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Sharp growth in America is at odds with sales declines in other regions, and Ericsson's $14 billion contract with AT&T still looks like a one-off.
As the real winter approaches for people of the northern hemisphere, a 5G market that had looked frozen stiff for several quarters finally has the color back in its cheeks. This time last year, Ericsson was grumbling about an inventory buildup in North America, where telcos relied on stockpiles amassed after the pandemic to upgrade their networks. Regional sales halved for the third quarter of 2023. A year later, they have enjoyed a dramatic rebound, boosting Ericsson's share price by 10% in Stockholm today at the time of publication.
It is thanks to that 51% rate of year-over-year growth (55% on a like-for-like basis), lifting North American revenues to 20.4 billion Swedish kronor (US$2 billion), that Ericsson was able to limit its overall sales decline to just 4% (as little as 1%, like for like), reporting turnover of SEK61.8 billion ($6 billion). Ericsson also returned to profitability, reporting net income of SEK3.9 billion ($380 million), after impairment charges a year before led to a SEK30.5 billion ($2.9 billion) loss. The uncertainty for analysts is how much of the North American improvement was down to AT&T.
Back in December, Ericsson hailed a new $14 billion contract with the US telco giant, describing it as the biggest deal in its history. But it was not prompted by an important upgrade or rollout of a new mobile generation, as such deals often are. Instead, AT&T saw fit to replace Nokia, which had previously served about one third of its footprint, with Ericsson, which already had the other two thirds.
AT&T justified the move to what Nokia subsequently described as a "one-vendor" arrangement on the grounds that Ericsson would supply an "open" radio access network (RAN) of swappable parts, allowing the operator to introduce other vendors in future or even replace Ericsson in specific areas. The RAN would also be hosted partly in the cloud and more "programmable" than its previous infrastructure, it said. But there are no signs other telcos are about to follow its example.
Börje Ekholm, Ericsson's CEO, was also not prepared to comment on whether AT&T's investments had compelled T-Mobile US and Verizon, its two big rivals, to undertake similar "modernization," when quizzed on the topic by a Deutsche Bank analyst earlier today. "That is a very interesting question that I think we'll not comment on specifically for the simple reason that it is a competitive market, and we should try to be neutral in any comments about the market," he said on the company's third-quarter earnings call.
"But what I will say is that the increase in North America is broader than just one contract," he insisted. "Unfortunately, you will have to make your own interpretations." Among equipment vendors including Ericsson and Nokia, the hope is that data traffic growth will eventually force operators to invest in 5G coverage and capacity. Yet many analysts think growth rates are slowing, and deployed 5G networks have so far handled increased usage well. Nor have 5G investments produced any meaningful sales growth for telcos.
Still miserable elsewhere
This "5G winter," as it has been described, explains why Ericsson's sales in other parts of the world – where there is no $14 billion contract to replace a rival – have plummeted. Strip out the North American contribution, and Ericsson would have reported a 23% drop across all other markets, to SEK41.4 billion ($4 billion). While North America was described as an "early adopter" of technology in its earnings report, there is scant chance of a big sales revival elsewhere in subsequent quarters. The latest forecast from Dell'Oro, a market research firm trusted by Ericsson, is that global RAN sales will fall 8% to 10% this year. North American is the only major region where it expects to see growth.
If it was not just about AT&T, then what is the reason for other US growth? Noting that an inventory correction has probably run its course, Fredrik Jejdling, the head of Ericsson's mobile networks business group, attributes some of the growth to interest in fixed wireless access (FWA), used to provide residential broadband in areas that are hard to reach with fiber. "That is also driving a lot of traffic in the networks right now," he told Light Reading. "For our customers, they reutilize the capacity in the midband and get a discrete revenue source from that."
But there are few other places where 5G-delivered FWA has taken off or has such a big opportunity as it does in North America, vast swathes of which remain poorly served by fixed-line technologies. "So far it is not the broad market that fiber is, at least not in Europe," said Ekholm on the earnings call. "Europe is still a fiber continent, I would say. It's built on glass works."
The other factor to bear in mind about North America is that spending is still well below the levels seen in previous quarters. "We have to remember that 55% depends on how low the denominator is," said Jejdling, referring to the recent growth rate in North America. "It was quite low last year." Back in the equivalent period of 2022, Ericsson recorded North American revenues of SEK26.5 billion ($2.6 billion), a figure that is about 30% higher than its sales number for the most recent quarter.
Margin call
Nevertheless, despite the overall sales decline, Ericsson's profitability has continued to improve. Its gross margin soared by 7.2 percentage points year-over-year, to 45.6%, for the recent third quarter, and its adjusted operating margin (ignoring impairment charges), rose 5.9 points, to 11.9%. Some 2,000 jobs were scrapped in the quarter, leaving Ericsson with precisely 95,984 employees on September 30, it said. The company employs 15,480 fewer people than it did when Ekholm took charge at the start of 2017.
Ericsson has, however, ringfenced its research and development activities from cuts and its spending in that area was up 10%, to roughly SEK13.1 billion ($1.3 billion), compared with the year-earlier quarter. "We invest significantly in R&D to stay ahead of the curve," said Jejdling. "That means we need to be first with equipment that brings down the cost performance for our customers."
That profitability rose so much when Ericsson is swapping out Nokia's hardware in AT&T's footprint may come as a surprise, especially given earlier speculation that it had bid aggressively for the deal and would shoulder some of the cost burden. But the US has long been seen as one of the most profitable markets for equipment vendors, regardless of the work they are doing. And recent margin improvements probably owe something to the shift in business from Asia to North America. Ericsson also pocketed SEK3.5 billion ($340 million) in revenues from highly profitable licensing activities for the quarter, a 25% year-over-year increase.
What's encouraging for shareholders is the indication from Ekholm that markets like India are becoming more profitable than they used to be. "The one thing that we have worked on a lot over the past several years – but even more so since it was clear India would roll out – is to make sure we have a global track for our products as much as possible," he said in discussing the margin profile of Indian 5G business. "If this would have been ten years ago, we would have been struggling on gross margins." The next challenge is to do the same for global sales.
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