Nokia: What if Its Operating Margins Keep Falling?

by: Trefis

Nokia’s (NYSE:NOK) operating margins have declined in recent years as a result of competition with Apple (NASDAQ:AAPL), Research in Motion (RIMM), Samsung (OTC:SSNLF) and LG (OTC:LGERF). The company’s mobile phone operating margins decreased from about 20% in 2007 to around 13% in 2009. Although we expect a rebound in Nokia’s operating margins, there could be a downside of about $7 to the $26 Trefis price estimate for Nokia’s stock if Nokia margins were to remain flat over our forecast period and even greater downside if margins continue to decline.

We believe Nokia’s operating margin declines are attributable to three factors:

1. Declining Nokia Mobile Phone Pricing

Pricing of Nokia mobile phones has declined at a fast rate for the last few years. Pricing in Emerging Markets (India, China, Brazil) fell from Euro 71 in 2007 to Euro 54 in 2009, while pricing in Developed Markets (US, Canada, UK, Germany) fell from Euro 121 to Euro 91 during the same period.

2. Declining Nokia Market Share

Concurrent with falling prices on Nokia mobile phones, the company’s market share has also declined. We estimate that Nokia’s market share in Emerging Markets declined from 44% in 2007 to 40% in 2009, while market share in Developed Markets fell from 30% to 27%.

3. Increasing R&D Expenses with Respect to Revenue

Nokia has been investing heavily in research and development (R&D) and has been working on improvements to its Symbian and Maemo Operating Systems. Nokia’s R&D as a percentage of revenue increased from 7.6% in 2007 to 10.7% in 2009. We believe improvements to the Nokia mobile phone operating systems and the associated software are a key to competing effectively with mobile phones from Apple and RIM that have superior operating systems.

Emerging Markets Operating Margin is Most Important

We believe that Nokia’s operating margin in emerging markets is the most important. We estimate that Nokia’s emerging markets business constitutes 71% of the Trefis estimate for Nokia’s stock. (Click to enlarge)

Operating Margin Improvements Expected

We expect improvements to both Nokia’s Emerging Markets Operating Margin and Developed Markets Operating Margin. We believe that introduction of higher priced smartphones in emerging markets will help improve Nokia’s average mobile phone pricing, slow declines in market share and lead to improvements in operating margins. As a result, combined margins are expected to improve from 13% in 2009 to 20% by the end of Trefis forecast period.

What if Operating Margin Decline Continued?

However, if mobile phones price were to increase at a slower rate due to increased competition from Apple and RIM, it may mean additional downside to our operating margin forecast.

If Nokia’s operating margins were to remain constant in Emerging Markets and Developed Markets, it could mean a loss of $7 to the $26 Trefis price estimate for Nokia’s stock.

You can modify our forecast for Nokia Emerging Markets Operating Margin above to see how Nokia’s stock could be impacted if margins remained flat or continued to decline. You can see the average Trefis community forecast for Nokia’s operating margin in emerging markets here (select the Compare button below the chart and plot Community Average).

For additional analysis and forecasts, here is our complete model for Nokia’s stock.