Will Nokia Adopt Android or Windows Phone 7?

Nokia's (NYSE: NOK) new Chief Executive Stephen Elop is expected to spell out the company's strategy at the analyst day to be held on Feb. 11.

The event will be closely followed by both investors as well as industry vendors as there are speculations that Elop could announce adoption of a new operating system (OS) for its smartphones.

Adoption of a new OS would be a key step for the Finnish company to regain its market share in the United States, which is the biggest market for smartphones.

During the earnings conference call of Nokia held in late January, Elop said: Nokia must compete on an ecosystem-to-ecosystem basis. In addition to great device experiences, we must build, catalyze, and/or join a competitive ecosystem. And the ecosystem approach we select must be comprehensive, and cover a wide range of utilities and services that customers expect today and anticipate in the future.

The statement from Elop indicates that Nokia management is willing to consider wholesale changes to its existing smartphone strategy based around Symbian and MeeGo.

Market analysts also speculating that Nokia would eventually join the Google's Android or Microsoft's Windows Phone 7 ecosystem as Nokia's current OS strategy (Symbian/MeeGo) is not generating the expected returns, especially in the smartphone space..

We think the odds are better than even that NOK will join the Windows or Android ecosystem in an attempt to enter the US, where it has no traction, but stick to Symbian in regions where NOK has a following, Gleacher & Co. analyst Mark McKechnie wrote in a note to clients.

McKechnie has a neutral rating on Nokia shares.

Nokia's Symbian 3 line-up including the N8, C6, C7 and E7 has shipped about 5 million units, a distant cry in the smartphone race against Android, iPhone and Blackberry. Gleacher estimates fourth-quarter shipments of 25 milllion units, 16 million units and 14 million plus units, respectively, for Android, iPhone and Blackberry.

Only, Microsoft's Windows 7 models are lagging behind Nokia with shipments of around 2 million units.

For Nokia, smartphones now represent around 50 percent of Devices &Services (D&S) revenue, and with continued share loss accompanied with pricing pressure, analysts expect this to significantly affect Nokia's ability to grow revenues in its handset business.

Persisting with the Symbian OS going forward could result in Nokia's smartphone share declining to as low as 23 percent by 2013, Credit Suisse analyst Kulbinder Garcha wrote in a note to clients.

Garcha, who has an underperform rating on Nokia shares, expects the company's high levels of smartphone share in Western Europe and APAC will remain vulnerable as players such as Apple, RIM and Android-based vendors (Samsung, HTC, Motorola Mobility) continue to expand their reach and distribution in these regions.

..being dependent on Symbian/MeeGo platforms is no longer an option for Nokia as this could lead to continued smartphone share loss and margin pressure. This leaves two alternatives; either adopt Windows Phone 7 or Android. Garcha noted.

Adopting Android

Analyst Garcha said Android is probably the best option available for Nokia as this will give the company access to the most innovative, and fastest growing smartphone platform that has captured 26 percent market share globally. Android is also scalable both to lower end smartphones and tablets.

Recently, Android dethroned Symbian to become the top smartphone OS. Manufacturers shipped 33.3 million Android phones worldwide, compared to Nokia's 31 million, according to the latest data from the UK-based market research firm Canalys.

Also, Android OS has consistently seen improvements, with Google already having launched five major iterations of Android OS since its initial launch in September 2008.

In addition, Google has built an entire ecosystem around its Android software in terms of services, apps and developer support. In fact, the number of applications on Android Market currently stands at over 200,000 up from only 75,000 in June 2010.

Garcha sees Android volumes could reach 110 million units in 2011, up from 63 million in 2010.

Android device activations on a daily basis have increased to 300,000 in December 2010 from 200,000 in August 2010 and 100,000 in May 2010.

This growing run-rate of activations suggests that our Android smartphone estimate of 110 million units in 2011 could even prove conservative, Garcha said

Garcha says by adopting Android, Nokia could have an Android product within a year, which could drive a smartphone recovery through 2012-2013 and result in earnings power of €0.96 a share in 2013.

The analyst believes within 12 months of adopting Android, Nokia could start gaining relevance in the smartphone market, causing smartphone share to recover to 26 percent by 2013, with improving average selling prices (ASPs) and gross margins (GMs).

An additional advantage of Android versus Microsoft could be that it is already available for use on tablets following the introduction of Android v3.0 (or Honeycomb) and could resolve Nokia's gap in the fast growing tablet market.

In fact, Motorola already launched its first tablet called the XOOM, which is based on the new Honeycomb platform.

However, the major deterrent in pursuing this option is that so far Android-based smartphone vendors have shown very little differentiation in terms of form factor or functionality. In longer term, Nokia may become a commoditized hardware vendor with margins in the 8 percent range.

Also, Google may be less flexible on terms and conditions and follows a practice of controlling specifications tightly, in the process frustrating some of the device vendors.

Adopting Windows Phone 7 (WP7):

The first argument in favor of Windows Phone 7 (WP7) for Nokia is that it is a touch-screen user interface (UI) that presents a significant improvement over Symbian.

Second, the lack of significant hardware support for WP7 could actually be an attraction for Nokia paving the way for some sort of exclusivity.

Perhaps the most compelling argument is that Microsoft may be a flexible partner and Nokia would be able leverage its service offering.

By adopting WP7, Nokia could implement a decent touch screen OS for the smartphone market as WP7 offers tighter integration of Xbox and Zune services.

If Nokia were to move towards Windows Phone 7, the company would be able to differentiate the customer experience in an easier manner as compared to Android OS, especially given weak presence of Windows Phone 7 at vendors which are supporting both Microsoft and Android operating systems.

In addition, with Stephen Elop himself coming from Microsoft (NASDSAQ: MSFT), it is possible that he could encourage a closer cooperation between the two companies.

Garcha said a Microsoft-centric strategy could allow for a smartphone share recovery from mid-2012, improved revenue mix and margin recovery, all depends upon Nokia's execution.

Indeed, assuming smartphone share recovers to 26 percent by 2013, this could drive earnings of €1.01 a share for Nokia.

On the flip side, WP7, which was launched in late 2010, include a rigid approach from Microsoft in terms of form factor and specifications.

Secondly, Microsoft could charge a license fee (maybe $8 per device) for using its OS.

Last but not the least, WP7 is currently not optimized for the low-end of the smartphone market, nor is it designed for the tablet market.

As so far both parties have failed to acknowledge the speed of transformation in the mobile market, it can be argued that any relationship between the two firms is simply a 'coalition of the defeated'.

Disruption Likely

Regardless of the adoption of operating system, disruption for Nokia seems to be very likely due the transition period required to adopt an operating system.

As shown by the past experiences of Motorola and Sony Ericsson, the industry will not wait, as competitors will continue to evolve, management turns over and carrier promotions shift. All these pointing to an accelerated smartphone share loss.

In fact, having analyzed the level of smartphone share by region for Nokia, we believe this (market share loss) may trough at anywhere between 16 percent and 18 percent before starting to show any subsequent recovery, Garcha wrote.