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Nokia's (NOK) Q1 earnings report gives us a chance to look at their smartphone results (which are grouped into Nokia's Smart Devices business unit) and compare the gross margin value of their Lumia sales to BlackBerry's (BBRY) Z10 sales. We aren't going to look at Asha gross margins since BlackBerry doesn't have anything comparable for that target market.

What stood out for me from this analysis and comparison is that Nokia really doesn't make much money when it sells a smartphone, even for one of their newer Windows Phone 8 Lumia models.

Comparison Between BlackBerry Margins and Nokia Lumia Margins

I've converted Nokia's figures from Euros to USD at a rate of $1.30 per € to make for an easier comparison in the below chart.

The BlackBerry Z10's gross margins appear to be much higher than the gross margins for the Windows Phone 8 Lumias. BlackBerry makes about as much per Z10 as Nokia does for three Windows Phone 8 Lumias. In fact, BlackBerry also still makes 20% more per legacy BlackBerry 7 device than Nokia does for their new Windows Phone 8 Lumias. While Nokia may have needed to clear out inventory by selling their Windows Phone 7 Lumias at cost, BlackBerry is still able to get significant value from BlackBerry 7 customers due to service revenues.

Service revenues make up a much smaller proportion of the Z10's profitability, but it appears that this is made up for by hardware margins that approach Samsung's level.

(click to enlarge)Gross Margin Per Phone Sale

Now on to the calculations to get to these numbers.

Nokia Smart Device Margins

Nokia said that Lumia sales were 5.6 million units during the latest quarter and Symbian sales were 0.5 million. WP8 sales accounted for approximately 2/3rd of Lumia volumes.

We are going to assume that the WP7 Lumias were sold at cost since Lumia ASPs declined from the previous quarter and Nokia mentioned that was partially due to price erosion. The cost was estimated at €130 per WP7 Lumia based on comments in previous financial statements. WP8 Lumias are estimated to have a 22% margin based on comments that margins for those phones were somewhat above 20.7%. To arrive at a higher margin calculation than this for the WP8 Lumias would require the WP7 Lumias to have been sold below cost or to have the Symbian phones have a cost per device that is over double that of WP7 Lumias. The Symbian numbers may seem high, but the ASP number is derived from the financials, and cost of sales is assumed to be similarly high to allow for better Lumia margins.

I've also removed the effect on cost of sales of the EUR 50 million reversal of previously recognized inventory related allowances since that is a onetime transaction.

Lumia - WP 7

Lumia - WP8

Lumia - All

Symbian

Total

Phones Sold (Million)

1.8

3.8

5.6

0.5

6.1

Revenue (EUR Million)

234

785

1,019

145

1,164

ASP (EUR)

130

207

182

290

191

Cost of Sales (EUR Million)

234

612

846

127

973

Cost of Sales Per Phone (EUR)

130

161

151

254

160

Gross Margin Per Phone (EUR)

0

46

31

36

31

Gross Margin (%)

0.0%

22.0%

17.0%

12.4%

16.4%

BlackBerry Gross Margins

In an earlier article, we determined the hardware margins that BlackBerry made on both their BlackBerry 7 phones and their new BlackBerry Z10. However, to get a complete idea of the money BlackBerry will eventually make when they sell a phone, we need to add service revenue margins to the mix.

For service revenues, we are going to estimate that BB7 users generate $3 per month in service fees over a 24 month period. Service revenue margins are 86.1%, so the gross service margin for BB7 phones would be $62. The total value of lifetime gross margins for a BB7 sale is $72.47. BlackBerry has made their BB7 products appealing by reducing the upfront price and making back some money over time via service revenues.

For the Z10, we are going to estimate the Z10 users generate $1 per month in service fees over a 24 month period. This is a fairly conservative estimate that assumes 10-15% of Z10 users are business users (estimates seem to put business users at 20-30% of BlackBerry's subscriber base) generating $6 to $10 per month in service fees, and the rest generate zero service revenues. The gross margin for these service fees is $20.66 per Z10 phone.

The result is that a Z10 sale is worth $174.67 in gross margin, which makes them worth as much as 2.4 BB7 sales. Despite the loss of a significant proportion of service revenues, a Z10 sale is much more profitable to BlackBerry than a BB7 sale.

Type of Phone

BB7

Z10

ASP Per Phone

$230.87

$436.65

Cost of Sales Per Phone

$220.40

$282.64

Gross Hardware Margin Per Phone

$10.47

$154.01

Gross Service Margin Per Phone

$62.00

$20.66

Total Gross Margin Per Phone

$72.47

$174.67

Conclusion - Nokia

Nokia has been sacrificing device margins to try to boost smartphone sales. Despite this, they haven't been able to pull away from BlackBerry yet. Nokia's Q1 smart devices shipment numbers are similar to BlackBerry's shipment numbers in their most recent quarter, but the gross margin value of BlackBerry's sales are nearly three times that of Nokia's. It is a case where one company's customer is worth significantly more than the other company's customer.

The low device margins also call into question Nokia's ability to generate significant profits through phone sales. They are contending with declining feature phone sales (for reference a Windows Phone 8 Lumia sale generates as much gross margin as seven feature phones). Feature phone sales are down 15 million units year over year. Even if increased Lumia sales offset the decline in feature phone sales, the marginal impact of an additional 1 million Windows Phone 8 Lumia sales in a quarter would seem to improve net income by only around €0.01.

On the positive side, Nokia seems to have stabilized close to breakeven, and are likely going to be close to breakeven (plus or minus a few cents) for the foreseeable future. Whether Lumia sales perform strongly or poorly is unlikely to have a major impact on this earnings position unless they really take off (15-20 million Windows Phone 8 Lumia sales per quarter would push earnings into the €0.10 range).

Conclusion - BlackBerry

BlackBerry's higher gross margins per sale make it easier for them to achieve significant profitability. With BlackBerry the question is more about shipment volume levels. A 1 million increase in Z10 sales (or Q10 sales assuming the same profitability) would lead to a $0.22 increase in net income.

There have also been some concerns about declining service revenue. It is true that reduced service revenue will eliminate much of the safety net that enabled them to survive despite having a tepid response to their 2011 products, and then needing to rely on those products to sell into early 2013. However, Z10 sales are also worth 2.4 times that of a BB7 sale in terms of gross margin right now, so there should be no concern that BB10 sales are taking the place of BB7 sales that included more service revenue.

The short interest of nearly 30% of BlackBerry's shares also makes things interesting if BlackBerry has a very strong quarter. Due to BlackBerry's earnings sensitivity to changes in BB10 sales volumes, a very strong quarter could lead to some outstanding results. In terms of optimistic data points, Peter Misek's supply checks suggested BB10 builds of over 2 million units per month, while BlueFin Research suggested that component sales might be approaching 2011 levels (where BlackBerry was shipping 13 million units per quarter). While these are the most optimistic data points from analysts, sales of 6-7 million BB10 units would push earnings into the $0.65-$0.87 range for next quarter, which could lead to a Netflix-like short squeeze.

Source: BlackBerry May Make As Much Profit From One Z10 As Nokia Does From Three WP8 Lumias