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Ericsson Shares Hit by US Merger Uncertainty, Cost ChallengesEricsson Shares Hit by US Merger Uncertainty, Cost Challenges

Swedish kit vendor says business fundamentals remain strong but warns costs will rise this year.

Iain Morris

January 24, 2020

7 Min Read
Ericsson Shares Hit by US Merger Uncertainty, Cost Challenges

Ericsson swung to a fourth-quarter profit after reporting losses in the year-earlier period despite a slowdown in sales growth blamed on spending cuts by T-Mobile and Sprint as they continue battling opposition to their planned merger.

The Swedish equipment maker, whose rivals include China's Huawei and Finland's Nokia, said like-for-like revenues were up just 1% for the final quarter of 2019 as it reported a net profit of 4.5 billion Swedish kronor ($470 million), compared with a loss of SEK6.5 billion ($680 million) a year earlier. Reported sales grew 4% year-on-year, to SEK66.4 billion ($7 billion).

The 1% rate of organic revenue growth represents a decline compared with the increase of 4% a year earlier and raises questions about sales momentum at Ericsson as it continues to push for a leading international role in the deployment of new 5G networks.

While Ericsson did not specifically call out T-Mobile and Sprint in its latest earnings report, CEO Börje Ekholm said the "uncertainty related to an announced operator merger" was responsible for North America having "the lowest share of total sales for some time."

Figure 1: Ericsson CEO Borje Ekholm remains confident the Swedish vendor can hit financial targets. Ericsson CEO Börje Ekholm remains confident the Swedish vendor can hit financial targets.

The US service providers have been struggling to secure approvals for their deal, which opponents say will lead to job losses and a less competitive US mobile market. T-Mobile and Sprint have insisted the merger will not harm jobs and is necessary to speed up 5G rollout in the US.

Figures show that Ericsson's sales in North America dropped 4% for the fourth quarter, to SEK17.4 billion ($1.8 billion), compared with the year-earlier period, accounting for a little more than one quarter of total revenues.

The region made the second-biggest contribution to overall sales after Europe and Latin America, and growth in other markets was not enough to prevent a fall in the rate of sales growth compared with the fourth quarter of 2018.

Ericsson's share price fell 8% in Stockholm this morning after results missed analyst expectations, but executives at the company said underlying trends remained positive. "We have good overall momentum in 5G, and we are progressing in the right direction," said Fredrik Jejdling, the head of Ericsson's networks business, during a call with Light Reading. "We offset the relative decline in the US in other markets such as Japan and Saudi Arabia."

Overall sales were up 4% on a like-for-like basis for the whole of 2019 and Ericsson will be hoping for continued improvements in 2020, relying on initial forecasts by market-research firm Dell'Oro that industry sales of radio access network products will rise 4% this year. Ericsson grew RAN sales 6% in 2019 and now has 79 commercial 5G agreements, according to Jejdling. Its products are today powering 24 live 5G networks, he says.

On another positive note, the company is already in touching distance of its 10% operating margin target for 2020, reporting a margin of 9.7% for 2019, up from 4% in 2018.

That recovery follows restructuring efforts under Ekholm, who took charge of the company three years ago with a mission to restore profitability and concentrate resources on the development of network products.

Ericsson has subsequently slashed thousands of jobs and sold non-core activities, including some of its cloud and media assets. But the moves look to have paid off: After losing business to Huawei during the 4G era, the Swedish firm now claims to be growing its market share and has replaced its Chinese competitor as a network supplier to some operators.

Huawei has faced a backlash in some markets fueled by US authorities who say its products could include "backdoors" for China to snoop on other countries or even cripple networks.

Ericsson, however, denies the campaign has buoyed its own business, attributing recent gains to investments in research and development and a more competitive line-up of products. "We don't see any material impact of some suppliers having more challenges," says Jejdling. "As a matter of fact, it is a concern. The RAN [radio access network] market in Europe is not growing because the investment climate is affected by this uncertainty."

Cost pressure
While Jejdling declined to speculate on reasons for today's share price movements, some investors may have been unsettled by guidance that operating costs are likely to rise this year due to investments in further efficiency improvements, the integration of Kathrein, an antenna specialist that Ericsson acquired last year, and provisions related to its recent settlements with the US Department of Justice (DoJ) and Securities and Exchange Commission (SEC).

Ericsson was hit with a fine of about $1 billion for bribery and corruption that took place in several countries between 2000 and 2016. As part of its settlement, it will retain an independent compliance monitor for three years and has been working with a compliance advisory firm on changes to corporate governance.

In its push for market share, Ericsson has also been accepting network contracts that initially come with lower margins, insisting the strategy will pay off in the long term.

The operating margin at its networks business shrank to 14.4% for the fourth quarter, compared with 16.5% a year earlier, but Ekholm says the expected increase in operating costs this year will not jeopardize Ericsson's financial targets. By 2022, it is aiming for an operating margin of between 12% and 14%.

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Quizzed about costs during a phone call with analysts, Carl Mellander, Ericsson's chief financial officer, declined to provide guidance for operating expenditure this year but said the figure was likely to be "a bit" higher than the SEK54 billion ($5.7 billion) that Ericsson spent in 2019. "Our ambition is to grow the topline more to decrease the percentage of opex to net sales," he said.

On the sales front, the company could see a boost from the imminent award of 5G contracts in China. With most contracts handed out to domestic suppliers, Ericsson today claims only a 10% share of China's mobile infrastructure market and is hopeful it can improve this with the transition to 5G networks.

"There have been some delays, but we expect to see certain purchasing rounds in late Q1 and early Q2 to give some evidence of where this will ultimately end," said Jejdling when asked for an update on 5G contract awards in China. "We have made some assumptions in 2020 planning and that includes a bigger footprint. China is important for our 2022 targets, obviously."

Ericsson hailed continued progress with the turnaround of its small but underperforming digital services unit. Once restructuring charges are stripped out, that unit broke even for the final quarter of 2019 after racking up an operating loss of SEK3.5 billion ($370 million) a year earlier. Reported sales were up 1% year-on-year, to SEK13.2 billion ($1.4 billion).

The even smaller managed services business recorded fourth-quarter sales growth of 2%, to SEK7 billion ($730 million), and turned in an operating profit of SEK300 million ($31 million) -- roughly the same as for the year-earlier period.

Ericsson also reported sales of SEK1.7 billion ($180 million) at its "emerging business" unit, down from SEK2.3 billion ($240 million) a year earlier. The decline was blamed on the divestment of MediaKind, a media software business, in February last year. Meanwhile, the operating loss at the emerging business unit narrowed to SEK400 million ($42 million) from SEK1.9 billion ($200 million) a year earlier thanks to the "partial release of a previously made cost provision related to the resolution of the US SEC and DoJ investigations."

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— Iain Morris, International Editor, Light Reading

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About the Author(s)

Iain Morris

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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