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July 14, 2022
These are undoubtedly bearish days, but Ericsson CEO Börje Ekholm must sometimes wonder what he must do to please markets. The lurching drops in his company's share price over the past year have usually been triggered by revelations about wrongdoing in Iraq and the possible repercussions. But the fall of 11.5% when markets opened this morning came after Ericsson reported what – on paper, at least – looks like an impressive set of figures.
Net sales at the Swedish equipment maker were up 13% for the second quarter, to 62.5 billion Swedish kronor (US$5.9 billion), compared with the year-earlier period (growing 5% on a constant-currency basis). Ericsson's closely monitored EBIT (earnings before interest and tax) margin rose 1.1 percentage points year-on-year, to 11.7%. Net income shot up 19%, to SEK4.7 billion ($440 million), and Ericsson finished the quarter with a net cash position of SEK70.3 billion ($6.6 billion), an increase of 61%.
Markets seem to be in a fluster because Ericsson's core profitability was lower than predicted. Hit by rising costs and supply-chain disruption, its gross margin dipped 1.3 percentage points, to 42.1%. But this is a company that has undeniably coped far better than most other equipment makers with component shortages and inflation. As it tries to renegotiate contracts and pass on some of those costs, the main risk is that its biggest customers slash spending on network rollout.
Outside China, though, Ericsson now claims to serve more operators than just about any other vendor. Ekholm today put Ericsson's share of the market for radio access network (RAN) products at 39%, excluding China, telling analysts it has grown from just 33% when he took over in 2017. Fifty percent of 5G traffic outside China runs over Ericsson, he said, while 16 of the world's top 20 operators are using its 5G core.
Does the RAN market share mean Ericsson is now the world's biggest vendor outside China? "Absolutely," said Fredrik Jejdling, the head of the company's networks business. "The ambition was to grow 1 percentage point a year and we have been executing on that strategy." After several years of watching a geopolitical backlash against Huawei, and Nokia struggle with its 5G product competitiveness, Ericsson is now almost twice as big as its nearest competitor, insists Jejdling.
Product substitution ahead
With little visibility on when supply chains might recover, the broad strategy now is to fight short-term inflationary pressure through what Ekholm describes as "product substitution." As contracts come up for renewal, Ericsson believes it can increase prices by selling either technically superior products or additional features. If these promise cost savings for customers, Ericsson can justify the higher fees.
"The good thing is that when you can introduce new features you have a chance to discuss prices as well," said Ekholm on the results call with analysts this morning. "If you introduce products that lower energy costs, then we can have a discussion about the value of that product." Jejdling flags Ericsson's introduction of more lightweight radio units last year as an example. Because these units place less stress on supporting infrastructure, operators using them can reduce expenditure on steel or concrete reinforcements.
Accordingly, Ericsson continues to increase investment in research and development, a strategy it says has boosted gross margins by generating economies of scale for cutting-edge equipment. Quarterly R&D expenses increased a tenth year-on-year, to SEK11.5 billion ($1.1 billion), with Ericsson attributing the addition of about 400 employees since March (it had 101,459 in June) mainly to R&D recruitment. Ericsson Silicon, its in-house semiconductor business, remains a priority, but cloud RAN is another focus area today.
Figure 2: Ericsson's share price (SEK) (Google Finance)
Other telecom vendors certainly appear to have been harder hit by component shortages and related difficulties. Yet to report second-quarter results, Finland's Nokia blamed "supply chain constraints" for the 4% year-on-year drop (on a constant-currency basis) in first-quarter revenues at its mobile business, the rough equivalent of Ericsson's networks unit. Cisco, similarly, said that "China-related supply challenges prevented us from shipping products to customers at the levels we originally anticipated." Its first-quarter sales were the same as they were a year earlier.
"We haven't seen any material revenue impact," said Carl Mellander, Ericsson's chief financial officer, earlier today. "We have delivered on time and in the quantities required." Jejdling says this is partly down to management foresight – Ericsson began thinking about diversification and redundancy when US authorities first began penalizing Chinese vendors, he told Light Reading.
"We understood there were geopolitical headwinds," he said. "We thought there could be repercussions from China for ZTE and we consciously decided to build dual ecosystems where possible through dual vendors – to be involved with China and outside China. That was the first thing. Then came the shortage of critical components and we decided to make ourselves less susceptible to disturbances."
To some extent that has involved building up inventory, explaining a SEK1.3 billion ($120 million) charge for "changes in operating net assets," compared with a SEK200 million ($18.9 million) gain in the same quarter last year. While inventory levels are expected to fall later this year, Ericsson says it has been able to offset the additional costs largely through other working capital improvements.
Want to know more about 5G? Check out our dedicated 5G content channel here on Light Reading.
Still, a just-published report from Moody's on the outlook for telecom operators is a potential worry for Ericsson's investors. "The industry's pricing power is improving but we do not believe it is sufficient in many cases to insulate operators from cost pressures that range from labor to capital spending to leases," it said. The danger, clearly, is that operators cut their spending on suppliers.
Jejdling is sanguine, pointing out that Dell'Oro, a market research firm on which Ericsson relies for data, is still forecasting growth of 5% in RAN spending this year. "There is a case for investing in new technology to lower the cost of existing networks and reduce the carbon footprint," he said. Energy, however, accounts for as little as 5% of a typical operator's total operating costs, according to Moody's.
Struggling to cut jobs or suppress wages in the face of trade union opposition, some operators could instead look to extend the replacement cycles for equipment, according to the ratings agency. It would be a risky move in such an uber-competitive market, and one that might upset governments and regulatory authorities keen to see communications services upgraded. For now, Ericsson's confidence may be warranted.
— Iain Morris, International Editor, Light Reading
International Editor, Light Reading
Iain Morris joined Light Reading as News Editor at the start of 2015 -- and we mean, right at the start. His friends and family were still singing Auld Lang Syne as Iain started sourcing New Year's Eve UK mobile network congestion statistics. Prior to boosting Light Reading's UK-based editorial team numbers (he is based in London, south of the river), Iain was a successful freelance writer and editor who had been covering the telecoms sector for the past 15 years. His work has appeared in publications including The Economist (classy!) and The Observer, besides a variety of trade and business journals. He was previously the lead telecoms analyst for the Economist Intelligence Unit, and before that worked as a features editor at Telecommunications magazine. Iain started out in telecoms as an editor at consulting and market-research company Analysys (now Analysys Mason).
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