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A wireless winter wonderland?
Not exactly. A price war spells trouble for many carriers, cell phone makers and chip firms.
January 24, 2005: 1:06 PM EST
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) It's getting tougher and tougher to make it through the day without being bombarded by a cacophony of quirky cell phone ring tones.

With cell phones everywhere, the stocks of carriers, handset makers or wireless component companies should all be intriguing buys, right?

But that's not the case. Wall Street was disappointed last week with the guidance from Motorola (Research), the world's second largest manufacturer of cell phones, and Qualcomm (Research), a maker of wireless chipsets.

There are concerns about slowing growth as well as aggressive pricing from carriers and makers of handsets. And investors will find out just how tough the market is this week, with several key earnings reports due from companies all along the wireless food chain.

The three major Baby Bells, Verizon (Research), BellSouth (Research) and SBC (Research) will all report their results. (BellSouth and SBC co-own Cingular while Verizon co-owns Verizon Wireless with Vodafone.)

On the handset side, industry leader Nokia (Research) will report its latest results. And chip suppliers Texas Instruments (Research) and RF Micro Devices (Research) are also on tap.

The week is already off to a rocky start.

Can you hear me now?

Cingular Wireless, which recently completed its acquisition of AT&T Wireless, reported healthy fourth quarter gains in revenue and subscribers on Monday but average revenue per user (ARPU) fell and the unit posted an operating loss.

Drake Johnstone, an analyst with Davenport & Co., said that Cingular's results show that the company is trying to gain market share with lower rates, a strategy that can work in the short-term but is troublesome.

"Its one thing to add customers but if you're not profitable what's the point?" said Johnstone, adding that Cingular's lack of profitability is a main reason why he does not like either SBC or BellSouth's stock.

Johnstone said that he doesn't think that Verizon will need to aggressively lower prices to compete with Cingular because it can tout its better network quality as a selling point. He thinks Verizon's wireless unit will show stronger gains in revenue than Cingular and an operating profit margin of about 22 percent. As such, he likes Verizon's stock.

Greg Gorbatenko, an analyst with Marquis Investment Research, also said Verizon looks attractive, primarily because of its strength in wireless. In addition, shares trade at 14 times 2005 earnings estimates, a discount to both BellSouth and SBC.

"I like Verizon at these levels. It's doing the right things in wireless and should get a premium," Gorbatenko said.

But with Sprint (Research) and Nextel (Research) in the process of merging and Alltel (Research) buying regional wireless carrier Western Wireless (Research), it seems that another wireless price war could soon be in the cards.

Handset and chip prices under pressure

That's good news for consumers, of course, but not investors, especially for the companies that make cell phones and chips used in them.

"We should see competition heat up because of consolidation and with that comes several negative consequences," said Ping Zhao, an analyst with CreditSights.

For one, she said that larger carriers should have more pricing power and will likely be able to command bigger discounts for cell phones. That would likely hurt all the major manufacturers of handsets.

So investors will need to keep an eye on whether or not Nokia reports a sizable decline in the average selling prices (ASPs) of its cell phones. If so, that could be problematic for the companies that make chips used in these phones, firms like Texas Instruments and RF Micro Devices. That's because if the cell phone makers are feeling a pinch from carriers, they are likely to try and bargain for lower component prices from their suppliers.

What's more, Zhao said that Nokia has been lowering prices to win back market share it lost to rivals including Motorola, Samsung, and LG in 2004. Finally, Zhao said she's concerned about demand slowing down for handsets because many consumers bought newer phones to replace older models last year.

"In the last number of quarters, handset makers benefited mostly from camera phones. In 2005, the question is what is the next feature application to drive the next big upgrade cycle?"

And this could be a major problem because both the chip makers and handset companies are building up inventories with the expectation of extremely strong sales in 2005.

"We are starting to definitely see that the chip companies have more supply than demand. There are inventory issues," said Gorbatenko. "And the handset side is tight because of oversupply. There is somewhat of a glut."

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking ties to the companies.  Top of page

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