Coke (NYSE: KO) vs. Pepsi (NYSE: PEP), Intel (Nasdaq: INTC) vs. AMD (NYSE: AMD), Tiger vs. everyone on the PGA Tour, and Nokia (NYSE: NOK) vs. Ericsson (Nasdaq: ERICY). All great rivalries, but we all know that only one fits in the throne. Lately, we have taken notice to Pepsi's run at the soda crown. Should we now be concerned with Ericsson's mandate yesterday to "become a world leader in telecommunications" by combining its mobile phone business with Sony's (NYSE: SNE)?
The deal will create a powerhouse in the electronics industry, no doubt. The 50/50 joint venture to be based in London and rumored to be named Sony Ericsson will have over 50 million unit sales and $7.0 billion in revenue based on the last fiscal year's results from both companies. But even though it's been a while since my Mom reminded me, two wrongs don't make a right. Ericsson and Sony have struggled with their handset units and shipping the responsibility off to a new entity in England will not fix those problems.
The new company will be responsible for "product research, design and development, as well as marketing sales, distribution and customer services," according to the press release. Manufacturing will remain unchanged for the immediate future. Sony will keep its production facilities and Ericsson's electronic manufacturing services contract with Flextronics (Nasdaq: FLEX) will remain intact.
Yet, judging by Ericsson's negative operating margins in its handset unit (-80% last quarter), it will take more than a merger to fix the problems. Much of the criticism has been aimed at Ericsson's lack of touch with the consumer. Therein lies the logic behind the merger. Sony is a consumer electronics guru with devices like the Walkman, Playstation, and the camcorder on its resume.
This partnership is also an attempt to get in front of the Third Generation (3G) wireless tidalwave. As wireless bandwidth expands, video, audio, and gaming will gain prominence on wireless devices, and Sony has been a global leader in these markets. This deal also helps Sony expand in Europe and Ericsson in Japan.
That said, the deal doesn't provide any immediate advantages or -- I apologize in advance for using this word -- synergies the way, for example, merging two drug companies does. When Pfizer (NYSE: PFE) swallowed Warner-Lambert, its savings ($430 million in 2000 and $1.2 and $1.6 billion estimated in 2001 and 2002, respectively) were not just from the consolidation of various administrative and support functions and facility closings, but also from the elimination of redundant positions and expanding the product line of a world-class sales force.
The Ericsson/Sony deal seems a little too back-of-the-napkin to me. Are the benefits truly there or were both Sony and Ericsson just at a loss for what to do with their handset divisions? Is this deal the equivalent of transferring your worst soldier off to man a weather station in Alaska?
Also troublesome is the turbid manufacturing plan. Why are both Sony and Flextronics involved in the manufacturing? Simply figure out which way is most efficient and run with it. Not ironing out these types of details ahead of time leads me to guess this deal was hurried. It smells of Co-CEO syndrome. Speaking of Co-CEOs, Kurt Hellstrom, Ericsson's President and CEO, will be Chairman of the Board of Sony Ericsson and Katsumi Ihara, Sony's Corporate Executive VP, will be president of the joint venture. Fifty/fifty may look good on paper, but at the end of the day, who makes the call? For investors' sake, I hope a clear line of authority has been determined.
No matter, because stepping up its laggard ways in handset design will only help Ericsson level the playing field. The new company still has Nokia to deal with. Nokia has been a pioneer in handset design as well as the driving force behind turning handsets into more than communication devices. With interchangeable faceplates and trendy colors, Nokia is pushing the handset towards fashion accessory and away from geek device. It's a smart strategy that has worked in the past. Remember Swatch? Swatch turned the everyday wristwatch into a fashion accessory, and sales soared. Sony will certainly help Ericsson in this regard, but it's nothing Jorma Olilla, Nokia's President and CEO, will lose sleep over.
The new entity has to take on the world's most efficient handset maker, not to mention well-established firms like Motorola (NYSE: MOT), Siemens, and Samsung. Comparing the state of affairs at Nokia and Ericsson today is embarrassing for the Swedes. Here's a breakdown of the most recent quarter's results:
Ericsson(1) Nokia(2) Networks
Revenue $4.3B $1.8B YOY Change 13% 35% Op. Margin 4% 18% Handsets
Revenue $0.7B $5.2B YOY Change (80%) 21% Op. Margin (52%) 20%
Conversion rates used: (1) 1 SEK = $0.0975 (2) 1 Euro = $0.8946
Lastly, it's my duty to remind you that Ericsson derives less than 15% of its revenues from handsets while Nokia pulls in over 70% from mobile phones. Let me rephrase that. Nokia is predominately a mobile phone maker and Ericsson is NOT. Ericsson is a wireless network infrastructure company. The press does a horrible job of highlighting this disparity. That said, the lines are blurring and my point may be moot soon enough. Nokia announced in its Q1 earnings press release that it wants to be numero uno in the network infrastructure market. As if to counter that punch, when asked about the merger, Ericsson's CEO stated, "The whole idea is to be #1 in this business."
Nokia's has proven it can win the Daytona 500 in its finely tuned handset stock car. Now it's ready to take on Ericsson at the Indy 500 in formula one racing with its networks car. Can it dominate both? Right now, Team Nokia is cruising around the track at near-record speeds while Team Ericsson is tinkering with the engine in the pits. If Ericsson doesn't finish its tune-up pretty darn soon, Nokia's lead may become insurmountable. The Maker port is proud to be a sponsor of Team Nokia and recently gave it the top spot on our Rule Maker Top 25 report.
Todd Lebor owns shares of Intel and Pfizer but only uses products from the former. Todd's other holdings can be found online along with the Fool's complete disclosure policy. The Motley Fool is investors writing for investors.
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