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Nokia (A)
NOK M E R R I L L L Y N C H Research Bulletin
Telecommunications/Equipment Reference Number 10123933
Finland Aug/27/2003 00:09
Peter Dionisio
NEUTRAL Volatility Risk: HIGH
Event
Nokia's management held a press conference in Moscow this afternoon highlighting their views on the potential of emerging market countries both from a handset and an equipment perspective. On the back of this, the company unveiled two new low-end GSM phones (Nokia 1100 and 2300) targeted at the
emerging markets and provided more details about its initiatives on the infrastructure side.
Analysis
We would point out that this is not the first time that Nokia discussed its emerging market opportunities. For instance, in its mid-year Strategy Update, the company talked about helping emerging market wireless operators achieve lower costs to enable them to make a profit based on a lower level of ARPU. Our
view is that the important implications on Nokia of lowering overall subscriber cost of ownership (making handsets more affordable, in particular) lie in three main areas: 1) volume growth, 2) ASPs, and 3) ultimately, free cash flow.
o On volume growth, we concur with Nokia's assessment that its strategy for the emerging markets should lead to a greater level of wireless penetration and, in turn, handset shipments.
o However, we also believe that pushing volumes up in emerging markets could come at a "cost" to handset vendors in the form of much lower ASPs. In essence, our view is that there is a real risk that subscribers who would otherwise pay for a higher ASP handset may end up buying a cheaper phone (such as the 1100) because of the obvious cost benefit - i.e., product cannibalization. (To some extent, we have seen this product mix shift develop in the more mature European market over the past 24 months.) In other words, we think that it will be difficult, if not impossible, to confine the sales of these ultra-low-end phones (e.g., the 1100) only to the subs that they were intended for in the first place.
o As a result, Nokia's revenues and free cash flows resulting from these "additional" subscribers may not really turn out to be incremental (particularly if we do not see an offsetting ramp in phone shipments). We believe that the 1100 handset could have an ASP lower than EUR 60 ($65) compared to the company's overall ASP of EUR 135 in Q2 '03. In addition, while the 1100 and 2300 (and other similar phones) are aimed at the emerging markets, we would note that there should not be any reason why a European operator cannot use these phones (as opposed to higher priced ones), for instance, on pre-paid programs.
Recommendation
On a PE basis, we estimate that Nokia trades at c.21x our '04 EPS if we adjust for cash and corresponding interest income. We believe that the stock is fully valued and maintain our Neutral recommendation.
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