Cheap phones can get cheaper, margins thinner

By Lucas van Grinsven, European Technology Correspondent

BARCELONA (Reuters) - Nokia and Motorola, who dominate the low-cost mobile phone segment, could feel the pinch after Vodafone's (VOD.L) deal to buy cheap handsets from Chinese handset maker ZTE (000063.SZ).

Nokia (NOK1V.HE) may have lifted investor confidence in the fourth quarter after it showed it can still raise profit margins on cheap phones, but operators are now saying even a $25 mobile phone is too expensive.

"Even at $25 or $30 per phone, the operators believe there's a premium associated with the Nokia and Motorola brand. So, they're getting ZTE in," said analyst Ben Wood at CSS Insight.

The first phones from ZTE will be available to Vodafone customers this summer and it may cause pressure on margins at Nokia and Motorola (MOT.N), analysts said.

The cheapest phone currently on the market is the Motorola C113a, specifically designed for emerging markets, which could be bought for 18.23 euros ($23.92) on the January wholesale spot market, according to data provided by gsmExchange.

The ZTE products may cost several euros less. Nokia's 1110 model sells for around 30 euros.

ZTE's handset deal is not restricted to supplying cheap models to Vodafone's customers in emerging markets. It will also supply developed markets where many consumers are looking for cheap pre-paid deals.

Nokia Mobile Phones Chief Executive Kai Oistamo told Reuters at the 3GSM conference in Barcelona he was not particularly worried about smaller players entering the low end of the handset market.

"I think it's going to be very, very difficult. Today, making profitable low-end phones really requires economies of scale," Oistamo said.

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But he acknowledged "the margin, in the end, depends not only on what we do but also what the competitors do" and "everything is also a function of our cost base and our ability to price things competitively".

Financial analysts scrutinize Nokia's profit margin of low and mid-end phones, because that is where it sells most of its products and where it has made recent margin improvements.

Its mainstream mobile phones unit profit rose to 1.26 billion euros in the fourth quarter, reversing a trend of falling profit margins and turning in a 17.8 percent operating profit margin on sales compared with 17.1 percent a year earlier and 13.1 percent in the third quarter.

Nokia's shares are up 13 percent since it published earnings late last month, sharply outperforming a flat DJ Stoxx European technology index .SX8P.

While the Vodafone and ZTE deal could put those gains under pressure, analysts say Nokia and Motorola can still count on customer loyalty.