Nokia Corporation (ADR) (NOK)’s Long March to Profitability

Even as Nokia Corporation (ADR) (NYSE:NOK)’s smartphone sales continued to collapse, down 32% year over year and 6% sequentially, CEO Stephen Elop claimed that Nokia had “achieved underlying profitability” at the quarterly conference call.  As usual, his claim excluded restructuring charges that pushed Nokia Corporation (ADR) (NYSE:NOK) into an operating loss of  $152 million for the quarter. The sole legitimate, though limited, sign of progress was an increase in sales of Lumia Windows 8 phones from last quarter’s 5.6 million to 7.4 million.

Total revenue for the company was down 24% to $7.5 billion.  Nokia’s net cash and equivalents fell by more than $528 million from $5.9 billion to 5.37 billion. About the only positive in Nokia Corporation (ADR) (NYSE:NOK)’s overall financials is that it isn’t as bad as a year ago, when the operating loss was $1.09 billion on revenue of $9.953 billion. Elop may call this achieving underlying profitability, but I call it hanging on by your fingernails.

Smartphone Zero Sum Game

Last quarter I pointed out that Nokia had effectively cannibalized its own low cost Asha line of smartphones as well as Symbian smartphones it was still selling. As the table below shows, this continued into Q2.

In order to make this less apparent, in Q1 Nokia stopped reporting Asha in the Smart Device category and lists Asha in the mobile phone category, even though Nokia Corporation (ADR) (NYSE:NOK)’s own report continues to refer to Asha as a “full-touch smarphone.” This allowed Nokia to claim a 21% increase in Smart Device unit sales, from 6.2 to 7.4 million.  But in fact, selling smartphones has become a zero sum game for Nokia, where it can only increase sales in one line at the expense of the other.

While steeply discounting Lumia Windows phones pumped up the unit volume, it didn’t help Smart Device revenue, which was down 24% year over year and unchanged from last quarter at $1.54 billion. Both Microsoft Corporation (NASDAQ:MSFT) and Nokia Corporation (ADR) (NYSE:NOK) were “on the same page” at their conference calls, claiming to be pleased with Windows Phone “momentum.”

Elop pointed out that Nokia has now sold 13 million Windows Phones, as many as it sold in all of 2012, but this really underscores the flop that was Windows Phone 7, especially since WP8 became available in 2012 Q4.  At this rate, can the Microsoft keiretsu really build a sound ecosystem?

Long March, or Death March?

I’ve estimated that a mobile device ecosystem requires about 100 million users to become self-sustaining. This figure varies somewhat depending on the licensing structure of the OS. Currently, Microsoft still pays slightly more in platform support payments to Nokia Corporation (ADR) (NYSE:NOK) than Nokia does in licensing fees, so in effect, the OS is free and Microsoft is being forced to create a self-sustaining mobile ecosystem in the Google Inc (NASDAQ:GOOG) vein, supported by advertising and search revenue, and sales in its content stores.  In this mode, 100 million users is probably conservative, since Microsoft Corporation (NASDAQ:MSFT) doesn’t have anything close to the mobile device advertising revenue of Google Inc (NASDAQ:GOOG), judging by the way Microsoft’s Online Services Division (home of Bing) continues to post operating losses ($110 million in Q2).

According to Gartner Research, there were about 12 million Windows Phone sales through the end of Q1 worldwide.  Assuming that Windows 8 Phones sell about 10 million this quarter (including Nokia’s 7.4 million), that means that there are about 22 million Windows Phone 8 users in the world.  Just 78 million more to go, or about two more years at 10 million per quarter.