Myths of the Nokia Turnaround

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The myth of the Nokia turnaround is not merely a single fantasy, but an artfully constructed interwoven web of myths designed to appeal to the hopes of Nokia (NYSE: NOK) and Microsoft (NASDAQ: MSFT) investors and fans.  In the space of this article, I cannot hope to enumerate all of them, but only the most central myths.

The myth of “underlying profitability”

The Devices and Services Division, which is home to all Nokia phones and phone related services and central to Nokia's business, achieved “underlying profitability” in Q4 2012.  This myth was promulgated by none other than Stephen Elop himself, who announced it with much fanfare at an earnings pre-release on January 10, only to have the claim withdrawn when Nokia finalized their earnings report for the January 24 conference call. 

Nokia's CFO, Timo Ihamuotila went even further, repeatedly stating that Devices and Services had not achieved sustainable positive cash flow and that he was focused on achieving this in 2013.  His tone came across as a firm rebuke to Elop, and is probably indicative of mounting frustration in Finland with Elop and his Windows Phone strategy. 

The message of “underlying profitability” had subtly metamorphosed in the two weeks since January 10.  Now Elop was claiming that Nokia as a whole had achieved “underlying profitability” in Q4, but even this claim has to be greeted with skepticism. 

What this term means, in Elop-speak, is that the company achieved a non-IFRS (International Financial Reporting Standards) operating profit for the full year of 126 million Euros, but this excludes “one-time only” charges related to restructuring as well as proceeds from the sale of assets.  As I've pointed out in the past, I tend to mistrust such exclusions, since restructuring charges have a way cropping up repeatedly as companies try to regain profitability.  For the year, Nokia had an operating loss 2.3 billion Euros on an IFRS basis. 

The myth of Windows Phone 8 success

In Q4 2012 Windows Phone sales quadrupled compared to Q4 2011.  Windows Phone 8 is a hit.  The reasonably objective characterization is that Windows Phone 8 is less of a flop than Windows Phone 7.   The quadrupling of sales only speaks to the deplorable performance of Windows Phone 7 in the global marketplace. 

In 2012 Q4 I estimate global Windows Phone shipments to be 5.5 million units, 4.4 reported by Nokia in their earnings release and 1.1 million units for HTC (the only other Windows Phone manufacturer).  The HTC figure is an estimate based on the historical ratio of sales between Nokia and HTC, since HTC hasn't disclosed sales numbers for their line of Windows Phones. 

IDC has estimated the total shipments of smartphones in Q4 to have been 219.4 million units, giving Windows Phone a market share of 2.5 %  This is enough to put it ahead of Symbian, for the first time, but not ahead of the Nokia OS which powers Asha smart phones.  In Q4 Nokia sold 9.3 million Asha phones, giving it a 4.2 % market share.  One could certainly question whether Asha deserves to be called a smart phone.  Nokia does, but then doesn't count Asha in their own Smart Devices category, along with Symbian and Windows Phone.   

Depending on how well or poorly Blackberry did in Q4, Windows Phone is probably going to wind up in fifth place in worldwide market share, unchanged from Q3. Whether forthcoming platform share numbers from IDC and Gartner will reflect this depends on whether they choose to accept Asha as a true smart phone.  If they don't accept Asha as a smart phone, this may artificially promote Windows Phone into fourth or even third place ahead of Blackberry. 

As I've stated elsewhere, the smart device “war of ecosystems” is basically a battle for market share among the “big three” keiretsu led by Apple, Microsoft, and Google, and to a lesser extent, Blackberry.  Sales market share is essential to build up the user population of the ecosystem to the point where it can be self-sustaining.  I have estimated that this critical mass of users is about 100 million for companies such as Google and Microsoft.

A fundamental question is whether Windows Phone can achieve critical mass before Microsoft throws in the towel and gives up.  I have previously estimated the user base of Windows Phone to be about 20 million.  Given that Microsoft is already two years and countless billions of dollars into this process, I doubt that they'll be willing to go more than two more years.   One has to postulate a dramatic increase in average quarterly sales (about double Q4 2012) in order to achieve critical mass in the next two years.   With over 70 million current users, and new innovative smart phones on the way, Blackberry has a better chance of achieving critical mass than Microsoft. 

The myth of “unfair comparisons”

Nokia's sales figures can't be compared directly to other large competitors such as Apple, since Apple is so much larger in Market Cap.  This was one of the more thoughtful comments I received on my recent Nokia articles.  A variant on this theme was a proposal that Nokia's sales/volumes be normalized (divided by) market capitalization or some other size related metric.  I think this is an interesting approach, but more appropriate for a small start-up that just hasn't had time to become profitable.  Nokia is neither particularly small, nor a start-up, and its market cap reflects its poor performance, not its size. 

Fundamentally, these arguments ignore the fact that Nokia is part of the Microsoft keiretsu, and as such, its market capitalization is irrelevant.  If some size normalization were to be performed, it would have to be keiretsu wide, but I doubt any such normalization is useful, since it would imply that there's some benefit to being small.  In the war of ecosystems, size counts, and confers numerous advantages. 

The large ecosystems of Google and Apple have deep pockets and enjoy significant economies of scale. They each derive ongoing revenue from user bases that number about a half billion each, and growing rapidly.  These size advantages translate into consumer “gravitational pull”, the ability of the ecosystems to attract new users and hold existing ones.  It is the lack of “gravitational pull” that disadvantages Windows Phone going forward, and members of the Microsoft keiretsu, such as Nokia.

MarkHibben has a position in Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of 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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