Nokia

This week, Nokia announced that it expects to lose market share this quarter in part because it chose not to follow price reductions enacted by its low-cost competitors.  Last quarter, Nokia had projected 40% market share in Q3, unchanged from Q2.  Following Nokia's warning, the market promptly punished the stock, which fell 13% to $20.10.  

Before going on, I should let you know that I have a bit of history with Nokia.  Back on January 29, 2004, I had bought Nokia at $20.60 on the advice of a friend who was an analyst at a major Wall Street research firm.  A few months later, in April 2004, Nokia promptly announced that it would miss earnings targets, and the stock plunged to the $13 range in May 2004, and even further to the $11 range in August 2004.  It wasn't until 2006-2007 that Nokia came back to the $20 range.  Then in early 2007, Nokia took off, hitting a high of $40 or so in October to November of 2007.  I sat down and analyzed the stock in December 2007, and came to the conclusion that I should sell.  Still, I was lackadaisical, but finally sold in April 2008 at $28.73.  So lost out on $10 or so of gains, but well, I guess I can be happy I didn't hold until today.  At the end of the day, I had about 40% gain over four years, so I can't really complain.  

Now, I'm not reviewing this to toot my horn.  As always, the question is, what could I have done better?  What have we learned?  There are actually several lessons that I want to jot down and remember.  

Let's start with a review of my notes from December 2007.  At that time, I looked at five factors that were needed to drive further growth:

- faster than expected market growth

- continued market share growth 

- continued margin expansion

- new models that drive revenue or pricing

- diversification, or new revenue sources

On the first, faster than expected market growth, predictions at the end of 2007 were that the market was well ahead of expected growth trends.  Nokia expected the world market to be 4 billion subscribers by 2010. but the consensus was that we would hit that target in 2009.  Still, I was concerned that a slowdown in the Americas and Europe, plus a correction in China, would weaken the consumer and pressure sales.  As everyone knows, the latter has turned out to be the more critical trend. 

As for continued market share growth, I thought in December that this was unlikely.  I thought that Nokia would be pressured by a revived Motorola, and also by other competitors, such as Samsung, Ericsson and even Apple or RIM.  Moreover, I thought much of Nokia's share gain in 2007 was due to the failure of Motorola, so further share gains were going to be harder to obtain.  

As it turns out, I was wrong about Motorola, which basically is stuck in the oblivion of a bottomless pit (from which it may never emerge).  I was right about continued competition, as evidenced by Nokia's announcement this week.  

On the issue of continued margin expansion, I thought this was unlikely because Nokia was trying to sell more low-end phones in emerging markets.  On the low end, competition only puts downward pressure on margins.  Analysts often praise Nokia's scale and its "best of breed" status.  Still, none of that can save it from vicious competitive pressures, especiall in Asia.  there, ZTE, Huawei and other domestic producers are filling the market with low-cost phones. 

Nokia also put out some two new high-end phones - the N85 that retails for $662, and the N79 which retails for $514.  The problem?  Nokia sells a lot more low-end phones, so a few high-end models won't make up for the decline on the low-end.  Nokia learned this back in 2004 when I first invested.  Guess what the reason was for missing numbers back then: Nokia had gotten so enthralled with making new, upscale phone models that they let the low-end competitors eat their lunch.  

In recent years, Nokia had also tried to diversify its revenue base.  The company offers internet services, music downloads and digital maps.  Right now, these businesses are still nascent and don't add enough revenue to offset declines in the cellphone arena.  

The conclusion: Nokia remains a cellphone company vulnerable to competitive pressures and weakness in consumer demand.  I always find this interesting, because you tell people this, and they all seem to say, "Yes, that's obvious."  But turn it into an investment decision, and its not so obvious. 

Take for example, this question: should you buy Nokia now that it's down at these "ridiculously" low levels?  If you've been watching Fast Money, as I do, the answer would seem to be yes.  Several of the traders and some guests say its a value right now. 

I think the answer is no, you do not buy Nokia now.  The fact that Nokia is best of breed doesn't matter these days; the industry is highly competitive, and there's very little that Nokia can do to ward off the sharks.  So competitors will continue to come up with new, cheaper models, and Nokia will either lose share or have to cut prices to keep up.  As Buffett would say, Nokia has a narrow "moat".  

The second reason you should stay away is that the demand won't come back anytime soon.  World economies are pulling back, and consumers aren't going to be able to fix their problems this quarter, next quarter, or even the quarter after that.  I think consumers around the world will be under pressure for a long time, and as a result the cellphone market will be too.  

Now one other lesson in this exercise.  I always have to ask, should I have know this was coming?  And the answer is yes. 

The first and simplest indicator was technical.  After a run from the $20 range in February 2007 to the $40 range in December 2007, Nokia fell below it's 50- and 100-day moving average in December 2007 and January 2008.  The stock came back, but crossed these lines again in February 2008.  So here were  two clear sell signals.  After that, Nokia has been below these two indicators ever since.  

Secondly, competitors have been signalling problems for months.  Sony Ericsson barely broke even in Q2, pressured by falling average selling prices.  The company has issued two profit warnings this year.  Also, Vodafone, Europe's largest mobile operator, had poor results in July and a weak full-year outlook.  At the time, Vodafone saw weak market conditions in Spain and Turkey, and rising costs as well.  Finally, Samsung and Sony Ericsson cut prices in Asia in August, and Samsung is aggressively pursuing the European market.  

The Great Unwind

So I wrote my monthly investing article, this time entitled "The Great Unwind", for Asiance Magazine.  You can read it at www.asiancemagazine.com/sep_2008/investing_the_great_unwind.

The Dow is down 345 points today.  All the indices are down, almost every sector.  Funny, the best that CNBC could do was say the market's in a bad mood.  

I think its much more than that, I think it's the great unwind, continued.  Truth be told, I had wanted to short commodities (or at least buy puts).  I thought a couple weeks back, when I was thinking about it, that I had missed the opportunity to benefit from the downside.  

It seems to me, there's a great liquidation going on right now.  One indicator is the Ospraie Commodities Fund, which went under yesterday.  The liquidation explains yesterday's weakness.  I think today's weakness says, if Ospraie went under, anybody else holding commodities should sell.  And as in previous periods earlier in the year when there was a lot of selling, EVERYTHING got sold because there was short covering, or people needed to take profits in other areas in order to cover losses in whatever was being liquidated.  So the entire market gets hit.   Another indicator is in the Swiss Franc vs Yen chart, which is going through a major downtrend (when borrowing yen and investing in Swiss Francs, the chart would be positive.  When unwinding, that is, selling Swiss Francs and buying Yen, the chart is downward trending).  

One lesson in all this is that the Great Unwinds (and I'm referring to major liquidations, like now) take a long time.  So I could have bought puts in commodities last week and still be profiting.  Oh well, next time.  

The question is, how far does this go.  Does it continue tomorrow?  I can't really tell you, I don't have any way of estimating.  Many charts are near the bottom of their short term trading ranges, but in this market, they could easily break support.  I guess we'll find out over the next few weeks. 

Meanwhile, the only thing going up is the dollar, which I'm looking to buy on a pullback.  Problem, no pullback yet.  

On tech, it's taken a beating lately.  In addition to signs of worldwide weakness from Dell, Ciena announced a weakened outlook last week.  Ciena provides network equipment to telecom companies, and they said that telecoms have become more cautious in spending and are upgrading networks more slowly.  "While we've seen no project or order cancellations, sales cycles are lengthening and some deployments are slowing," said CEO Gary Smith.  So more fuel for the thesis that tech is not immune to the worldwide slowdown.  Only a couple weeks ago I wrote about the common belief, based on recent reports from various tech companies, that tech might weather all the problems in the world economy.  

I have not yet decided where I come down on tech.  I think it's going to be stock-dependent.  As a whole, tech has to take a hit.  But certain stocks, such as Apple, are likely to have a good year.  And certain stocks, possibly Intel, might be oversold.  It's hard to say today, because the tech stocks have yet to stabilize.  

Financials in general took a hit too today.  I have no doubt there will be another round of financial battering, or at least, announcements of losses and writedowns from the financial sector.  It's likely that the market reaction will be a drubbing.  But we will see soon.  

Ming is long INTC, AAPL and several other tech stocks not mentioned in this post.  

The Coming Problems in Commercial Real Estate

Last week, the rent-regulated Riverton Apartments in Manhattan warned that it may not be able pay a $225 million mortgage payment due in September.  If they can't pay, it would be New York's largest commercial default to date.  Riverton's debt was packaged into a commercial mortgage-backed security (CMBS), split up and sold as bonds in the spring of 2007.  The owners had also assumed that worse case, the low-rent apartments could be sold at the then-high real estate prices.  

And thus comes the next stage in the credit crisis.  According to the New York Times, Deutsche Bank (DB) held $25.1 billion of commercial mortgage backed securities, Morgan Stanley (MS) held $22.1 billion and Citigroup (C) had $19.1 billion at the end of the second quarter.  Lehman Brothers (LEH) is trying to sell about $40 billion of commercial real estate assets, as well as its entire real estate business.  Moody's REAL Commercial Property Price Index has dropped 12% since its high last October.  

Over the next six months to a year, mortgages priced during the last throes of the real estate bubble should run into trouble.  As these real estate owners try to refinance, costs should be higher, making the problem even worse.  This will force writedowns at the banks mentioned above.  

Position: Ming is long C and MS.  

Is Tech the Next Trade?

In recent weeks, things have been looking up for the tech sector:

- In an interview with Jim Goldman on CNBC, Intel's (INTC) CEO Craig Barrett said that the company was shielded from vagaries in the US economy because 75% of its business is from outside the US.  Intel's customers have business models that have 60-80% of their sales outside the US.  So as long as the emerging markets are strong, he argues, Intel will do well.  (The interview was Tuesday, August 19, 2008 - see www.cnbc.com )

- IDC reported that PC shipments rose in the second quarter, growing 3.1% from the first quarter, and 16.1% from last year.  Usually the second quarter is the slowest period for personal computer chip shipments, so this activity is very unusual.  IDC analyst Shane Rau attributes this to strong demand for notebooks and Intel's "very aggressive push" in the PC chips market.  Intel's processor shipments grew almost 4.3% in Q1 and 20.8% over last year, while AMD's processor shipments were flat.  Intel is estimated to have 80% (up  1%) of the market for PC microprocessors, while AMD has about 20% (down 1.2%).  IDC expects the PC processor market to grow 7.5% in 2008 to $32.8 billion (www.smartmoney.com, August 18, 2008)

- On August 24, 2008, Gartner reported that worldwide server sales rose 12.2%, year over year,to 2.3 million units in Q2.  Meanwhile, revenue was up 5.7% to $13.8 billion.  The major drivers were the replacement of x86 servers, expansion of data centers for websites, and growth in emerging markets.  IBM had 31.2% of revenue, up 11.5% from 29.6%; HP was second with 27.6%, a drop from 28.4%; Dell held third with 13%, up 1%; Sun and Fujitsu share of revenue was down.  In terms of units, HP's share dropped from 31% to 30% (although units rose 8.7%); Dell's share rose from 22.3% to 24.7% (unit growth grew 24%); and third-place IBM also lost unit share.   

- Hewlett-Packard (HP) recently reported a 14% increase in quarterly profit driven by international sales and issued an optimistic outlook for the current quarter.  HP's PC revenue was $10.25 billion, up 15% from the same quarter last year.  This was largely driven by a 26% increase in laptop sales.  Corporate purchases were strong.  Enterprise servers and storage were up 5%, but sales of blade servers grew 66%.  The services division increased revenue 14%.  The company is estimating current quarter revenue of $30.2 billion to $30.3 billion and EPS of 95 cents to 97 cents (see wsj article, August 20, 2008)

- Cisco (CSCO) recently reported 10% revenue growth in the fiscal fourth quarter.  While John Chambers, the CEO, expects slower revenue growth of 8% in fiscal Q1 (the next quarter) and 8.5% in fiscal Q2, he anticipates a recovery early next year in the beginning of 2009 (Chambers noted that his fiscal Q1 and Q2 growth figures could be +/- 1%).  Overall, Chambers reiterated the company's annual growth forecasts of 12% to 17%.  In the current quarter, enterprise IT spending did grow 13% over last year's figure, compared with only 6% last quarter (see wsj article,  August 5, 2008).  While all this may not seem extraordinary, analysts consider these pronouncements positive compared to statements from the past year in which Chambers reported significantly weakening spending.  Keep in mind that it was Chambers' negative comments that started the decline in tech last fall.  

- EMC reported on July 24, 2008, that second quarter net income rose 13% while revenue grew 18%.  CEO Joseph Tucci called the environment "manageable" and said that customers were continuing to spend because they still need to manage an ever-increasing body of information.  Sales in the US were weaker, growing only 10% over the same period a year earlier, but sales outside the US grew 27% year over year and accounted for 48% of total second quarter revenue (see WSJ, July 24, 2008).  

All in all, these reports indicate that the tech market is not as soft as many analysts had feared.  Following the credit crisis, many thought that weakening financials - usually one of the biggest buyers of tech - would severely damage the tech sector.  As a result, tech pulled back over the last year.  Now it seems that corporations have not pulled back as much as previously expected, and that overseas spending is continuing.   

Positions:  Ming is long INTC, EMC