How is Nokia doing right now? It's trading a shade under its 52-week high, at a P/E of over 78x consensus forecast earnings for this year (fiscal 2000). Sales growth was clocked at about a 34% compound annual growth rate (CAGR) from 1995 to 1999, and it doesn't look like it will slow in the near future. Profits from continuing operations have risen even faster at a 39% CAGR. While the net profit margin slipped a bit in 1999, it still broke the 13% mark. While there hasn't been much to worry about over the past four years or so, there may be some things to worry about in the future, especially considering the current price.
Allow me to lay out some things I think investors need to consider if they want to invest in this company. First, most of Nokia's revenues come from cell phone -- or I should say handset -- sales. In the last three years, mobile phones have risen from 53% of sales to 67% of sales. In fact, handset sales surged over 63% in 1999 alone. Can Nokia hold onto its lead in this segment? Maybe not. For one thing, price and service tend to be important factors when people buy handsets. It looks like companies in Korea and China are improving their manufacturing capabilities. As they improve their quality and designs, they could make inroads into Nokia's market share and pricing ability.
Most analysts expect handsets to become extremely common devices over the next few years. I suspect that most of the new buyers are not going to be as interested in all the bells and whistles as they will be in a handset that gets the job done for an acceptable price. If handsets become more commodity-like, the current leaders will lose their pricing ability, which could eat into both sales and margins for Nokia.
The expansion that's expected to rock, or perhaps rocket, the industry in the next few years leads to a very critical problem that Nokia has to face: Third Generation. If you follow this industry, you know that everyone is extremely excited about the next generation of wireless technology, known as 3G. Soon, people wandering about much of the planet will be able to access the World Wide Web -- the real one, not that ultra-simplified WAP thing -- at speeds higher than what a regular modem is capable of. Just that sentence conveys how significant this change will be.
To create a system capable of such incredible speeds, the industry is moving toward two primary standards, CDMA2000 and W-CDMA. Since much of the W-CDMA infrastructure is designed to be compatible with current GSM infrastructure (the standard that runs most of the world's cellular networks) and Nokia supports this standard, the future looks golden, right?
Not so fast.
Unlike competitors like Ericsson (Nasdaq: ERICY), Nortel (NYSE: NT), and Lucent (NYSE: LU), Nokia has not taken a crucial step toward 3G: making peace with Qualcomm (Nasdaq: QCOM). These companies, and several courts, have established that Qualcomm owns critical chunks of W-CDMA, even though the company was not an active developer of the standard.
The other companies have established their royalty agreements and will be able to move to the next step unfettered. But Nokia has yet to come to terms with Qualcomm, which means the company is either setting itself up for a monstrous legal battle, or risking having to pay more for the technology. Either way, by delaying its agreements with Qualcomm, Nokia is risking losing its leading position in the industry to its better-prepared rivals.
Finally, I can't really complain much about Nokia's financial policies, but there is one thing that sounds odd, if not worrisome. On its investor relations website FAQ, the company has this question: "Nokia has had positive operating cash flow the last several periods. What does Nokia do with this cash?" The answer is to invest the funds in T-bills and Treasury bonds. This answer seems strange to me. Wouldn't the company be better served by investing the money into its business? Perhaps they think that hefty Euro 1.8 billion research budget will always be enough and they don't need to worry about any more investments. Or, perhaps they feel that investing in their business won't yield more than the 6% that they get from the government securities.
Like I said at the beginning, Nokia has had a great couple of years both as a company and an investment. Will it continue to turn in incredible results? I'm not so sure about that, especially considering some of the risks the company faces in the next couple of years. If nothing else, look at the company's current strategy of locking in low returns on very safe government securities instead of investing more in their own business.
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