Don't Get Hung Up on Cell Phones' 2002 Prospects

Expectations for handset makers next year may be higher than justified.
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Mobile-phone investors haven taken their feet off the brakes in the past two months.

After a 2001 market most notable for overflowing handset inventory, 2002 is going to be a year of new phones and new wireless technology. Investors inured to this year's continually sinking handset forecasts have bid up mobile-phone makers' stocks in anticipation of a sweeping change. At analysts' estimates of 450 million phones to be shipped, next year's market won't live up to pre-2001 expectations in the 600 million phone range, but 12% to 20% growth over 2001 is a possibility as the market regains some of its old form.

Investor optimism about 2002 is pushing up the prices of the handset makers, but the outlook may not be as rosy as the expectations. It remains to be shown that subscribers will buy the services that require third-generation networks. And generic handset-makers will continue to nibble away at the lower end of the mobile-phone business.

Nokia

(NOK) - Get Report

has been the biggest beneficiary of investor excitement, with its stock up 81% since Sept. 10. Europe buzzed Friday with sneak peeks at two new Nokia phones to be introduced during the International Nokia Mobile Internet Conference in Barcelona, Spain, this week.

The new phones apparently will be the 7650 phone with a color screen and a low-end 5210 phone. Nokia plans to revamp its phone lineup from initial GPRS to cheaper phones, a move that has been applauded by the Street and the market, and will likely be an emphasized topic at Nokia's Capital Markets Day on Nov. 27 in New York City.

Motorola

(MOT)

is expected to follow suit, with

Ericsson

(ERICY)

and

Sony

(SNE) - Get Report

unveiling the first fruits of their joint venture later in the year. Quite a change from 2001, when the only new thing coming out of the mobile-phone world was the occasional profit warning.

Coming into 2001 with a huge stockpile of phones from a lukewarm holiday 2000 season, this year has been devoid of stylistic or technological innovation. New offerings must prove whether there are still good margins to be had in the mobile-phone industry based on attractive products. With the most recent quarter's long-in-the-tooth models, Nokia boosted its phone margins to 19%, while Ericsson bombed with a negative 51% margin. Motorola's margins rebounded slightly because it had few cheaper end-of-life phones left to sell after a second-quarter flurry.

Motorola and Ericsson have not benefited as lavishly as Nokia from the recent market upturn, with ailing Motorola up about 23% and Ericsson up 36% from Sept. 10. U.S. Bancorp Piper Jaffray's Sam May likes Motorola the best of all three. "Nokia has twice the market share, but the opinion of Motorola has been so low for so long, there's more to be gained from Motorola," May says, adding that he believes Nokia is a buy at $25, and that Motorola is even more attractive at current levels around $18.

Many doubt whether the phone business will return to the era of high hopes that ended at the close of 2000. With so many phone makers and well-advanced form factors, the handset market has threatened to turn into a clone of the PC market with its slashed prices and little chance for differentiation. UBS Warburg's Jeffrey Schlesinger argues that it will be applications, not an influx of vast new populations of untapped subscribers, that will drive future handset sales.

"I think secular growth is dead. The key is product cyclical growth," Schlesinger says. "We need new applications. GPRS is a technology, but people don't buy technology, they buy applications." One of the bigger doubts leading into 2002 will be whether cell-phone users snap up the chance to send short messages and use location-based services on new generations of data-friendly phones.

Looking toward a more gloomy aspect of the future, Nokia joined Motorola and Ericsson this week in reaching out to companies that will eventually benefit from commoditization in the years to come, preparing itself to license its mobile-phone architecture to generic phone sellers. In markets with well-understood technologies, bargain manufacturers are cropping up to sell knockoff phones. Motorola made the initial effort to roll out a program in the early summer to sell chip, RF (radio frequency) and programming technology for mobile phones to the upstart manufacturers. During

Comdex last week, Nokia announced a move to do the same with its intellectual property.

May sees the move as an attempt to be a part of the inevitable rise of second-tier manufacturers, but he doesn't think mobile phones have gone the way of the sub-$1000 PC just yet. "Clearly, it's a big market; there are lots of units," May says. "You get to large numbers and markets slow down. As we get to 800 million subscribers, 900 million -- growing to 1 billion in the next 18 months -- that's a lot of people. But it's not going to get commoditized just yet because the technology is still difficult to master. This year with the move from 2G to 3G, you still need to know what you're doing."

For the next few weeks, expect Nokia and Motorola to flex their muscles. Nokia, above all, will be rewarded.