Why I'm Worried About Nokia's Long-Term Prospects

May.31.13 | About: Nokia Corporation (NOK)

Nokia (NYSE:NOK) has been one of my leading picks for a while now. Starting from my initial article on the company, I have said many times that Nokia's stock has the potential for extraordinary returns. And while the stock has performed very well ever since my initial recommendation, giving ample time for investors to book profits along the way, nevertheless there have been issues that have troubled me.

My question is, what kind of a company is Nokia and what added value does it offer investors over the long term? Before I answer this question, let me give you my answer for BlackBerry (NASDAQ:BBRY) and Apple (NASDAQ:AAPL).

BlackBerry is a pure-play in the space. BlackBerry designs its devices and has total control over the ecosystem. In other words, BlackBerry controls the whole nine yards and does not depend on anyone. It has total control over the hardware, software and makes all the decisions in between.

Apple is a similar company. It has total control over the ecosystem, the design of the phone, and even designs its own processor. There are no middlemen and no one can tell Apple what to do or how to do it.

Both BlackBerry and Apple offer mostly premium devices and both have their own place in the smartphone space and both control their own future.

Microsoft (NASDAQ:MSFT) on the other hand simply provides the ecosystem. Microsoft however, if it so chooses, can suddenly decide to make its own smartphone device and compete head on with other WP8 device makers (something I have said all along it should do anyway).

Google (NASDAQ:GOOG) is in the same boat with Microsoft, although with the Motorola acquisition, is also has total control over both ecosystem and hardware.

Nokia has no control over the WP8 operating system. Its Asha OS is no competition for Google's Android OS and in most parts of the world it's losing ground, because people are replacing feature phones with smartphones.

By not having its own added value ecosystem, Nokia is dependent on Microsoft. What would happen for example if Microsoft suddenly decided not to license out its operating system anymore and make phones for itself?

What choices does Nokia have if for some odd reason, WP8 never becomes a mainstream smartphone OS and never gets more than 5% market penetration?

Nokia does not have an exclusive arrangement with Microsoft. What might happen if all other major smartphone manufacturers also decide to roll out WP8 phones in droves? So far only HTC (OTC:HTCCY), Huawei and Samsung (OTC:SSNLF) make WP8 devices. But that does not mean that many other manufacturers can't get on the bandwagon also. Will Nokia be forced to compete on price alone, as are so many other Chinese smartphone manufacturers doing today in the Android space?

Contrary to BlackBerry and to a certain extent Apple, Nokia has no service revenue model. Making money on hardware alone is not an easy thing to do. So far only Apple and Samsung have managed to do that very successfully.

Even though Nokia was the number one brand years ago, it is still losing market share. I do not doubt that the Lumia line of phones will sell well, but the question is, is this enough?

Yesterday Royal Bank of Canada suggested that Nokia is likely to announce a profit warning to investors within the next few weeks, after worse than expected sales in Q2 2013. Lumia shipments haven't met with Nokia's predictions RBC claimed in a note to investors. Finnish paper Taloussanomat reported operating margin for Nokia's smart devices division tipped to be around -3%.

Adding insult to injury, Google will be making its Moto X smartphone in an old Nokia factory in Fort Worth Texas. It's just another sign that things have changed for Nokia and was once king.

Bottom line

While I still think that Nokia is a very undervalued stock with great potential, I have many reservations over the long term, mainly because it has no control over the ecosystem.

As such, I cannot place the same premium on the stock that I put on Apple or BlackBerry. And if indeed Nokia announces a profit warning over the next several weeks that will simply be another confirmation that Nokia's difficulties are far from over, and my reservations of its long-term prospects will be enforced.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.