A case of cannibalization
Judging by the comments I’ve received in previous posts about Nokia, Microsoft Corporation (NASDAQ:MSFT) and Nokia investors assumed that the low Lumia sales of the Q4 2012 were an artifact of “limited availability” and that there was much pent up demand remaining for Nokia’s Windows 8 phones. Last quarter, Nokia sold 4.4 million Lumia smartphones.
This quarter, the number of Lumia phones sold rose to 5.6 million. In fact, this was higher than I expected since I was expecting a sequential decline to 3 million as phone makers normally experience this after the Holiday season. But investors have little reason to cheer about this.
Nokia Corporation (ADR) (NYSE:NOK) pumped up its Lumia sales volume by selling steeply discounted low-end Lumia phones into emerging markets. The reader might recall recent reports that Lumia was outselling iPhone in Russia. In the process, Nokia very effectively cannibalized their own alternative smart devices, the Asha and legacy Symbian smart phones. The Asha runs an OS called simply Nokia OS, a variant of Symbian. The net effect was an overall decline in sales volume for the smart device category, as well as mobile phones.
| Quarter | Lumia Units in million | Asha Units in millions | Symbian Units in millions | Total in millions |
| 2012 Q4 | 4.4 | 9.3 | 2.2 | 15.9 |
| 2013 Q1 | 5.6 | 5 | 0.5 | 11.1 |
Not only did Lumia cannibalize Nokia Corporation (ADR) (NYSE:NOK)’s non-Windows phones, but appears to have cannibalized feature phones as well. Total mobile device shipments shrank by 28% sequentially to 61.9 units. Net sales for the Devices and Services business unit decreased by 32% year-over-year to EU 2.88 billion.
The myth continues
Once again, CEO Stephen Elop declared that Devices and Services had achieved “underlying profitability,” but of course, this was by virtue of excluding a 72 million restructuring charge. The IFRS (International Financial Reporting Standards) compliant operating income for the group was EU -42 million, while Nokia on the whole had an operating loss of EU -150 million (IFRS).
This points out why I dislike such exclusions. Nokia was supposedly done with restructuring, but here we go again. As I’ve pointed out in the past, companies suffering the revenue collapse that Nokia is still going through (-20% for the quarter year-over-year to EU 5.852 billion) can’t reasonably exclude restructuring charges as “one time only” since they tend to recur quarter after quarter. Such charges have a very real impact by diverting cash flow from more productive uses and should be considered by investors.
Revealing geographic data
Nokia’s geographic data also confirms the lack of penetration in what is arguably the most knowledgeable and sophisticated smart phone market: North America. Mobile device sales volume declined catastrophically by -43% sequentially to a mere 400,000 units, a mere 0.65% of total shipments. This was followed by a -39% decline in Europe to 11.8 million units, 19% of total shipments.
Currently mobile device volume is the highest in the Asia pacific region (excluding China) at 23.1 million, 37.3% of total. I often heard it asserted that Nokia was going to do well in China, but Nokia Corporation (ADR) (NYSE:NOK)’s geographic data completely belies this. The greater China sales volume of 3.4 million (5.4% of total) is the second smallest after North America, and also suffered a precipitous -26% sequential decline from Q4.
Should Microsoft be happy?
Undoubtedly, Microsoft Corporation (NASDAQ:MSFT) will point to growth of sales volume of the Lumia and other Windows 8 phones as a sign of progress. Based on Nokia Corporation (ADR) (NYSE:NOK)’s number, I expect that research firms such as IDC will report about 8 million unit sales for Windows Phone in Q1. Given that Q1 2012 shipments of Windows Phones only totaled about 3.3 million units worldwide (IDC), the huge year-over-year increase will be touted as a sign of increasing momentum. In terms of unit sales, it is genuine momentum given that market share will increase from 2.2% in Q1 2012 to about 4% in Q1 2013.
Microsoft investors should find some encouragement in this, tempered by the realization that the smartphone wars are as much about monetization as they are about sheer numbers of phones. As Philip Elmer-Dewitt pointed out in a recent post, a Canalys study showed that Apple Inc. (NASDAQ:AAPL) was taking about 74% of all mobile device store revenues, leaving 26% to Google Inc (NASDAQ:GOOG), Microsoft, and Research In Motion Ltd (NASDAQ:BBRY). Such a percentage comes from dominance in affluent markets such as North America and Europe. Selling highly discounted Windows phones into emerging markets isn’t really going to make for much of a revenue stream for Microsoft. In this regard, it’s fortunate that Microsoft intends to start collecting license fees from its manufacturing partners, including Nokia, starting this year.
The bottom line
I think Nokia has yet to show that it can forge a profitable business out of Windows Phone devices, and this should be worrisome to Microsoft. Microsoft would like to have additional OEM partners and has announced that Huawei and Samsung will be joining Nokia and HTC. Is there enough business to go around for four manufacturers? I’m not convinced there is, but clearly Microsoft needs for all its partners to be successful. The Windows Phone share of the mobile pie is still relatively slender, and split four ways, this could mean a net decline in sales for Nokia Corporation (ADR) (NYSE:NOK)’s Lumia, at a time when increased sales volume is essential to achieve genuine profitability. I’m sure this is not the turnaround story Nokia investors were hoping for.
The article Nokia Earnings Smackdown originally appeared on Fool.com and is written by Mark Hibben.
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