Ericsson Shares Tumble Despite Profit Growth

Shares in Ericsson have dropped 6% during morning trading in Stockholm despite a sharp increase in profits during the final quarter of 2015.

The decline appears to reflect lingering concern about the equipment maker's prospects in emerging markets and the IP equipment sector, where it faces a major challenge from the recent merger between Nokia Corp. (NYSE: NOK) and Alcatel-Lucent (NYSE: ALU). (See Finn de Siècle for Alcatel-Lucent.)

Earlier this month, Deutsche Bank AG lowered its outlook for the Swedish company, saying it did not expect Ericsson AB (Nasdaq: ERIC) to report any growth in earnings per share this year. (See Ericsson Shares Drop on Analyst Downgrade.)

Ericsson's fourth-quarter results received a boost from continued progress on efficiency measures but noted ongoing sales pressure in the big markets of Russia and Brazil.

Net income rose by 68%, to 7 billion Swedish kronor ($820 million), compared with the same period last year, while sales grew by 8%, to SEK73.6 billion ($8.6 billion), on a reported basis, but were down 1% in constant-currency terms.

Table 1: Ericsson's Headline Results (SEK Billions)

Revenues from intellectual property agreements with other vendors and handset makers, including Apple Inc. (Nasdaq: AAPL), also contributed to bottom-line growth. "We have now signed deals with all the major mobile infrastructure and handset vendors, which is a great job by the intellectual property team," said Hans Vestberg, Ericsson's CEO, during a discussion with analysts.

The Swedish company, which still ranks as the world's biggest vendor of mobile broadband networks, faces a slowdown in maturing 4G markets as well as growing competition from China's Huawei Technologies Co. Ltd. and Finland's Nokia, whose recent takeover of Alcatel-Lucent has produced a player of similar size to Ericsson in revenue terms.

Vestberg told analysts the combination of mobility and cloud services in mature 4G markets would open up new business opportunities this year, citing virtualization and the overhaul of existing IT systems as important future developments.

Ericsson last year signed a major strategic deal with Cisco Systems Inc. (Nasdaq: CSCO) that could help it address such opportunities and counter the challenge posed by Nokia/Alcatel-Lucent in this area. (See Cisco + Ericsson: From Soup to Nuts.)

It has also been channeling resources into a number of targeted growth areas, which include IP networks, the TV and media business and OSS/BSS.

Despite Deutsche Bank's concerns, revenues from those markets grew at an impressive rate of 20% last year, to SEK45 billion ($5.3 billion), making up about 18.2% of Ericsson's total.

While the vendor witnessed sales declines in the emerging markets of Russia and Brazil, it flagged a partial recovery in mainland China -- whose operators are still rolling out 4G equipment -- as well as growth in India, South East Asia, sub-Saharan Africa and the Middle East.

"A big trend is the transition from 3G to 4G in emerging markets," said Vestberg. "There were 1 billion 4G subscribers last year and growth is being driven by that transition."

After a difficult start to 2015, Ericsson also saw some improvement in North America, its biggest regional market in revenue terms, with sales up 31% on a reported basis, to SEK8 billion ($940 million).

Nevertheless, investor concern was likely fueled by contraction in Ericsson's gross margin, which shrank to about 36% in the fourth quarter from 37% in the year-earlier period, excluding restructuring charges.

Chief Financial Officer Jan Frykhammar blamed the shrinkage on a "mix shift," with software accounting for about 23% of overall sales compared with 24% in the year-earlier period.

The development has evidently troubled analysts who expected to see an increase in software sales, as a percentage of the total, in line with developments in the targeted growth areas business.

Executives said the company was making good progress on its cost and efficiency program -- whose goal is to reduce annual operating costs by around SEK9 billion ($1.1 billion) in 2017, compared with 2014 -- but hinted that further measures may be necessary in future.

"We need to safeguard a certain type of profitability to invest and be competitive," said Vestberg in response to analyst questions. "We are prepared to look at volumes if we need to do something more -- we monitor that daily -- but it's important [first] to execute on what we are committed to."

Frykhammar expressed satisfaction with efforts to reduce operating expenses but told analysts there was more work to be done on the "margin side" with regard to cost of sales.

Longer term, Ericsson hopes to be at the forefront of the shift towards 5G networks, although it will be several years before operators start to make big commercial investments in this area, Vestberg acknowledged.

Operators including Verizon Communications Inc. (NYSE: VZ) in the US, SK Telecom (Nasdaq: SKM) and KT Corp. in South Korea, and MegaFon and Mobile TeleSystems OJSC (MTS) (NYSE: MBT) in Russia have previously flagged plans to begin trials of 5G technologies between 2017 and 2020. (See Russia's MTS to Trial 5G in 2018, Verizon CEO: US Commercial 5G Starts in 2017, Is This the 5G You're Looking For?, Verizon & Partners to Field Test 5G in 2016 and DoCoMo & EE Share 5G Visions.)

Swedish operator Telia Company last week joined that group, announcing a partnership with Ericsson aimed at developing 5G services for customer testing by 2018. (See TeliaSonera, Ericsson Join 5G Early Movers.)

— Iain Morris, , News Editor, Light Reading