Can Nokia Make a Comeback in Smartphones?

By Markets Fool.com

It seemed like Nokia (NYSE: NOK) would never make smartphones again after selling its handset unitto Microsoft (NASDAQ: MSFT) back in 2014. Microsoft subsequently dropped the Nokia brand from its Lumia devices later thatyear, seemingly erasing the Finnish brand from the smartphone market.

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Microsoft's Lumia devices. Image source: Microsoft.

But a series of recent leaks indicate that Nokia is gearing up tore-enter the mobile market with two high-end Android devices with 5.5" and 5.2" displays next year. Reports suggest that both all-metal devices will be powered by Qualcomm'sSnapdragon 820 processors, have QHD displays, and run Nokia's own Z Launcher for Android.

Taking a lower risk approach to mobile devices

Nokia previously designed and manufactured its own mobile devices. At the beginning of 2007, Nokia controlled over 50% of theglobal smartphone market with its Symbian-powered devices. But after iPhones and Android devices stole the mobile spotlight, Nokia's share plunged to about 3% in 2013 -- the same year it agreed tosell its handset business to Microsoft.

Under that deal, Microsoft gained all of Nokia's manufacturing plants and the right to use the Nokia brand until the end of 2016. Nokia also couldn't reenter the smartphone market with competing smartphones until that deal expired.

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Since Nokia no longer had any production facilities left, it adopted a new model of licensing out its brand and mobile designs to third-party OEMs. Under that model, Nokia received royalties and licensing fees from the OEMs, but wouldn't shoulder any of the production costs. To test out that approach, it signed a deal with Foxconn to manufacture the N1 Android tablet last year.

The N1 tablet. Image source: Nokia.

Less risk, less revenue

The N1 was well-received and sold well in China, but most of the revenue went to Foxconn instead of Nokia. The royalties and licensing fees went to Nokia's Technologies division, which was formed after the sale of its handset business to house its massive IP portfolio. It also produces niche first-party hardware products like the Ozo VR camera.

The Technologies segment only accounted for 6% of Nokia's sales last quarter, but generated a whopping 40% of its operating income. The unit's revenue and operating income respectively rose 13% and 10% annually last quarter -- easily outpacing the double-digit revenue and earnings declines at its core Networks business. That business, which sells wireless infrastructure equipment, faces tough competitive pressure from worthy rivals.

Earlier this year, private equity fund Smart Connect formed a new company, led by former Nokia executives, calledHMD Global. HMD obtained the exclusive global license (excluding Japan) to create Nokia-branded phones and tablets over the next ten years. HMD will exclusively source the production of those devices to Foxconn's subsidiary FIH Mobile. HMD and FIH Mobile also co-purchased Nokia's feature phone business from Microsoft in May.

This means that HMD and Foxconn will handle the production of new Nokia devices, while paying a steady stream of licensing revenue to Nokia Technologies. Therefore, the actual risk in launching new smartphones is very low for Nokia, but the rewards are also fairly limited.

But will the Nokia brand become relevant again?

Many analysts believe that Nokia's refusal to manufacture Android devices caused it to lose the smartphone market. Nokia erroneously believed that its aging Symbian OS could fend off the expanding iOS and Android app ecosystems.

Nokia's Android X devices, which werereleased shortly before the Microsoft deal closed, were subsequently killed off by Microsoft. Microsoft, which wanted to use Nokia's devices to showcase Windows Phone, then refused to launch any more Nokia-branded Android devices.

Today, the smartphone market is a heavily commoditized one filled with companies struggling with declining market shares and margins. The leaked specs of Nokia's new devices indicate that they will likely struggle to stand out in the crowded market of high-end Android devices. A recent Canaccord Genuity report claims that only the largest two OEMs are selling theirdevices at a profit -- which means that it could be tough to sell Nokia's devices at premium, high-margin prices.

The key takeaway

Nokia's "comeback" in smartphones relies heavily on the appeal of the Nokia brand, which has diminished among consumers over the past nine years. The N1's strong debut suggests the brand still has some clout, but it could be tough succeeding in the smartphone market where countless others have failed.

Regardless of what happens, investors should remember that the new Nokia devices won't really be manufactured or sold by Nokia. Instead, they will merely buy it some licensing revenues to supplement its growing Technologies business.

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Leo Sun owns shares of Qualcomm. The Motley Fool owns shares of and recommends Qualcomm. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.