Smartphone Price Wars: How Can You Profit?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The price war surrounding smartphones is accelerating as more companies are gaining traction in this space. Devices and content seem to be moving towards a razor and razor blades pricing strategy. You subsidize or lose money on the initial purchase of a razor so that you can make money on the blades. This strategy would apply to smartphones as content like applications or other downloads can be sold at a profit once an attractively-priced smartphone is sold to a customer.

In the meantime, companies will see declining profits as they slash prices for their devices. Investors should protect themselves from profit-eroding competition by requiring attractive valuations.

Nokia beats expectations

Nokia’s (NYSE: NOK) stock price jumped 18 percent when it beat expectations for the fourth quarter. Chief Executive Officer Stephen Elop has had a difficult time trying to revive the mobile-phone business, and the recent profits may be an indicator that his efforts are paying off. Jyske Bank analyst Robert Jakobsen recommended Nokia stock to investors while applauding the company’s efforts to develop new devices and increase asset sales. According to Jakobsen, “This clearly shows Nokia is making good progress with consumers”.

One of Elop’s main concerns has been the growing smartphone market. He has helped put Nokia on the map with Lumia smartphones that run on Microsoft’s (NASDAQ: MSFT) Windows software. Nokia sold more than 4 million Lumia smartphones in the fourth quarter, though Elop indicated that the Lumia 920 faced supply constraints in Germany, the U.S., and Italy. Nokia also made significant revenues from Asha smartphones that are cheaper than the Lumia, and this brought the total number of handsets sold to 86.3 million in the fourth quarter of 2012. Nokia appears to be more creditworthy since it is much cheaper now to insure Nokia bonds. Relief in the bond market can be attributed to the handset maker’s improved performance.

Nokia Siemens Networks, the joint venture between Nokia and Siemens, also reported better operating profits as compared to what was forecasted. Danske Bank analyst Louis Landeman spoke highly of the joint venture and the plan to invest in Nokia Lumia. According to Landeman, “This is clearly very positive news from Nokia as it both shows that the company’s new Lumia product launches are performing well and that the NSN networks business has gained good momentum”.

The growth of Nokia and its surpassing expectations has not come without a few negative implications. To reduce on operating expenses Elop had to lay off about 20,000 employees and close down some research and production sites. The low supply of Lumia 920 also made it difficult for the company to compete favorably with Apple’s (NASDAQ: AAPL) iOS devices and Samsung’s (SSNLF) Android smartphones, which currently control the smartphone market. Elop indicated that the challenges are being looked into and supply is expected to stabilize after the first quarter of 2013. Other players in the market like Alcatel-Lucent (ALU) and Ericsson (ERIC) also performed well in their respective Exchanges.

Amazon to Launch Smartphone

Amazon (NASDAQ: AMZN) is planning to launch a new smartphone later in 2013. It is expected that the company will provide a “disruptive” pricing plan. Last year, the company launched Kindle Fire HD tablet to compete against Apple’s iPad, Google’s (NASDAQ: GOOG) Nexus, and other tablets.

Kevin Smithen, an analyst at Macquarie Capital, expects that the company will offer the new phone in mid-2013 at prices of $100 to $200. Smithen said, “We expect that Amazon’s smartphones may include a disruptive pricing plan. The Kindle 3G offers unlimited 3G access, which can be used to download Kindle content over 3G connections, without an incremental data fee to the end user.”

The company’s strategy is to sell hardware at almost break-even and earn profit on the content users buy from the company for use on the Kindle. This is horrible news for companies that try to turn a profit by selling smartphones.

Google’s Android operating system and its host devices were already a disruptive technology in the smartphone space. Instead of turning a profit from the software and hardware, Google was trying to parlay its participation in this technology into advertisement and other revenue sources. Amazon would be another disruptive threat to smartphone makers.

Looking for Value

Since a price war is brewing, we must check to see if any smartphone players trade at attractive valuations:

Ticker

Company

P/E

P/S

P/B

P/FCF

NOK

Nokia

NA

0.42

1.66

NA

RIMM

Research In Motion

NA

0.6

0.8

9.2

AMZN

Amazon

3884.29

2.15

16.31

116.3

MSFT

Microsoft

14.71

3.16

3.33

10.21

AAPL

Apple

11

2.92

3.86

11.03

GOOG

Google

22.71

5.01

3.5

18.8

Nokia and Research In Motion (RIMM) are very speculative since neither one has made a net profit for the trailing twelve months. They would be very speculative bets, at best.

Amazon is expensive based on an earnings basis. Though its price price-to-sales ratio may seem reasonable compared to smartphone companies, it is high relative to its competitors in retail, its core business. Investors should avoid Amazon until its price multiples drop to lower levels.

Apple is clearly the best investment relative to Google or Microsoft. It is trading at a price-to-earnings ratio that is lower than its peers and the market average. It also trades at a solid price-to-free cash flow multiple and owns the world’s most valuable brand. Yes, its price-to-sales multiple will probably fall as it lowers prices, but it will remain higher than the industry and market averages based on consumer perceptions of brand value. Apple customers are happy to pay more for just the Apple logo.

Conclusion

The smartphone market is going to see lower prices for devices and lower profits. It seems industry rivalry among competitors is already baked into Apple shares, which trade at low valuations today.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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