Ericsson Suffers Margin Crunch

Ericsson AB (Nasdaq: ERIC) suffered a significant hit to its margins during the fourth quarter of 2011, with the company attributing the squeeze to a shift in the mix of its business.

The mobile networks market leader reported fourth-quarter revenues of 63.7 billion Swedish kronor (US$9.43 billion), up 1 percent compared with a year earlier thanks to a much stronger performance from its Global Services division, which reported revenues of SEK27 billion ($4 billion), up by 18 percent year-on-year.

But its gross margin slipped 6.8 percentage points to 30.2 percent, while its operating margin excluding joint ventures dipped by 7 percentage points to 6.4 percent.

The vendor blamed "weaker development in Networks, as well as an expected gross margin impact from a changed business mix with more coverage projects, modernization projects in Europe, and a higher services share" for its gross margin slump. Revenues for the Networks division were down by 9 percent year-on-year to SEK33.3 billion ($4.9 billion).

And the ongoing financial woes at the vendor's joint ventures, handset firm Sony Ericsson Mobile Communications (soon to be offloaded) and chip-maker ST-Ericsson , contributed to a 66 percent slump in Ericsson's fourth-quarter net income to SEK1.5 billion ($222 million). (See ST-Ericsson Loses $231M in Q4, Sony Ericsson Reports Q4 Loss and Euronews: Sony Buys Ericsson Out of Handsets.)

Table 1: Ericsson Q4 2011 Key Financials

In billions of Swedish kronor	Q4 2010	Q4 2011	Y/Y change	Q3 2011	Q/Q change
Revenues	62.8	63.7	1%	55.5	15%
Gross margin	36.6%	30.2%	Decrease of 6.4 percentage points	35.0%	Decrease of 4.8 percentage points
Operating margin excluding joint ventures	13.4%	6.4%	Decrease of 7 percentage points	11.3%	Decrease of 4.9 percentage points
Net income	4.4	1.5	-66%	3.8	-61%
Source: Ericsson

There's little hope of margin improvement any time soon. In the company's earnings press release, CEO Hans Vestberg noted that in the short term, "we expect operators to continue to be cautious with spending, reflecting factors such as macro economic and political uncertainty. We will continue to execute on our strategy which means that the business mix, with more coverage and network modernization projects than capacity projects, will prevail short-term."

The vendor added: "All modernization projects that Ericsson has won have started by the fourth quarter 2011. The network modernization projects in Europe, with their lower margins, fully impacted the fourth quarter. Since average project duration is expected to be 18-24 months, the impact is expected to prevail for a couple of more quarters."

That assessment, and the fact that fourth-quarter revenues and margins were all below market expectations, sent investors running: Ericsson's share price slumped by 14.3 percent to SEK 58.7 in morning trading on the Stockholm exchange.

In terms of regional sales, revenues from North America suffered a 20 percent year-on-year dip due to lower network equipment sales. "The networks business developed slower in the second half of 2011 after a period of high operator investments in network capacity along with operators focus on cash flow management as well as negative impacts from operator consolidation," the vendor noted.

Table 2: Ericsson Q4 2011 Revenues by Region

Revenues in billions of Swedish kronor	Q4 2010	Q4 2011	Change
North America	14.1	11.2	-20%
Latin America	6.1	7	16%
Northern Europe and Central Asia	4.8	3.8	-22%
Western and Central Europe	5.9	5.3	-11%
Mediterranean	6.9	8.2	19%
Middle East	4.6	5.2	12%
Sub-Saharan Africa	2	3.2	59%
India	2.8	1.5	-46%
China and North-East Asia	9.5	10.9	15%
South-East Asia and Oceania	3.9	4	2%
Other	2.2	3.3	57%
Total	62.8	63.7	1%
Source: Ericsson

For the full year, Ericsson reported a 12 percent increase in revenues to SEK226.9 billion ($33.5 billion) while net income grew at the same rate, though gross and operating margins took a hit.

Table 3: Ericsson Full Year 2011 Key Financials

In billions of Swedish kronor	2010	2011	Y/Y change
Revenues	203.3	226.9	12.0%
Gross margin	38.2%	35.1%	Decrease of 3.1 percentage points
Operating margin excluding joint ventures	12.0%	9.6%	Decrease of 2.4 percentage points
Net income	11.2	12.6	12%
Source: Ericsson

The company noted that its focus on mobile broadband, services and Service Provider Information Technology (SPIT) had paid off during 2011. "We have further strengthened our market position in mobile networks. With 70 new managed services contracts during 2011 we are confident of our strong offering and market leadership. With the acquisition of Telcordia, now concluded, we have also gained a leadership position and skilled people in the important areas of operating and business support systems," stated Vestberg.

Revenues were boosted by stronger regional sales in China and North-East Asia, Latin America and Northern Europe and Central Asia in particular.

Table 4: Ericsson Full Year 2011 Revenues By Region

Revenues in billions of Swedish kronor	2010	2011	Change
North America	49.5	48.8	-1%
Latin America	17.9	22.0	23%
Northern Europe and Central Asia	12.2	15.2	25%
Western and Central Europe	19.9	19.0	-4%
Mediterranean	22.6	23.8	5%
Middle East	15.1	15.5	2%
Sub-Saharan Africa	9.2	10.2	11%
India	8.6	9.8	13%
China and North-East Asia	26.0	38.2	47%
South-East Asia and Oceania	14.9	13.9	-7%
Other	7.4	10.6	41%
Total	203.3	226.9	12%
Source: Ericsson

— Ray Le Maistre, International Managing Editor, Light Reading