically, the same: the iPhone. In his conference call with analysts after the earnings announcement, Ericsson CEO Hans Vestberg pointed to the rapid growth in mobile data services in the U.S.—a phenomenon largely driven by Apple's popular device and the voracious wireless bandwidth consumption of its users. Investors see huge opportunity for Ericsson to sell equipment that serves that growing demand, which in some cities has already lead to network saturation. Credit Suisse figures Ericsson could be 20% undervalued at its current price.

As for Nokia, its shares are likely to remain under pressure until it shows a clear turnaround. With further delays on tap in next-generation software, says analyst Mark McKechenie of Broadpoint AmTech, 2010 is likely to be a "more of the same" year. The truth is, being the volume leader with dominant market share outside the U.S. just isn't enough when you're facing a phenomenon like Apple.

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