Its latest numbers show the importance of emerging markets and the need to cut costs from the Marconi business

July 21, 2006

4 Min Read
Emerging Markets Boost Ericsson

Ericsson AB (Nasdaq: ERIC) announced financial results pretty much in line with market expectations today, but behind the numbers lie some interesting pointers about the state of the mobile infrastructure business and the aftermath of a major acquisition. (See Ericsson Reports Q2.)

First, the numbers. The company generated net income of 5.7 billion Swedish Kronor ($782 million) from revenues of SEK44.2 billion ($6 billion).

Overall, this is a "reasonable set of results that indicate Ericsson is continuing to make the most of the market opportunities," stated Nomura Securities analyst Richard Windsor in a research note today.

He added that the operating margin of 18.7 percent was higher than expected because of a good performance in the vendor's handset joint venture Sony Ericsson Mobile Communications and ongoing cost cutting, "but we are not convinced that this is sustainable."

Windsor reckons that "mobile infrastructure is holding up better than we have anticipated largely, we suspect, due to strong net adds in emerging markets," but added that "operating margins of 13 percent to 15 percent is where the fundamentals will settle once the emerging market bonanza dies down."

That "bonanza" is alive and kicking at the moment, though. (See Africa Racks Up Mobile Subs , FT Eyes Emerging Market M&A, Emerging Markets See More Mobile M&A, Vodafone Unveils Convergence Plans, Indian Operator Outsources to Finland, and India's Telecom Market Accelerates.)

Ericsson CEO Carl-Henric Svanberg said during this morning's quarterly press conference that "80 percent of growth is coming from emerging markets" currently, and went on to note that Ericsson's largest geographic region by revenues in the second quarter was Central and Eastern Europe, Middle East, and Africa.

Sales in that region grew 24 percent compared with a year earlier to SEK12.9 billion ($1.77 billion), with Pakistan, Russia, Saudi Arabia, and South Africa picked out as high growth countries, with most of the sales coming from 2G GSM systems rather than the latest 3G infrastructure. (See Ericsson Wins Saudi Deal, Ericsson Demos HSDPA, and Ericsson Signs MTS Contract.)

The vendor also noted a 55 percent year-on-year revenue hike in Asia/Pacific to SEK11.2 billion ($1.5 billion), with Svanberg citing strong sales in China in the second quarter. (See Ericsson Lands $290M.)

Ericsson isn't the only beneficiary of the mobile growth in emerging markets. On Thursday, Nokia Corp. (NYSE: NOK), announcing its latest financials, noted that sales of wireless network equipment "were positively impacted year on year by Nokia's improved position in the emerging markets, and increased in all regions except Latin America and Europe. Net sales more than doubled year on year in Middle East & Africa." (See Nokia Reports Q2.)

But there's another factor hitting Ericsson's margins –- Marconi.

When Ericsson acquired Marconi in October 2005, the Swedish vendor said its plans were to maintain a 20 percent operating margin in the long run, even though Marconi's margins were significantly lower. (See Ericsson Buys Bulk of Marconi and Optical, Access Help Marconi.)

But Ericsson's fixed line business, which, effectively, is Marconi, is losing money. Second quarter revenues were SEK2.5 billion ($343 million), generating an operating loss of about SEK200 million ($27.4 million).

Nomura's Windsor also noted that gross margins, at 42 percent, were slightly weaker than expected. "This was explained by the increasing contribution of services and fixed line revenues, both of which have lower gross margins," noted the analyst.

Ericsson CEO Svanberg says the situation is being addressed, and that the numbers don't tell the whole story. He says operating results will improve following the current round of staff cuts. Ericsson took 6,600 Marconi staff on board in January, but about 1,000 of those "have been identified for lay-offs," and another 600 staff that are surplus to requirements will be chosen during the current quarter.

In addition, Ericsson has implemented supply chain changes that will reduce costs in 2007, and Svanberg says there's a growing "order backlog" for Marconi gear. He expects to see an improvement in the fixed line business "in the Autumn."

The CEO also noted that as Marconi's product lines –- VOIP systems, broadband access equipment, and transmission gear -- are integrated into Ericsson, it's hard to accurately track exactly which sales should be attributed to the former Marconi business.

That accounting grey area will affect Alcatel (NYSE: ALA; Paris: CGEP:PA) and Lucent Technologies Inc. (NYSE: LU), and Nokia and Siemens Communications Group too once they have completed their respective merger processes, reckons Svanberg. (See Alcatel, Lucent Seal Deal and Nokia, Siemens Create Networks Giant.)

Ericsson's share price is trading down nearly 2 percent at SEK22.60 on the Stockholm exchange Friday morning.

— Ray Le Maistre, International News Editor, Light Reading

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