Ericsson hacks into costs as sales keep shrinking

Ericsson's big customers either have well-stocked larders or remain on hunger strike. For about a year, the Swedish kit vendor's resounding message to frustrated investors has been that telcos will eventually have to feed on its products. Their own customers continue to burn through gigabytes each day. Unless networks are replenished, services will suffer, insists Ericsson.

"The traffic growth continues, and you start to see in many markets congested networks, which means that when it is crowded you may actually get a signal but cannot use it," said Börje Ekholm, Ericsson's CEO, during today's quarterly Q&A with analysts. "You simply have no capacity left." Yet the spending squeeze persists, as results for the first quarter of the year today show.

Ericsson's headline sales fell by 15%, to 53.3 billion Swedish kronor (US$4.9 billion), compared with the year-earlier quarter, toppling 21% at a networks business responsible for 63% of the total amount. The big problem remains the profitable North American market, where Ericsson generates more than a quarter of its revenues. Mobile operators there previously overloaded on supplies and have been living off them ever since. The 18% year-over-year drop in sales this time round is what Ericsson has come to expect.

CEO Börje Ekholm, nevertheless, remains confident the situation will improve in the second half. Those North American store cupboards look increasingly bare, and Dell'Oro, a market research company Ericsson trusts, appears to believe the addressable regional market for radio access network (RAN) products will grow by 10% to 20% this year. In December, Ericsson also landed a new $14 billion contract with AT&T to replace Nokia equipment across one third of the network (Ericsson already had the other two thirds), although there is a question mark over the profitability of that deal.

Even so, Dell'Oro expects the entire global RAN market to shrink by 4% this year and Ericsson clearly fears a sharper decline. "That looks a bit optimistic to me," said Ekholm on his regular quarterly call with analysts. Without an obvious growth story for those beleaguered investors, he has, accordingly, made cost savings a current focus. Since around this time last year, Ericsson has cut a net total of 5,791 jobs, nearly 6% of the prior amount. Cuts have even affected research and development, spending on which fell by 3%, to SEK11.6 billion ($1.1 billion).

The efficiency drive showed in Ericsson's closely monitored gross margin, which may also have benefited from what the company sometimes calls a "business mix shift." In the first quarter of last year, it was still engaged in a lightning-fast rollout of 5G networks in low-margin India. With much of that work now finished, the entire South Asia region contributed a much lower share of Ericsson's revenues. At company level, Ericsson reported a gross margin of 42.5%, up nearly four percentage points year-over-year.

Operating and net income, meanwhile, were fattened by the cost cuts as well as a 25% increase in licensing revenues, to about SEK2.5 billion ($230 million). Ericsson's operating margin rose to 7.7%, from just 4.9% a year earlier, while its net profit grew 66%, to roughly SEK2.6 billion ($240 million). This was all better than analysts polled by Reuters seemed to have been expecting. Ericsson's shares were up 6% in Stockholm this morning, although they have dropped 11% so far this year.

Long-suffering cloud and Vonage inertia

Unfortunately, Ericsson has little else to fall back on when the mobile kit market is in poor health. Its long-suffering cloud software and services business, which operates in an increasingly competitive market, has struggled for years to register any profit, and it made a SEK400 million ($36.5 million) loss for the recent first quarter – an improvement on the SEK900 million ($82.2 million) loss a year earlier – with sales down 3%, to SEK13 billion ($1.2 billion).

The enterprise unit is even smaller, generating just SEK6 billion ($550 million) in revenues, unchanged compared with the year-earlier quarter. Like cloud software and services, it is also unprofitable, registering an operating loss of SEK1.6 billion ($150 million). This unit, though, is positioned by Ekholm as the company growth story, housing the Vonage business that Ericsson bought for S6.2 billion in mid-2022.

It is pitching Vonage as a platform intermediary between developers and telcos. The broad idea is that developers would pay Vonage for access to a standardized set of application programming interfaces (API), allowing them to produce applications that tap into the supposedly valuable but largely undiscovered features of the world's 5G networks. Revenues generated by Vonage and others in this API game would then trickle down to operators, enabling them to invest in the network products that account for most of Ericsson's sales.

Yet Vonage's sales were down 5% year-over-year, to SEK3.7 billion ($340 million), and there are signs of investor impatience at the slow progress on network APIs. Company executives blamed sales weakness on the loss in the recent fourth quarter of a contract unrelated to network APIs and said Vonage – or Global Communications Platform, as Ericsson now calls it – has also been cutting back in some areas. Last year, moreover, Ericsson booked a $2.8 billion loss after writing down the value of Vonage.

"Our focus is on driving the global network platform for network APIs," said Ekholm. "That is where we are tremendously focused, and we are of course trying to manage the current business as prudently as possible, but it is really about the focus on executing the strategic rationale behind the acquisition." Shaping the market will take another one or two years, he said, before new applications begin to deliver long-term growth.

Yet one analyst on today's call expressed concern Ericsson is drifting, with no obvious catalyst for renewed investment by telcos. Consolidation in Europe would help, said Ekholm. "The industry has a problem with return on investment and we need to see in-market consolidation get approved." An average European operator serves about 4.5 million customers, he pointed out. Comparable figures are 95 million in the US, 300 million in India and 400 million in China, he reckons.

Of greater concern, though, is the decoupling of traffic growth from telco revenues, a problem Ericsson did not create but one Ekholm thinks his Vonage initiative could potentially fix. "We need to define that new type of use cases that unlocks those revenue streams," he said. "Otherwise, the customers – our operators – they're not going to see growing revenues. And if they don't see growing revenues, they're not going to invest."