Last Updated: March 19, 2008: 1:29 PM EDT
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Sony Ericsson's wireless disconnect

The No. 4 handset maker surprises investors by sharply lowering its profit forecast, further fueling fears of an industry slowdown. Is No. 1 Nokia next?

By Scott Moritz, writer

NEW YORK (Fortune) -- A fresh chill is blowing through the once-scorching mobile phone market. This time the source is Sony Ericsson, which warned Wednesday of a steep profit shortfall.

The No.4 player in the cell phone industry cut its current-quarter profit forecast to less than half the year-ago level, citing a slowdown in consumer spending on its mid-priced and high-end phones. The company, a joint venture of Swedish phone maker Ericsson and Japanese entertainment giant Sony (SNE), says it now expects a pretax profit of about $276 million, down from $571 million a year ago. Analysts had been looking for a profit as high as $315 million for the first quarter ending March 31.

Ericsson (ERIC) shares fell 10 percent on the news, dragging Nokia (NOK) down 7 percent on fears that the world's largest handset maker will also post lower-than-expected first-quarter results. Even wireless standard bearer Qualcomm (QCOM, Fortune 500) felt the jolt as investors fret over signs of slowing 3G phone sales.

Overall, growth in the mobile phone industry has fallen steadily from its 31% peak in 2004. Analysts now predict that growth will taper to 15% in 2008. But that pace could slow further as the industry gets squeezed by a slowing economy and the dwindling supply of first-time phone buyers.

Last week Texas Instruments (TXN, Fortune 500) sounded the slowdown alarm when it blamed fewer mobile phone chip orders for its lower guidance. The culprit, according to analysts, was key customer Nokia and a possible inventory pileup.

To be sure, downward adjustments aren't uncommon in the first quarter, which tends to be the slowest time of year for phone sales after the Christmas shopping season. But the size of Sony Ericsson's shortfall suggests things might not be going along swimmingly in the phone market. And while that puts the focus on Nokia, it puts even more pressure on stumbling Motorola (MOT, Fortune 500), which risks finishing the year as the world's fourth-largest phone maker, down from its current No. 3 spot.

Some industry analysts caution, however, that Sony Ericsson's problems might not spell gloom for the entire sector. The company makes most of its revenues in Europe, where it sells phones that are generally higher priced than its rivals' devices. Also, as trends go among finicky mobile users looking for the next cool handset, Sony Ericsson may have reached the end of its good run with the popular Walkman phones.

"They rode really high in the last few years when the Walkman phone was so popular," says Roger Entner of IAG Research. Now, he says, Sony Ericsson might be seeing the end of two buying trends: The Walkman phone's wane and a delays in the all-important replacement cycle. For years, people replaced their old phones every three years on average. But that replacement rate has shot up in recent years as phones have become fancier and networks faster. And with growing signs of a global economic slowdown, budget-conscious consumers may be putting off new phone purchases.

In response to the profit warning, Sony Ericsson vowed Wednesday to become less dependent on the high-end European market, and move toward the faster growing markets in developing countries with cheaper phones.

If successful, this gain will likely come from Motorola's weak efforts in the newer hotter markets like Asia and South America.  To top of page

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