Are handset sales set for a fall?

By Jennifer L. Schenker, BusinessWeek
Monday, March 17, 2008 11:04 AM

news analysis On Mar. 10, Texas Instruments, a leading supplier of semiconductors for cell phones, set off shock waves in the multibillion-dollar mobile industry by lowering its first-quarter growth estimates for sales of wireless chips. TI pinned the blame on weakening demand from a major customer for high-end chips used to power third-generation (3G) phones.

Investors made the assumption that the client might be Finnish giant Nokia, which accounts for nearly one-third of TI's wireless chip business. On Mar. 11, investors drove down shares in the world's top handset maker by as much as 4.75 percent. The key question: Did TI's warning signal a broader industry slowdown?

Consumers curb spending
Financial analysts clearly are worried. Although part of TI's retrenchment is likely due to a first-quarter inventory correction, there's growing concern that the handset market--especially for pricey high-end models favored in the United States and Western Europe--may be feeling the effects of economic downturn and slower consumer spending.

Consider Said Nafea, a Parisian shopper in his 30s checking out new handsets at the FNAC electronics emporium on Paris' Champs-Elysées. He has a three-year old Samsung that fits nicely in the front pocket of his jeans. And while he'd like something newer, with more bells and whistles--especially an Apple iPhone--he has decided to wait until he can afford it.

Customers like Nafea are what worries experts. The typical pattern in first-quarter mobile-phone sales includes a relatively weak January and February, following fourth-quarter holiday purchases, and then a sharp uptick in March. All indications from sales channels in recent weeks were that everything was going as expected. So, TI's slowing chip orders in March hinted at deeper problems in the market.

Analysts aren't surprised
That's why "there was a heck of a lot of drama" after TI's announcement, says Mark McKechnie, an analyst at American Technology Research, a Greenwich (Conn.)-based independent research firm. "You don't see that kind of shift when there's a superhealthy end market."

In the wake of TI's news, McKechnie has trimmed his first-quarter profit forecast for Nokia by 2.4 percent, to US$2.16 billion. He's not forecasting a meltdown, noting in a research brief that "we still view handsets, and Nokia specifically, as more resilient than most to global macro conditions." But, he adds, no industry or company is "entirely immune." Nokia declined to comment.

Indeed, indications of a slowdown are causing some analysts to rethink prospects for the entire year. Richard Windsor, an analyst at Nomura Securities in London, has lowered his estimate for 2008 global handset shipment growth from 11 percent to 8 percent--for a total of about 1.2 billion units.

Handset outlook
As a result, he has sliced nearly 7 percent off his estimate for Nokia's first-quarter revenues and lowered his annual revenue target to US$85.2 billion, down from an earlier forecast of US$88.2 billion, though that's still up 7.5 percent from 2007 in constant dollars. Windsor also has lowered his revenue estimates for struggling Motorola and Swedish-Japanese joint venture Sony Ericsson. "All players are likely to take a hit as a result of a lower overall market that has suddenly become unusually soft at the high end," Windsor said in a research note.

Nokia could fare the best, thanks to its unique product mix. With more than 40 percent global market share, it has the widest distribution and reach of any handset maker. That exposes it more broadly to economic forces around the world, but also protects it from the ebbs and flows of particular markets, such as the struggling United States. More important, Nokia gets nearly 90 percent of its total handset revenues from lower-end models popular in still-thriving emerging economies.

By comparison, Sony Ericsson is much more concentrated at the high end and in developed economies, which is where market weakness appears to be creeping in. Nomura's Windsor figures the company gets more than 40 percent of revenues from high-end models, so after TI's announcement, he lowered his 2008 revenue estimate from US$23.21 billion to US$21.6 billion. Sony Ericsson declined to comment.

TI's news also could spell trouble for rival vendors of handset chips, especially for the high-end 3G segment. A few may even exit the business. "Some of the larger semiconductor vendors will see an opportunity in the stock price contractions of their smaller competitors to push some consolidation down the road," predicts Amit Kapur, an analyst at brokerage Piper Jaffray in New York.

Losing share to rivals?
To be sure, some observers think it's premature to call an industrywide slowdown. Malcolm Penn, founder of British semiconductor research firm Future Horizons, speculates that TI's warning may simply reflect that it has lost some business from Nokia. Chips for 3G phones have become fairly standardized, so it's easy for manufacturers to move business around among multiple suppliers. Sources say Nokia may have shifted some orders to TI rivals such as STMicroelectronics.

One financial analyst, who requested anonymity, even suggested that TI could find it "convenient" to blame its retrenchment on an overall market slowdown rather than admit to a loss of business from Nokia. TI couldn't be reached for comment. Another plausible explanation for the dip in orders could be that Nokia is trying to reduce its own chip inventories after a period of stockpiling to avoid shortages. Or perhaps the company is winding down production of a particular series of products that used the TI chips in question.

"Our take is that it is easy to overexaggerate the component shortage," says Geoff Blaber, director of devices at CCS Insight, a British mobile-phone consultancy. "We don't see any evidence of a severe slowdown beyond the seasonable impact you would expect in the first quarter."

Some are even more bullish. Michael Wilkins, executive vice-president for sales channel development for T-Mobile International says he has seen an overall rise in demand in the first quarter. "When we have economic slowdowns, of course there is a potential impact on the mobile industry," says Wilkins, who oversees the German operator's European sales channels and supply chain management.

But in January and February, he says, T-Mobile saw 20 percent higher handset sales than in the same period a year earlier--some 10 percent to 15 percent above the company's forecast. While these figures include all types of phones, about half the models in T-Mobile's portfolio use 3G.

The real test of whether end-customer demand is slowing will come over the next few weeks, say CCS Insight analyst Blaber and others. And if it materializes, the impact will extend well beyond this week's round of stock declines. "If there is a real issue, we are more likely to see it in the second quarter," Blaber says.