Carphone clobbered by mobile slowdown

There was further grim news for investors in Carphone Warehouse yesterday when Britain's biggest mobile phone retailer issued a profits warning as a result of weaker demand over Christmas.

The company said its full-year earnings before interest, tax and depreciation of assets, would be as much as 10 per cent below market forecasts of £83m. The shortfall is largely due to problems in Germany, the Netherlands and Belgium. In the UK, the shift towards higher margin monthly subscription contracts, as opposed to pay-as-you-go sales, was slower than expected.

Carphone shares fell 17.5 per cent to 93.25p. They now stand at less than half the 200p issue price when the business came to the market in May 2000 and valued at £1.6bn. The flotation made Charles Dunstone one of Britain's richest men after selling £56m of shares in the float and retaining a 38 per cent stake. But after floating his business at the peak of the tech-bubble, he must prove he can make Carphone a stock- market success in an increasingly difficult environment.

Mr Dunstone, Carphone's chief executive, tried to put a positive gloss on the warning yesterday. "In most markets we performed exceptionally well but we let ourselves down in three markets.... We said the market was going to be down this Christmas. We got there but for these three areas."

Carphone's announcement must be put in context. Earlier this month, Dixons reported that its mobile phone sales in December were 50 per cent lower than the same month last year when demand was inflated by huge discounts being offered by the handset manufacturers. Like-for-like sales at the Link, its mobile phone chain, were down by 18 per cent in the half year, compared with minus 5 per cent at Carphone.

Figures issued by Nokia today and Ericsson tomorrow will show sharp falls in handset shipments in the final three months of 2001. And Carphone has been improving its sales of monthly subscription phones, which now account for 43.2 per cent of its sales mix, compared with 37.5 per cent a year ago.

As one retail analyst put it: "The market is down 40 to 50 per cent and yet Carphone's UK profits are flat. Is that so bad? Show me another retailer that could do that?"

Carphone has been expanding aggressively in Europe but struggled in Germany where the market fell even more sharply than in the UK, while in Belgium and the Netherlands rivals wooed customers with more innovative marketing. One analyst said: "[Carphone] is a robust performer, but the empire has got bigger and more difficult to control. The management is able but are there enough of them?"

Another analyst said the mature UK business had performed well but the problems in Continental Europe were a cause for concern as this is where the growth was expected to come from. For example in Belgium and the Netherlands, Carphone's number of connections fell 35 per cent. In Germany, the group entered the market after the boom in pre-paid phones and is a relatively small player in a cut-throat market where return on capital is woeful. The German operation will lose £10m this year.

The result has been savage downgrades. Credit Suisse First Boston, one of Carphone's joint brokers, cut its current year pre-tax profit forecast by 11 per cent to £49m and next year's estimate by 17 per cent to £60m.

Carphone is outperforming its peers in the UK. Its market share has grown from 8 per cent in December 2000 to over 20 per cent now and the market shake-out is working in its favour. Four firms have gone bust since Christmas – Phone People, Wap Store, Mobile Phonehouse and Mobile Communications – with around 300 outlets between them.

Carphone is also building its recurring revenues, which have doubled in a year. As well as taking a slice of the monthly mobile contracts, Carphone makes recurring revenue from selling insurance policies and signing facilities management contracts. Under these deals Carphone manages billing and customer service for network providers like Vodafone.

But the Holy Grail for the sector is new handset designs and new technology and so- called "third generation" phones that enable fast internet access. "The overall market for mobile handset sales will continue to be tough for the next six months," Mr Dunstone says. "But from this Autumn onwards we believe that a combination of new handset functionality and innovative technology will once again stimulate the market."

The arrival of new colour-screen mobiles, such as the Rescission T68, is already catching the eye of consumers. Phones that will be able to send pictures as well as text messages are also expected to stimulate demand when they hit the shops later this year. On top of this, Mr Dunstone says, the arrival of a fifth network player later this year in the shape of Hutchison should lead to a further round of aggressive promotion that will lure customers back to the shops.

Perhaps. The counterargument is that the UK and Western European markets are saturated and that consumers may not replace their handset as often as the sector hoped. With more than 60 per cent of the UK population now possessing a mobile, growth must come from consumers replacing their handsets. Carphone Warehouse reckons people will do this, typically, every 18 months as new designs and functions hit the shelves.

However, the failure of the Wireless Application Protocol in 1999 shows that consumers will not necessarily buy a new product just because it is heavily advertised – people have to really want it.

Other much heralded new formats that have bombed include Digital Audio Tape and Laser Discs, while Mini Discs have only achieved modest sales. All came too soon after established products such as compact discs and video recorders. Conversely, DVDs have proved a stunning success – nearly 20 per cent of UK homes have one three years after launch – partly because they have come 20 years after traditional video recorders.

Carphone Warehouse must hope that new technology such as 3G turns out to be the next must-have gadget rather than another WAP.