FOOL ON THE HILL: An Investment Opinion
All of the sudden the mobile phone companies are trying to outdo each other with negative projections for next year's growth. Texas Instruments and Motorola have each lowered their projections for the market for both this year and next year. Nokia warned for the third quarter due to a poor product mix. Ericsson continues to fade. But there are some new players here, rapidly taking market share. These include Alcatel, Siemens, Sony, and Kyocera. What is the real story?
After Motorola's (NYSE: MOT) warning last week that its mobile phone sales, and all mobile phone sales, were growing slower than expected, all of the largest handphone makers -- Motorola, Ericsson (Nasdaq: ERICY) and Nokia (NYSE: NOK), along with some of the smaller market players Siemens and Alcatel (NYSE: ALA) -- have gone into a tailspin.
The problem? Well, industry insiders once believed that the mobile phone market would surpass 500 million units globally this year. But after Motorola's warning, as well as downward revisions by cellphone chipmaker Texas Instruments (NYSE: TXN), those targets have drifted quickly to the low 400 million range.
I'm not sure I buy these suddenly lowered numbers for 2000. Industry observers are remarkably inaccurate in their projections in high-growth situations (anyone remember the B2B projections ranging anywhere from $1.5 to $8 trillion?) but it seems a bit strange that now, at the end of 2000, companies are finally coming out and saying sales will be soft by nearly 20%.
Texas Instruments, as the bellwether producer of digital signal processors (DSPs) for mobile communications, gets the benefit of the doubt, particularly since its projections were always in the range of 435 million. Texas Instruments reports at the close of business today, and we'll see if the sudden downdraft in mobile phone stocks has much merit when it does. I tend to doubt it, and expect Texas Instruments to repeat its 60%-plus gross margins on its mobile phone DSPs, along with good growth rates. Texas Instruments is, to my mind, the true gauge of mobile phone growth.
Motorola is not Indicative of the industry
Motorola, on the other hand, has lost its edge. It, along with Ericsson, has been beaten on the low end by Nokia and edged out by former bit players in Europe and in Asia. But one must read in between the lines to see that the problems with Motorola are not in anyway part and parcel with an overall slowdown in mobile phones.
Motorola's market projections for 2001 mobile phone sales were in the range of 525-575 million units. But pay attention because Motorola also lowered its estimates from $1.44 to $1.20. Motorola is a diversified manufacturer, but it is placing heavy amounts of blame on the "commoditization" of mobile phones and slower-than-expected growth. But if I do some back of the envelope calculations, I see Motorola's own estimates for the total market to be 28-40% larger than it is this year. That's pretty significant growth for a "commodity."
Motorola has long suffered from anemic margins in its mobile phone division; for the first time in years its net margins have climbed above 6%. This increase seems to have come at a high cost, since Motorola's division annual growth rate has slowed to 4%. Given the overall growth rates in the industry, it's pretty clear that Motorola is doing something wrong. But does the trouble at Motorola spell difficulties for the industry overall?
I say no. Certainly, Nokia has also seen significant product mix problems in the last few months, but its overall margins have remained very high. It should see some slippage this quarter as its low-end units will be a larger portion of its sales mix, but with net margins of 13% plus, Nokia has some room to try to flush out its top competitors, which has been going on for the last several months. And now Motorola's "commodity" comment spells capitulation.
New competition from Siemens, Alcatel, others
But ask yourself this: Has there ever been a commodity with such rapidly changing suppliers, growth rates, or technologies? The fact is that Siemens, Alcatel, Kyocera (NYSE: KYO), Sony (NYSE: SNE), and others are chewing up market share while Motorola and Ericsson are losing it. If price were the sole factor here (something that is a key ingredient for commoditized products), then Ericsson would not be losing market share, though Motorola has long been known to be shifting out of low-margin ends of the market.
The point is not to trash Motorola. It is a highly diversified company that is competitive in many areas outside of handsets. But Motorola has made some mistakes within its handset division that make it a poor proxy for the overall performance of the industry.
Unfortunately the actual growth rate of handsets is still a moving target -- there has never been a real accurate way to discern growth in such a dispersed-market industry. Regardless, this is still one of the fastest-growing industries in history, with cell phone usage doubling every 18 months for the last 15 years. But questions remain as some trends toward slower replacement tendencies by users (currently around 18 months) are evident, and users are (apparently) awaiting the advent of the vaunted third generation mobile phones with Internet access. Both Motorola, and more importantly, Texas Instruments, are right in pointing these issues out.
But the negativity surrounding much of the mobile phone industry is overblown. Just as the Internet is not going away, there are still massive areas of potential growth for mobile phones, as the total penetration rates still remain below 4% of the worldwide adult population. That leaves plenty of room for growth. The question is whether the growth rate will be sufficient to justify share prices. The sentiment right now seems to be no, but looking at Motorola's returns and extrapolating the whole market is kind of like seeing election returns from New Hampshire and saying that they definitively point toward who will be president. The results matter, but they're not the whole story.
Bill Mann, TMF Otter on the Fool Discussion Boards