Nokia: It's Way Too Early For A Tablet

Aug.18.13 | About: Nokia Corporation (NOK)

In the last couple years, there were several times when people thought Nokia (NYSE:NOK) was coming up with a new tablet. Every time, I said "no, there won't be a Nokia tablet anytime soon because it doesn't make sense," however, recently, it looks like Nokia is finally giving in to Microsoft (NASDAQ:MSFT) in order to build a Windows-based tablet. I don't think this is a good idea.

I know that I've been arguing this for about a year now, but it makes little sense for Nokia to launch a tablet before its mobile phones are absolutely profitable. This way, if the sale of the tablets fails, the company could rely on the profits from its mobile phones. When Nokia's mobile devices are not profitable, it makes little sense to add another device that may or may not be profitable.

Microsoft attempted to create its own tablet, which was far from a success. Now it looks like the company wants to push the task to Nokia so that its risk is minimized while the Nokia investors will be the ones holding the bag if things don't work out. Nokia shouldn't do Microsoft's heavy lifting unless Microsoft becomes a direct customer of the company just like Apple (NASDAQ:AAPL) is a direct customer of Foxconn where the latter faces a limited risk because it only produces as many items as Apple will buy from it. Obviously, Microsoft wouldn't give Nokia this kind of contract.

Nokia has a strong brand name and recognition in most parts of the world, which allows many consumers to give its phones a chance. However, the company doesn't have much of a brand name in the tablet market. Years ago, Nokia attempted to create its own tablets; however, the public wasn't ready for the product and the idea was discontinued shortly after due to the weak demand.

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I know, I know, these tablets don't look anywhere near as appealing as the current tablets in the market; and if Nokia were to build a tablet today, it would look a lot better than these do; however, there is a strong chance that the tablets will not be very profitable for the company. Today, the tablet market is getting increasingly crowded and most producers are struggling to reach breakeven. While Apple is losing market share to cheaper Android tablets that can go as low as $50 in price, the company still claims a great majority of the profits in the market. The same arguments could also be made about the smart phone market; however, Nokia takes advantage of its strong brand name in the smart phone market and it may not be able to enjoy such a thing in the tablet market.

Besides, Nokia's tablet is likely to run on Windows RT if it comes out, and this is not the most popular operating system in the world either. Nokia can add a powerful camera and distract consumers from an unpopular operating system in smart phones, but this is more difficult of a task to do in a tablet. Will the company create a tablet with ultra-powerful camera? Would that even be enough to attract consumers?

Launching a new product from scratch takes a lot of initial investment and Nokia is in a position where it needs to hold onto every penny it can. The company is not in a position to spend money on ventures that may or may not work at this point and it can't expect NSN (Nokia Siemens Networks, now turned into Nokia Solutions Networks) to save its balance sheet and make up for the bad performance of smart devices forever.

Notice how I didn't even talk about the specifics of a possible Nokia tablet, because I don't think it is relevant at this point. Building a tablet is a risky business in a crowded market and it comes with razor thin margins. Add the weakness of Windows RT to the equation and you get a recipe for a disaster for Nokia. I would be more open to the idea of a Nokia tablet if the company's mobile devices division was highly profitable and it had some extra cash to throw in different R&D projects where it can afford to lose money. The company is far from that situation though and it already has enough on its plate as it is. In the last quarter, Nokia's devices and services segment had an operating margin of -1.2% and in the first quarter of the year, it had an operating margin of -1.5%. In non-IFRS measures, the business segment's operating margin was -1.2% in the second quarter and 0.1% in the first quarter. Keep in mind that these numbers include Nokia's patent payments from more than 40 different manufacturers around the world. In comparison, Apple's operating margins were as high as 26% and 28% in the last 2 quarters.

I am not saying that Nokia should be as profitable as Apple, but it would be nice if the company's mobile devices division achieves a healthy operating margin of 10% or above before it jumps into other risky projects (building a tablet is a risky business considering how most tablet producers have razor thin margins with the exception of Apple). Currently, Nokia should focus on mobile devices and making its mapping business profitable, rather than jumping into new ventures.

I still own Nokia shares but if the company announces a new tablet, this might be my "sell" signal.

Disclosure: I am long NOK, MSFT, AAPL. 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.