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.
