Nokia (NYSE:NOK) followed up on its profit warning last week with an even bleaker earnings report yesterday as the company’s revenues fell 29% y-o-y and operating losses nosedived to $1.7 billion in Q1 2012. However, a majority of the losses incurred were on account of non-recurring restructuring-related expenses in its Nokia-Siemens Networks division. Still, even after the one time expenses are accounted for, Nokia’s operating loss comes down to $342 million, a sharp contrast from the $925 million operating profit returned during the same period last year. Nokia is facing a downhill battle as its feature phones face pricing pressures in the emerging markets and the newly launched Lumia smartphones struggle to make up for the Symbian losses caused by increasing competition from Apple’s (NASDAQ:AAPL) iPhone and Google’s (NASDAQ:GOOG) Android-based smartphones.
The most valuable market for Nokia has historically been the emerging markets where although its market share has been declining fast, it is still ahead of the rest in terms of total units shipped. By our estimates, Nokia’s emerging markets division accounts for about 23% of the company’s value, the most among all the divisions. Which is why we believe the worst news to come out this quarter is from this division.
Nokia’s revenues from emerging markets fell more than 40% over Q1 2011 as the proliferation of cheap Android-based smartphones manufactured by Asian rivals ate into the volumes of its S40 based feature phones. Up until now, Nokia had been able to bring down the prices of its feature phones or enter into the dual-sim phone segment to compete and turn a small profit. But the entry of low-cost $100-$150 Android touch-based smartphones leaves it with little choice but to bring the prices of its feature phones further down to drive sales.
This will only serve to decrease operating profits in the coming quarters. Nokia’s feature phone unit is already on the verge of plunging into losses, with its operating margins falling drastically from 13.5% at the end of the December quarter to 4.6% after March.
What we believe the company needs right now is to broaden its Lumia portfolio to include a low-cost smartphone for the emerging markets. The current Asha series is based on the legacy Symbian platform, which isn’t competitive enough to stave off Android. And the only low-cost Windows Phone based smartphone it has right now is the Lumia 610, which is not cheap enough to address the flagging emerging market sales.
Meanwhile, Nokia’s performance in developed markets continued to disappoint as revenues slumped 35% over the same period last year. Symbian smartphone sales continued to fall and the Lumia failed to make up for the losses due to its limited time and exposure in the market. However, Nokia’s new flagship line has built up some momentum going into the second quarter, with the company shipping twice the number of units as it did in the previous quarter. Lumia’s presence also helped perk up the ASPs of developed market mobile phones. But gross margins on smartphones fell almost 29% YoY, implying that Nokia is selling most of these phones at low margins to create initial demand.
Apple and the horde of Android smartphones in the market have created two firmly entrenched ecosystems that customers have familiarized themselves with. To create a third ecosystem with Microsoft, Nokia faces a long and hard battle but the first signs of this partnership coming along are encouraging. Q2 will be the first full quarter of the Lumia 900’s presence in the U.S. market along with the Lumia 800C’s on China Telecom, and a continued strong performance in the two key markets of U.S. and China should bring some cheer back to the battered stock. (see Nokia Faces Big Tests This Year In China And U.S.)
We are in the process of revising our estimates lower based on these results.