Profit Warning Slams Ericsson

Ericsson AB (Nasdaq: ERIC) saw its market value crash by more than a quarter Tuesday morning after it issued a profit warning for its third quarter and said market conditions in the mobile infrastructure sector would remain tough through 2008. (See Ericsson Warns on Q3.)

The vendor's share price fell by more than 27 percent to 19.18 Swedish Kroner ($2.97) on the Stockholm exchange this morning after it announced preliminary third-quarter financials "below the company's own as well as current market expectations."

Ericsson expects third-quarter revenues to be SEK43.5 billion ($6.7 billion), operating profit to be SEK5.6 billion ($866 million), gross margin to drop to 35.6 percent, and net income to fall to SEK4 billion ($619 million). (See table below for year-on-year and sequential comparisons.)

Table 1: Ericsson's Q3 Slump: Annual and Sequential Comparisons
Swedish Kroner, billions Q3 2007* Q3 2006 Change Q2 2007 Change
Net sales 43.5 41.3 6% 47.6 -9%
Gross margin 35.6% 38.2% - 43% -
Operating income 5.6 8.8 -36% 9.3 -39%
Operating margin 12.9% 21.1% - 19.4% -
Operating margin excl. Sony Ericsson 9% 16.5% - 16.4% -
Income after financial items 5.6 8.9 -37% 9.3 -40%
Net income** 4 6.2 -36% 6.4 -38%
* Q3 2007 numbers are preliminary
** Attributable to stockholders of the parent company, excluding minority interest
Source: Ericsson

Financial analysts had expected an operating profit of around SEK8.9 billion ($1.4 billion).

The company's full third-quarter earnings report will be published on October 25.

The shortfall is down to factors affecting the mobile infrastructure part of the vendor's Networks business unit, noted Ericsson's CEO, Carl-Henric Svanberg.

The company's other business units –- professional services and multimedia (billing, messaging, IPTV, and so on) -– are performing well, he noted. (See table below.)

Table 2: Ericsson Q3 2007: Networks Takes a Hit
Swedish Kroner, billions Q3 2007* Q3 2006 Change Q2 2007 Change
Networks sales 28.5 29.2 -2% 33.7 -15%
Networks operating margin 8% 9% - 19% -
Professional Services sales 11 8.7 26% 10.3 7%
Professional Services operating margin 15% 12% - 15% -
Multimedia sales 4 3.1 31% 3.7 10%
Multimedia operating margin 1% 3% - 0% -
* Sales from acquired companies included from date of acquisition. All Q3 2007 numbers are preliminary
Source: Ericsson

But that isn't much compensation. "This is a day to be humble, concerned and disappointed," said Svanberg during a Webcast press conference this morning. "This is a dynamic business environment... We should have talked more about it and understood more about it. We have underestimated the impact" of changes in the market, added the CEO.

So at least he's not absolving himself of any blame.

The CEO also said that fourth-quarter sales are expected to be between SEK53 billion ($8.2 billion) and SEK 60 billion ($9.3 billion), with an operating margin in the "mid-teens," compared with 22.7 percent in the fourth quarter of 2006.

The operating margin in the second quarter this year was 19.4 percent, and is expected to be 12.9 percent in the third quarter.

Blame it on the mix
So what's the problem in Ericsson's mobile networks business?

Basically, sales are lower than expected, and the mix of sales is weighted more towards the low margin products Ericsson delivers for new network builds. The company's mobile business includes more new network rollouts, in India for example, and there has been a slowdown in network expansion and network upgrade projects, particularly in North America and Western Europe. Network upgrades in particular are more profitable deals because they involve high-margin software upgrades. (See BSNL Awards $1.3B GSM Contract.)

New network build business will dominate for the rest of 2007 and through 2008, noted the CEO.

Then there's the ongoing market pricing pressure that has been affecting Ericsson's main mobile infrastructure rivals, Alcatel-Lucent (NYSE: ALU) and Nokia Networks . (See AlcaLu: Pressure Is Still On, Pressure Grows on ALU, Instant Revamp for Nokia Siemens, AlcaLu Cuts 2007 Outlook by $1.25B, AlcaLu's Russo: We're Under Attack!, and Nokia Siemens Suffers Merger Blues.)

Svanberg says prices are being eroded at about 3 percent per quarter, but that Ericsson has ongoing cost-cutting measures that counter that particular factor.

Still the big hitter
Ericsson still commands a major advantage in terms of its mobile infrastructure (GSM and 3G) market share and corresponding economies of scale.

When Nokia and Siemens joined forces in April this year, Ericsson had about 35 percent market share, NSN around 30 percent, and AlcaLu about 20 percent.

The CEO said he has been focused on extending Ericsson's market share in the past year, and now, based on numbers from external sources, commands around 45 percent to 47 percent of the market, while NSN has around 27 percent and AlcaLu around 13 percent.

"We have pushed on market share because it is so strategic. Now it's time to leverage our position, so next year there's going to be less focus on gaining market share," said Svanberg.

He also sees the current slowdown in network upgrade business as a temporary blip -– "operators are healthy, networks are loaded, traffic is increasing" -– and that the current high volumes of new network builds will result in good future business. "They build greater footprint for future network expansions and upgrades," noted Svanberg.

Not just bad for Ericsson
Nomura International analyst Richard Windsor believes that although this is "a bad profit warning... the fundamentals of the mobile industry remain intact as new subscribers keep on joining the network and we are seeing the first signs of a lift-off in data usage."

In a research note issued this morning he added: "Sooner or later operators will have to resume spending on both capacity upgrades and software."

Windsor, therefore, expects Ericsson to recover, but "how long it takes to regain its former glory remains to be seen."

He also notes that the market conditions hitting Ericsson are bad news for AlcaLu, NSN, and Nortel Networks Ltd. . "This is clearly a market issue and not limited to Ericsson," concludes the analyst.

That was reflected in share price movements during the European business morning. Alcatel-Lucent saw its share price drop by €0.40, nearly 6 percent, to €6.50, while Nokia Corp. (NYSE: NOK), a 50 percent stakeholder in NSN, saw its share price fall by nearly 3 percent to €24.87.

— Ray Le Maistre, International News Editor, Light Reading

desiEngineer 12/5/2012 | 3:00:43 PM
re: Profit Warning Slams Ericsson So perhaps all you ALU naysayers can take back a little of what you've been saying? ERIC took more of a hit in one day than ALU over the last year - and they didn't go through merger blues. And except for some recent irrational exuberance because of wins in India, ERIC and ALU pretty much track each other over the last one year. I guess the wind is pretty much knocked out now.

Perhaps the wireless market is cut-throat, and perhaps ERIC did buy their way into accounts.

It's not necessarily a bad thing to underbid in order to secure the business for the future, but if all you do is look at numbers, the wireless market is crappy for all vendors.

ipee_on_everything 12/5/2012 | 3:00:43 PM
re: Profit Warning Slams Ericsson So Ericsson are waiting for the carriers to be ready to spend some cash ? That doesn't seem to align with the thread running under "Upheaval at BT's 21CN" where the rumour was that Ericsson have failed to deliver and that's causing delays...I guess if Ericsson can't deliver, then the cash won't arrive.
paolo.franzoi 12/5/2012 | 3:00:40 PM
re: Profit Warning Slams Ericsson
Anton Wahlman turned out a note today blaming the proliferation of WiFi for the slowing growth of cellular infrastructure. Right or wrong, it is an interesting read.

telcofortwo 12/5/2012 | 3:00:39 PM
re: Profit Warning Slams Ericsson I partially agree. However, consider this:

1. Yes, there is pressure across the board eating the vendors' margins. However, Ericsson has lower margins and increasing market share. Lucent has decreasing margins share and a shrinking market share based on CDMA, that's been having negative growth in regions other than North America, where they are going to GSM (sacrificing quality and a superior technology in favor of economies of scale).
2. Crying foul because of the market pressures is childish and laughable: If you are in a competitive environment with pressure, will you wait for merging competitors to be in full strength to resume the competition?

I am not a LU hater. I would like for them to succeed, but it is looking increasingly difficult.

bollocks187 12/5/2012 | 3:00:34 PM
re: Profit Warning Slams Ericsson I cannot see the logic as WiFi networks are different that cellular infastructure. People who build wifi do not build cellular ?
standardsarefun 12/5/2012 | 3:00:23 PM
re: Profit Warning Slams Ericsson and also there is so much noise these days about WiFi mesh projects geting dropped or slowed down. Nope, I don't get this either
paolo.franzoi 12/5/2012 | 3:00:23 PM
re: Profit Warning Slams Ericsson
Well, his point was that UMA was lowering the need for additional infrastructure.

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