A perfect storm of challenges in China, combined with chipset shortages in the United States and one less carrier customer all contributed to lower second-quarter revenues for CellStar Corp.
Foremost, CellStar is bracing to take on “significant changes in the handset market in China,” which typically represents about 50 percent of CellStar’s business. The changes include lowered handset prices, new government policies and the introduction of carrier subsidies into the market-all of which bring China to more closely resemble the U.S. marketplace, according to Robert Kaiser, CellStar’s chief executive officer.
Nokia Corp., which represents about 50 percent of CellStar’s business in China, lowered prices of its handsets during the second quarter, dropping the average sale price about 25 percent worldwide and 15 percent in China alone. According to CellStar, other handset makers followed the trend, further reducing CellStar’s revenues, despite the fact that CellStar units shipped in China were actually up approximately 19 percent for the quarter, said Kaiser.
Nokia commented on its pricing strategy in its second-quarter results, also released last week, saying it has deployed a pricing strategy designed to keep its position in the industry. “We employed pricing selectively with certain products to stabilize our mobile device market share,” said Jorma Ollila, chairman and chief executive officer of the company.
In what resulted in another blow to CellStar’s business, the Chinese government in early May implemented tightened credit controls “to cool an overheated economy,” which negatively affected consumer sentiment, explained Terry Parker, executive chairman at CellStar. CellStar said at this point it is “difficult to predict the impact” the policies will have on its business, adding that it depends on how those policies play out during the next six to 12 months.
CellStar also has witnessed structural changes in the Chinese market that indicate the country is moving to model the U.S. retail channel for cellular phones.
Most notably, Chinese carriers have begun subsidizing handsets, a strategy that has not previously been employed in China, according to the handset distributor.
Also “superstores,” resembling large consumer electronics retailers in the United States, are opening in China, and handset makers are attempting to sell their products directly to the stores rather than through distributor channels.
CellStar plans to spend the next 60 days reviewing its Chinese strategy and said it publicly will announce its plans prior to its third-quarter earnings release. The additional challenges in the market likely will further delay CellStar’s initial public offering of its China business, originally proposed in March.
The IPO remains something “we want,” said Kaiser. The company does not believe U.S. investors value its China operations and expects an IPO to unlock some of that value. Tax reasons also offer incentive to put the IPO through, and without prohibitive U.S. laws and anti-trade rules, profits from the CellStar China business could surge, said Kaiser.
Finally, CellStar blamed declining revenue in Asia Pacific on its efforts to reposition itself in Singapore and the Philippines. Kaiser said the company is assessing those operations to decide how they fit into the overall company going forward. Those regions are not included in the proposed China IPO.
Meanwhile, CellStar is working to refocus its U.S. market operations. Here CellStar said it saw a rebound in demand as compared with the first quarter because carriers had used up excess inventory they had in fourth-quarter 2003.
However, an unexpected shortage of CDMA chipsets affecting 5100 series phones meant CellStar could not meet the product demands. Suppliers indicated improvements in chipset supplies will be noticeable in July, but “we fear it may be as late as September that supply level returns to normal,” said Kaiser.
In addition, the second quarter was Cellstar’s first in three years without Cricket Communications, with whom it discontinued distribution services in February.
Going forward, CellStar plans to grow its margins in the United States by ramping up its additional offerings like the after-market accessories that it offers in Best Buy stores, Wal-Mart retail outlets and through Virgin Mobile retailers.
The company, for example, recently introduced a reverse logistics solution that it is selling to carriers, retailers and manufacturers. CellStar said it is in talks with up to 40 potential customers for that product and is striving to sign at least two by the end of summer.
Currently, 90 percent of CellStar’s U.S. revenues are handset-related. “We’d like that to be 60 to 70 percent of total revenues,” said Kaiser, adding that the company does expect to grow the handset portion of its business in the meantime.
Perhaps the most stable of CellStar’s regions is in Latin America. Second-quarter declines there were attributed to Mexico and Colombia.
CellStar recently reduced its ownership in its Colombia business by transferring equity to a local group, a strategy the company has employed throughout its Latin American regions that it said is paying off. As evidence, Kaiser said that so far this year CellStar has garnered approximately $3 million in income from its Latin American operations, vs. a loss of $4 million last year.
CellStar’s stock fell about $2 per share last week in anticipation of its second-quarter earnings release but rebounded slightly to trade at $5.28 per share at press time Friday.
