Nokia's Network Margins Take a Hit

Persistent and increasing price pressure severely depleted the operating profits of Nokia Corp. (NYSE: NOK)'s Networks division in the first quarter of this year. (See Nokia Reports 1Q07.)

While investors and analysts pore over the vendor's handset business, its infrastructure division delivered an operating profit of just €78 million ($106 million), down 48 percent from a year ago, from revenues of €1.7 billion ($2.3 billion). That's an operating profit margin of just 4.6 percent, even lower than the 6.2 percent that analysts at Lehman Brothers were expecting.

That'll give the management team at Nokia Networks , the new joint venture that now houses the Networks business, something to chew on. The first quarter was the last period in which Nokia is reporting its infrastructure business as a standalone unit: The new venture started operations on April 1, and Nokia will provide the financial details for Nokia Siemens Networks starting with its second quarter earnings report.

Nokia's CEO Olli-Pekka Kallasvuo said today that Nokia Siemens Networks faces "challenging market dynamics," but that it has the scale to be a market leader.

So why the low profit margin? The same reason given by Alcatel-Lucent (NYSE: ALU) when it reported wireless weakness in its fourth quarter of 2006 -- heightened competition and pricing pressure in the emerging markets, where much of the large deals are to be found these days. (See AlcaLu Breaks Down (in) 2006.)

Gabriel Brown, Chief Analyst at Unstrung Insider, who wrote a report on the economics of the $56 billion mobile infrastructure market late last year ("3G Base Station Design & Wireless Network Economics"), says Nokia has managed to hold its margins quite well up to now, but that it was inevitable that the fierce competition and drive by the main players to land massive deals in countries such as China and India would take their toll on profitability.

"There's very little profit to be had in wireless infrastructure these days, and the only way around this is to become bigger and more efficient, and expand the services side of the business, hence the vendor mergers," says Brown.

But even merging and gaining the economies of scale won't likely push operating margins up much as the Chinese vendors Huawei Technologies Co. Ltd. and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) keep the competitive pressures on all the traditional players.

And then there's Ericsson AB (Nasdaq: ERIC), which "holds all the cards," reckons Brown, who believes the Swedish giant could take advantage of the merger integration issues faced by Alcatel-Lucent and Nokia Siemens Networks to gain some price advantages and even greater market share.

— Ray Le Maistre, International News Editor, Light Reading