The Nokia Disaster

I am a serial telecom entrepreneur and I have followed Nokia for some time. While the stock has recovered a bit and the company is still relatively large, I believe that the story is a sad one - marked by a failed effort to use wealthy teenagers as a judge for market trends.

Back in the late 1990's, Nokia was amazing. This little tiny Finnish company had become the most influential company of the decade, building neat little wireless phones that people would not have been able to contemplate just a decade earlier. By 1999, Nokia was producing smaller, thinner phones with more interesting features than anyone - it had easily surpassed Motorola and Ericcson and seemed clear to become the most influential company of our lifetimes. Everybody was using their phones - including youngsters and businesspeople. As a telecom entrepreneur living in Europe, I would often try to swing through Helsinki in order to see their latest models and, thereby, gain some insight into the direction of the entire market.

Bitten by the market collapse of 2000 and dramatic diminution of value of 3G licenses, Nokia made a conscious effort to focus of 2G applications which they believed would carry them through the decade. That decision alone meant that Nokia would no longer be the most influential driver in developing new cell applications.

Based on my interactions with the company's executives in the early part of this decade, I am sure that Nokia believed that the they could determine what would be the next killer application in the cell phone industry by looking at adoption rates among well-to-do 16 year olds from northern Europe. For example, the extraordinary early text adoption rates in Europe and Asia (and much later in the US) among 16 year olds led Nokia to be certain that text messaging would be the next killer application. Their mid-line and even some high end phones became focused on allowing greater texting abilities. At the same time, Research in Motion was taking the first steps towards making texting obsolete by taking email wireless.

Nokia's 16-year old focus groups also told it that they wanted to personalize their phones. By the time the entire Nokia line had exchangable faceplates to respond to this demand, the flip-phone had become the rage and Motorola's RAZR had sold millions of units worldwide.

With the losses to Motorola and to RIMM, by the middle of the decade, Nokia's loss of its innovative edge and the wealthy fashion conscious as well as businesspeople in Europe, America and Asia have deserted it. Its innovation group responded by becaming still more entrenched with focusing on younger markets. They built music and video capabilities into their phones, but ultimately Ericsson and some of the lower cost Asian manufacturers have built better devices. Now, Apple's entry into the wireless device market will ultimately spell the beginning of the end for any strength that Nokia has among rich 16 years.

On the other side, their product is becoming a commodity. Nokia has outsourced its production and reduced its service-levels in order to try to compete with the cheaper phones produced by Sansung, UTStarcom and a entire host of Asian producers. As a result, Nokia today produces an inferior product to the ones they produced in the late 1990s and early 2000s, and one without solid service support. As their products have become more and more commoditized, the company relies on their customers worldwide to purchase accessories where margins are much higher. But, the accessory business has never been a good one.

It is silly season on Wall Street and everybody wants to know how to play the IPhone. An article in today's breakingviews.com section in the Wall Street Journal goes so far as to ignore reality and to suggest that Nokia is a "buy". The article reasons as follows: Apple will sell 10 million IPhones over the next 18 months (IPhone, it says, has a market cap of $34 billion since Apple's stock has appreciated by this amount since its unveiling) whereas Nokia has a market cap of $108 billion and will sell 550 million units over the same time. The article furthers that the margins are the same (13%). It goes on to conclude that Apple's IPhone is trading at 100 times operating profits whereas Nokia trades at 10 times.

For starters, the article is dramatically wrong about Apple (its entire busines has improved dramatically late 2006 so the market cap growth is not entirely attributable to the iPhone and, if it were, the author is ignoring the synergies with its other businesses) and Apple's margins (dramatically higher than 13% on the baseline IPhone especially when you include average follow-on entertainment licensing revenues). The authors are also wrong about Nokia's margins (much lower than 13% when you strip out accessories and carrier rebates) and their assessment of Nokia's business in 2008 and beyond is based on assumptions that are much more suspect than even the most aggressive assumptions being made about the IPhone.

If you happen to find yourself by Apple's flagship store in on 59th Street in New York, you should also walk south two blocks to Nokia's empty flagship store of 57th Street. While there, you should count the number of teenagers (those are who Nokia has staked its business on) - you'll only need one hand at the Nokia store.

In short, one day before the IPhone's launch, there is still a lot of uncertainty surrounding it. One thing that is not uncertain is that Nokia is not a "buy".