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Nokia's Cautious Outlook Confirms Slowing in Wireless Handset Industry

The company still predicts strong sales growth, but competition and lower demand may thwart that.

Nokia's

(NOK) - Get Nokia Oyj Sponsored ADR Report

pronouncements on Tuesday morning confirmed the gloomy outlook for the handset industry.

While the leading maker of cell-phone handsets in the world reported

fourth-quarter earnings that beat expectations, Nokia took down its estimate for industrywide handset sales in 2001. The Finnish company also warned of a more cautious outlook for the first quarter and disclosed that it won't ship second-generation handsets until the third quarter because of a slowdown in the U.S. economy and a delay by telecom operators in embracing second-generation (2G) and third-generation (3G) wireless networks.

Even so, it predicted increasing improvements in profits, revenue and margins that will make the second half of the year stronger than the first. But not everyone thinks that rosy outlook will come to pass.

Nokia has long been viewed as the one bright spot in the handset industry, and its news underscored that all is not well in the wireless world. Disappointed investors sent the company's shares down $2.77, or 7%, to $34.15 in midday Tuesday trading.

Nokia is the last of the three largest handset makers to cut its projections for global demand this year, to a range of 500 million to 550 million units from 550 million. Earlier this month, both No. 2

Motorola

(MOT)

and No. 3

Ericsson

(ERICY)

did the same, acknowledging that consumers

aren't replacing their handsets as quickly as originally thought.

For the first quarter, Nokia expects sales growth of 25% to 30% and earnings per share of 0.19 euro (U.S. 18 cents), the same as the first quarter a year earlier.

However, Nokia maintained its bullish forecast, issued last month, of sales growth for the year's first half in the upper range of 25% to 35%, with the same growth for the 2001 through 2003 fiscal years. That bullishness stems partly from the revenue jump it expects when it starts to ship second-generation GPRS (general packet radio service) handsets in the third quarter, with "volumes rising into the millions" in the fourth quarter. The company said it will ship its first 3G terminals with similar timing and volume expectations a year later.

Of course, Nokia originally intended to ship GPRS phones during the December 2000 holiday season -- and then pushed that back to the first half of 2001. Now the rollout has been further delayed, and there may very well be another postponement because a number of telecom operators in Europe seem to be in no rush to upgrade their networks to 2G, never mind 3G, networks in the near term.

"They are pretending that GPRS and 3G will save them," notes Philip Townsend, an analyst with brokerage house

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Arnhold and S. Bleichroeder

. (He rates Nokia a sell and his firm doesn't participate in underwriting.)

Townsend argues that Nokia needs to be saved because the outlook for its handset and infrastructure equipment businesses are dim.

It's true that Nokia still enjoys a tremendous lead in its share of the handset business, racking up a 30.6% share of the worldwide market in the third quarter, according to research firm

Gartner Dataquest

. Motorola is far behind at 13.3%, and Ericsson is even further back at 9.7%.

But given the lack of significant competition, Nokia should have increased the operating profit margins of its handset business to at least 25%, which it did a year ago. Instead, it recorded margins of 21.3% in the fourth quarter and claims that it will continue to keep its margins above 20% as the year progresses.

Incredibly skeptical of that claim, Townsend says that margins in Nokia's famously profitable handset business will only continue to fall, as Japanese manufacturers such as

Mitsui

,

NEC

and

Matsushita

(maker of the

Panasonic

brand) ramp up in the third quarter and give Nokia a run for its money by making basic, entry-level phones. Then there's slowing demand, increased pricing pressure as subsidies vanish and the possibility of more delays in network upgrades to deal with as well.

The delays in network upgrades will hit the company's emerging infrastructure equipment business as well. Already, the

Nokia Networks

division recorded operating margins of 16.4% in the fourth quarter (compared to 19.2% in the same quarter a year ago) because of "differences in product mix," meaning that the company is selling more lower-priced and lower-margin base stations that are required in the higher-density European market.