Cautious Network Spending Hits Ericsson's Profits

Price competition and operators ' reluctance to commit to high-cost network upgrades and expansions have again weighed on equipment suppliers' profits in Q312. Global supplier Ericsson has been hit particularly hard as it has had to offer lower prices for its transmission, switching and networking gear in order to continue to secure new supply deals. While this strategy has enabled it to keep its rivals at bay, particularly in the challenging European market, margins have suffered and a further fall in sales in Q312 puts those margins under even greater pressure. The market reacted negatively to the news, but other players are in a similar situation and will also have underperformed in Q312 , BMI believes.

Ericsson ' s core Networks unit reported net sales of SEK26.939bn in Q312, down by almost 3% sequentially and by 17.1% year-on-year (y-o-y). The third quarter is usually fairly subdued in terms of revenue growth as operators tend to commit to new equipment early in their financial years, but Ericsson continues to be hit by declining sales of its legacy CDMA equipment business (down by around 50% y-o-y) as well as rapidly contracting demand for its 2G GSM equipment, particularly in China. Interest in 3G solutions is also waning as key operators near the completion of their 3G rollouts and either defer committing to further upgrades ahead of transitioning to 4G LTE systems or look to extend the lifetime of their 3G systems with low-cost software-based enhancements.

A Pickup Is Likely, But Margins May Remain Low
Ericsson - Networks Sales Performance, 2008-2012

Ericsson ' s Q312 results show that the Networks unit ' s operating margin has declined to 5%, close to the level it reached early in 2009 at the height of the global recession. A year ago, the operating margin was 13% . and 18 months ago it reached a high of 17%, mainly on the back of 3.5G/3.75G upgrade requests and demand for its 4G LTE solutions. European operators are proving to be extremely cautious with regards to spending on high-ticket projects at a time when the ongoing eurozone sovereign debt crisis threatens many large operators' ability to service their existing debt and/or secure financing.

The picture may be grim at the moment - Ericsson, like its counterparts Alcatel-Lucent and Nokia Siemens Networks , is streamlining its business, changing its sales and services strategy to pursue cost savings and introducing more flexibility with regards to pricing - but BMI believes the current headwinds should start to ease within the next 12 months. In H212 alone, an unprecedented number of new high-end smart devices has been unveiled, including a new iPad from Apple , a heavily revised Kindle Fire tablet from Amazon and initial forays into the tablet hardware space by Microsoft and Google . These devices will put further strain on mobile operators' core networks as well as their backhaul systems and will force them to commit to more ambitious upgrade projects. In addition, as operators increasingly move away from loss-making unlimited bandwidth subscriptions to tiered pricing schemes, so they will need more complex traffic routing and smart customer management solutions.

One potential long-term downside to this scenario is that operators will come under greater pressure to consolidate or at least pool network assets to gain the scale they need to grow. This trend is already playing out in the US and Europe, where T-Mobile and MetroPCS are to merge, Sprint and Clearwire are being absorbed by Japan's Softbank and Euro pean players such as Telefónica and T-Mobile are looking to share infrastructure and jointly procure new equipment. This reduces the number of potential customers for Ericsson's equipment, gives the surviving players more leverage when negotiating new supply contracts and may see Ericsson displaced in favour of other suppliers.

In the meantime, Ericsson plans to improve the Networks business ' profitability by leveraging the company ' s installed base of radio, core and transport equipment, presumably meaning that it will be looking to help operators extract greater efficiencies and value out of their existing infrastructure. Other key priorities are to grow IP equipment sales and secure contracts for Voice over LTE (VoLTE) among the more mature 4G operators . In this regard, the Americas could be a valuable growth market as Ericsson notes that - once it has executed all existing contracts - it will have a footprint of more than 50% in Latin America, substantially greater than its existing share of the 3G market in the region.

Nevertheless, the next three to four quarters could yet see Ericsson report further lacklustre sales growth and suppressed margins, a factor that smaller and nimbler competitors could exploit when looking to secure supply contracts with new 3G operators in Africa and Asia and among carriers still evaluating the cost benefits of transitioning to 4G.

This article is tagged to:
Sector: Telecommunications
Geography: China, Global, China, Japan, United States, Global, Global, Global

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