Nokia Corporation (NOK) shares plunged 11.45% on Thursday after the company reported lower than expected first quarter earnings. Though results were a mixture of good and bad, analysts were disappointed by a huge drop in overall sales numbers and the declining feature phone sales.
But the kind of drop the stock witnessed Thursday indicates that the markets are overreacting, or sentiments are more bearish than they should be. Let's start with the negatives. Total mobile phone volume sales declined 25% QoQ and 28% YoY. Nokia Siemens Networks, its joint venture with Siemens, also lost significant business. NSN's profits were about 3 million euros, that's a hopeless profit if you have net sales of 2.8 billion euros. First quarter revenues of $7.7 billion missed Wall Street estimates, though losses narrowed to 7 cents per share.
There were positives that investors and analysts seem to have ignored completely. Lumia shipments soared to 5.6 million units, up 27% QoQ from 4.4 million in the fourth quarter of 2012. The company has $5.9 billion in cash. Gross margins improved during the quarter, and smartphone ASP rose to 191 euros in the latest quarter from 143 euros in the year-ago quarter.
I think the solid increase in Lumia shipments is much better than it appears on the surface. Past record shows that smartphone sales of Nokia and other companies usually witness a decline in the quarter that follows the holiday season. Usually a 25% decline. Posting a 27% increase while the sales usually fall 25% is no joke. Even better, the company expects Lumia sales to rise 25% QoQ to 7 million units in the second quarter.
Time To Shift Focus Away From Feature Phones
Feature phones still make up about 90% of Nokia's total unit sales. They have been declining consistently for the past several quarters, and sank to 55.8 million units in the first quarter. I believe Nokia is unlikely to sustain in the feature phone market in the long run for two reasons. One, most of the feature phone sales comes from emerging markets, which are increasingly flooded with the cheap Chinese handsets. Second crucial point, an IDC survey suggests that smartphone sales will overtake feature phone sales by volume. And the market share of smartphones will continue to rise in the future.
If Nokia continues to compete in the shrinking feature phone market, its revenues are destined to decline as the market would almost disappear within a decade. Additionally, I don't think it makes any sense to compete on volume if the phone is sold at $20-$30 each.
It's time the company should recognize that it must stop fighting on volume. Nokia now needs to shift its focus on Lumia and Asha series.
Address Supply Chain constraints
Supply chain issue was the biggest reason the company couldn't reach its full potential in the first quarter. Nokia lost a lot of money because it couldn't supply enough devices. For example, the Finnish phone maker shipped only 30,000 Lumia 920T units to China Mobile by January 30, while the world's largest mobile carrier had placed an order for 90,000 units through January 30. Most of the China Mobile outlets didn't have the flagship Lumia 920T during the crucial China New Year holidays due to supply constraints.
Even Nokia CEO Stephen Elop admitted a few months ago that the Q4 2012 Lumia sales were hurt by limited supplies. I think the company should focus on lowering costs and developing its manufacturing capacity to avoid supply constraints.
Patent is extremely important for tech companies, and Nokia owns one of the most impressive patent portfolios the tech world has ever seen. As far as I know, Nokia has over 10,000 patents and it has licensing agreements with about 40 companies, including Apple Inc. (AAPL) and Research In Motion Ltd (BBRY) or BlackBerry, that would give the company steady revenue. During the company's Q1 earnings call, CEO Stephen Elop said that Nokia expects to generate 500 million euros ($653 million) through patent licensing agreements.
Nokia is pursuing some patent lawsuits against many Android smartphone makers. Recently, the company won a patent infringement case against HTC in Germany. There are still several pending cases against Viewsonic and HTC. I believe that HTC and Viewsonic will finally settle the lawsuit and sign a licensing agreement with Nokia.
However, Nokia's biggest opportunity for IP revenues lies somewhere else. Search engine giant Google Inc. (GOOG) wants to bring an industry standard for voice technology, but that patent lies in the hands of Nokia. And the Finnish company is unwilling to license that, at least so far. Maybe Nokia sees the importance of that patent, and is waiting for the time when its value grows manifold.
Nokia is trying hard to bounce back. The company is still in the process of transformation. So, I think creating a bearish outlook based on the first quarter results, which shows positive as well as negative signs, doesn't make sense. Lumia smartphones continue to receive rave reviews from users and critics. I believe once the company rolls out the Lumia smartphones worldwide (Lumia is yet to be launched in many countries) and the supply constraints are addressed, the company will be in a much better position.