Wireless leaders Sprint PCS ( PCS) and Nokia ( NOK), despite having reduced guidance for the second half, still may have higher expectations than their businesses warrant. The guidance for Nokia and Sprint PCS is built on some hopeful projections: Sprint hopes that customers will flock to its third-generation network; Nokia is betting that many consumers will want to replace the handsets they bought in 2000. Based on those outlooks, the companies have penciled in very good fourth quarters to meet their own expectations. But anecdotal evidence suggests the optimism might be misguided. "We believe investors will start to reduce second-half expectations, after digesting second-quarter results," J.P. Morgan U.S. wireless services analyst Thomas Lee wrote last week. "Despite rock-bottom valuations, investors are cautious."
If You Build It?
The catalyst for companies both on the equipment and the carrier side is the launch and expansion of high-speed 3G networks. Companies are counting on 3G to increase the growth of new subscribers, boost average revenue per user and to encourage sales of upgraded handsets. But obscured behind the hullabaloo of Sprint PCS' launch of its first nationwide 3G service, Japanese wireless carrier NTT DoCoMo ( DCM), which has had raging success with its I-mode 2.5G offering, actually logged a moderate 7.5% decline in spending for its 3G service subscribers. DoCoMo blamed the average revenue per user shortfall to $65.40, compared with $70.70 in the prior quarter, on the cost of aggressive promotions to boost subscriptions, which logged moderate growth. The dismal reception 2.5G services have had in Europe the past few months also has caused concern. The response to the high-speed data systems launched months ago in some parts of Europe has been lackluster. Sprint PCS President Charles Levine pooh-poohed comparisons of Japanese or European markets with the North American market. "The Japanese customer is not identical to the Korean customer who is not identical to the European customer who is not identical to the American customer," he told TheStreet.com in an interview Thursday. "People claim that Europe is way ahead on data. What Europe has done with data is a ton of SMS short message service messaging. "That's sort of the Pong of data, relative to what we've got which is sort of the Tomb Raider 3 of data," he said, using a video-game analogy to compare European usage patterns to first generation games. Levine expects new subscribers will spend more than the current $63 average revenue per user to download games, new ring tones, Web pages and email. On Sprint's 2G networks, data revenues contributed less than 2%, or about $1 per user, according to company estimates, but should move higher in the coming months. One particular concern about Sprint PCS on Wall Street is ambivalence over its admittedly aggressive growth targets, even after it lowered expectations. It currently expects to add 2.5 million to 2.7 million net additional subscribers for the year, down from a prior target of 2.7 million to 2.9 million. Considering the company has logged net adds of about 1 million for the first half, it's hard to see how the second- half growth will be 150% to 170% of the first half's, especially in a distressed economic environment. "PCS is ... front and center of what's going to disappoint," said Morningstar analyst Todd Bernier. "Where's the catalyst?" "The target is assuming we're going to have a fair amount of success at PCS Vision the company's marketing moniker for its 3G network ," Levine said, when asked about the company's forecast. "This launch is absolutely critical to our success in the future." Ned Zachar, the Thomas Wiesel wireless services analyst, downgraded the company's ratings to market perform from buy, based on its aggressive net add projections. He also noted that based on the firm's estimates, Sprint PCS trades at a higher multiple than its peers, at around 6.1 times the firm's 2002 estimated earnings before interest, taxes, depreciation and amortization. By comparison, AT&T Wireless ( AWE) currently trades the lowest at four times 2002 EBITDA estimates, Zachar said. Adding to concerns at Sprint PCS and for the carrier sector as a whole, J.P. Morgan analyst Lee reduced the firm's projection on industry subscriber net-add figures to 14 million, from 15 million. In January, the industry expected 20 million net adds for the year. Lee also expects Sprint PCS to achieve about 2.2 million net adds for the year, below PCS' own estimates.
Betting on a Big Bounce
Nokia CEO Jorma Ollila is betting that cell-phone users will be lured by the new color screens and designs of new handset models (which will have the ability to access the latest high-speed wireless data networks). The company reaffirmed its lowered guidance this week, expected to reach 77 to 82 cents per share for the full year. Sales are expected to improve from 3% to 10% year over year. Based on the company's performance to date, the guidance presupposes a fourth-quarter surge in sales, in order to reach its full-year pro forma EPS target. That assumes fourth-quarter EPS will rise to a range of 23 cents to 30 cents. The projection essentially translates into a quarter-to-quarter bounce that could range from about 40% to more than 100%, making it one of the highest sequential jumps in the past few years. "We have taken a very conservative look at the U.S. and at the European economy as they might evolve," Ollila said at a U.S. Bancorp Piper Jaffray conference last week. "Working in Nokia's favor are pressures to replace dated phones dating from the industry boom year of 2000, when 405 million phones were sold worldwide." But recent checks with distributors raise questions about such projections, analysts said this week. One Wall Street observer scoffed at the guidance, saying it was ambitious at best. "Last two years, we've exited fourth quarter with too much in inventory, and carriers are clearly trying to manage their working capital more effectively," said the observer, who requested anonymity. "That means lower inventories and inventories are at an all-time low. Carriers will try to avoid exiting with too many handsets." For Nokia and other handset manufacturers including Motorola ( MOT), that means, "We're not likely to see as high of a jump sequential as we've seen historically. It adds to the challenge to their backend-loaded forecast," the observer said. In a recent Deutsche Bank research note, the firm's own checks with wireless handset distributors indicated flat third-quarter sales, which further adds pressure for a miraculous boost in the fourth quarter. At worst, said analysts, Nokia will guide downward again in an upcoming quarter, a practice the company has become notorious for.