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A Nokia sale of mobile, especially to the US, would be nuts
Nokia's hiring of Intel's Justin Hotard to be its new CEO has set tongues wagging again about a mobile exit, but it would look counterintuitive and inadvisable.
It wasn't obvious Ericsson would carve out such a big chunk of India's 5G market when the first contracts were awarded last year. India's government and its operators had been hyping homegrown 5G. Reliance Jio, India's biggest telco, had bypassed Nordic vendors in 4G, opting entirely for South Korea's Samsung instead. But investors can be thankful Ericsson finally came through. Without India, the Swedish company would be in a far worse state.
Sales to southeast Asia, Oceania and India rocketed 138% for the just-ended first quarter, to about 13.9 billion Swedish kronor ($1.4 billion), compared with the year-earlier period, while no other big market area registered any growth whatsoever. Even with that performance, Ericsson's overall sales were unchanged on a constant-currency basis. And although total reported revenues were up 14%, to SEK62.6 billion ($6.1 billion), just about every profitability figure shrank. Net income dropped 46%, to SEK1.6 billion ($160 million).
Unfortunately, India, in the booting-up phase of 5G, is far less profitable than the relatively mature North American market. And the latter is currently about as vigorous as a drunk zombie. During the lockdown era of component shortages, Ericsson's customers appear to have built up stock they are now using for any network modernization. It means, of course, they are not spending as much with Ericsson. On a like-for-like basis, North American sales fell a quarter.
Figure 1: Ericsson CEO Börje Ekholm remains confident telco spending will recover.
(Source: Ericsson)
"Some customers are reducing the rollout pace somewhat, but the big effect is inventory adjustment after they built up large inventories when supply chains were tight," explained CEO Börje Ekholm on a call with equity analysts. He expects most of these inventory adjustments to be finished with this quarter.
Ekholm and his lieutenants are confident spending will rebound as smartphone consumers continue to gorge on data. "In the long term, we expect to see network investments recover as underlying traffic growth goes up at a high rate and more capacity is needed," he said. The rationale is that operators will have to spend more to reinforce their networks against that deluge of smartphone data.
But some analysts sound unconvinced. "In past cycles, we've seen that once a reduction in 4G happened it didn't recover till 5G came," said Sandeep Deshpande, an analyst with JP Morgan, on this morning's call. Capital intensity (spending as a percentage of revenues) has tended to be highest among telcos when they are investing in coverage expansion rather than capacity.
Nor does recovery necessarily mean a return to the 5G growth of previous years. Dell'Oro, a market research firm cited regularly in Ericsson's financial reports, expects there to be no sales growth in the global market for radio access network (RAN) products this year, with North America shrinking 7%. At its capital markets day last year, a Dell'Oro forecast shared by Ericsson showed the RAN market outside China would not grow before 2025 at the earliest.
Enterprise pivot
This largely explains Ericsson's pivot toward the enterprise as (hopefully) a new sales opportunity. It has splashed about $1 billion on Cradlepoint, an American maker of edge networking equipment for public-sector and business customers, as well as $6.2 billion on Vonage, a US software company that sells unified communications products. But neither has yet delivered on its promise (the Vonage deal closed as recently as July), and each has chewed further into those dwindling profits.
The Vonage deal, in particular, seems like an expensive move today. While it generated another SEK3.9 billion ($380 million) in revenues for the first quarter – reporting year-on-year growth in dollar terms of 14% – it also brought an additional SEK2.1 billion ($200 million) in selling and administrative expenses alone and was to blame for much of the profitability squeeze. Once a double-digit source of pride, Ericsson's operating margin shrank to just 4.9%, from 8.6% a year before.
Ericsson's rationale for the deal is a complicated one about exposing advanced network features to developers through application programming interfaces (API). Developers would access these APIs through the Vonage platform and supposedly pay for the privilege, presumably believing they will be able to sell a better product to their own customers thereafter. Ericsson expects to start generating revenues from these network APIs later this year.
But executives could not say what kind of growth they anticipate when pressed about it during this morning's call. "It is not a formal market yet," said Ekholm. "The platform we could show at Mobile World Congress is not fully industrialized yet, but at least it allows us to get this first feedback from developers, from enterprises, that this is a workable market and can actually make sense. That's why we're confident we'll start to see revenues this year. But it's too early to put a number on that for this year and into next and the year after."
Figure 2: Ericsson's share price (SEK) (Source: Google Finance)
Growth, however, would have to be astronomical if Vonage is to share these revenues with Ericsson's telco customers, as it has promised, and make a noticeable impact on telco sales. Ericsson's hope is that telco revenue growth stimulated by Vonage will persuade operators to spend more on the network products that account for most of Ericsson's sales (68%, for the first quarter) and all its profit (the networks unit made SEK6 billion ($580 million) in operating profit, while other units reported a SEK3 billion ($290 million) loss).
The current issue for Cradlepoint is that costs are booked for sales and marketing, as well as research and development, before revenues show up. "Cradlepoint has a subscription business model with upfront payment for an average three-year contract and revenues and gross profits are deferred and recognized monthly over the contract period," said Ekholm. "As we grow this will mean we'll generate a loss for accounting reasons but in the long term this business area has a very attractive profitability profile."
More restructuring
The other troubled and loss-making unit is the relatively new-look cloud software and services group, formed from the merger of digital and managed services. It had a good quarter for sales – up 5% year-on-year in constant-currency terms and 11% on a reported basis, to SEK13.4 billion ($1.3 billion) – but its operating loss widened 13%, to SEK900 million ($87 million).
Ericsson is guiding for breakeven this year, though. Its recently announced plan to cut about 8,500 jobs from the organization's payroll – roughly 8% of the workforce in December – should support that effort. It is also eyeing an additional SEK2 billion ($190 million) in annual run-rate cost savings by the end of 2023, which would boost the total to about SEK11 billion ($1.1 billion) without apparently necessitating further layoffs.
"The marginal increase from SEK9 billion [$870 million] to SEK11 billion doesn't involve any additional headcount reduction," confirmed Fredrik Jejdling, the head of Ericsson's networks business, on a call with Light Reading. "About 70% is in cost of sales and there we look at automation and ways of doing things differently across the supply chain, across service delivery, and 30% is in opex."
Protected from savings programs thus far, research and development functions are to be included this time around, but not without prudence. "In R&D, the ambition is to maintain a high level of output," said Jejdling. "That is our competitive edge. With the growth we have, we see opportunities for productivity improvements, but we won't sacrifice our position when it comes to competing on products. We will never do that."
Ekholm used the word "choppy" to describe the outlook this year, noting there is "poor visibility" in the market. That seems like a fair assessment of broader conditions. But Ericsson's own business is in flux as it moves deeper into the enterprise and software arenas, ultimately envisaging itself as a platform player. With the company's share price down about 7% at the time of publication, it may have to do a lot more work to persuade investors.
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— Iain Morris, International Editor, Light Reading
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