In its third quarter, Ericsson reported a year-on-year drop in organic sales for the first time for five quarters. The vendor’s results have been on a gradual but steady upward path for a couple of years under the CEOship of Börje Ekholm, but its Q3 fallback reflects several key industry trends.
These are primarily the loss of market share in China, as a result of geopolitical tensions, which Ekholm warned investors about in the second quarter results discussion; and the pandemic-related supply chain disruption.
Both challenges have had limited visible impact on the Swedish firm’s financials until now, and even in Q3, sales only fell by 1% on a constant currency and like-for-like basis, to SEK8.6bn ($1bn), while net profit rose by 4% to $673m.
A third quarter operating loss of SEK800m ($92.9m) was blamed on higher R&D investments to support the 5G core, rather than negative trends, while gross and EBIT margins were up slightly (to 44% and 15.7% respectively). CFO Car Mellander maintained previous guidance that Ericsson would break even in the fourth quarter.
Ekholm blamed the sales decline mainly on retaliatory measures that followed “decisions Sweden took to exclude Chinese vendors in the build-out of 5G networks in Sweden” (decisions that Ericsson lobbied against). He said the supply chain issues, as well as a fall in managed services contracts, would both continue to weigh on performance in Q4, and of course, the drastic decline in sales to China may be a permanent factor.
“As a consequence of the loss of sales in China, we have to rightsize our sales and delivery organizations in China, and that will start this quarter,” said Ekholm. Sales in North East Asia fell by 33% “due to the significantly lower market share in Mainland China”, Ericsson said.
In 2020, Ericsson made revenues of $2.9bn in China, up by $400m on the previous year, and that equated to 10% share of mobile RAN and core. That share was reduced to just 3% in the second phase of China’s 5G contracts, according to local estimates. In Q3, sale to China were down 74% year-on-year, an even steeper drop than in Q2, when they fell by 63% year-on-year. For the first three quarters of 2021, Chinese revenues for Ericsson Networks and for Digital Services (which houses the 5G core) have dropped by 23% year-on-year.
The losses in China were partly offset by growth in western regions, in particular. European sales rose by 5% and Latin America sales by 29%, while North America sales increased by 13% during the quarter. But sales in Southeast Asia, Oceania and India decreased 16% year-on-year, and Middle East and Africa sales by 10%. The strongest territories tend to be those where Huawei has been restricted in many countries and so Ericsson has an increased opportunity to grow share. Whether these gains will fully compensate for a potentially long term loss of Chinese business is a question that investors will be asking in the years ahead as the 5G game plays out.
Ekholm insisted, in analyst discussions, that Ericsson was not giving up on China, though it would restructure – with potential job losses – to account for a smaller operation there. “I like to think that when you lose a contract, you start to fight to win it back. It’s the same thing with China,” he said. “I do believe we have a chance to win back the trust to deliver products in the future.”
As for the supply chain disruptions, Ekholm boasted that Ericsson and its customers had felt very little impact until now, and that “we’ve taken very proactive efforts and we have built inventory… but late in the third quarter we saw some impact on shortages of individual components that resulted in the loss of some sales.” He added: “We have reasonably good visibility, and we have quite good management of the supply chain. I wouldn’t exaggerate the risk going forward, but it poses some threat.”
Ekholm and Mellander were keen to emphasize areas of growth, even if, for now, they will not offset the reduction in China. One is the Emerging Business unit, where the Cradlepoint enterprise wireless activity, acquired last year, is growing as Ericsson expands the smaller organization’s primarily north American base internationally. The business reported a 26% year-on-year increase in revenue to $232m in Q3.
By contrast, Ericsson’s Networks business unit reported a 3% year-on-year drop in revenues to $4.7bn while Digital Services fell by 1% to $999m and Managed Services by 8% to almost $581m.
Another growth area is the start of 5G Standalone deployments, providing opportunities for Ericsson’s Digital Services unit, which houses the 5G core portfolio. Mellander said: “Customers now are making long term commitments in the choice of vendors, and we are winning a lot of these deals and this is really a cornerstone in our journey… we have increased R&D significantly when it comes to 5G core and orchestration. It adds expenses in the short term but builds value clearly for the mid- and long-term.” As the cores go live, revenues start to flow – “Revenues will start towards the end of the year and then continue to grow over time,” the CFO added. He said Ericsson now has 45 5G SA core contracts, of which eight are live and starting to generate revenues.
Meanwhile ZTE has been bouncing back strongly from its disastrous year in 2018, when it was close to bankruptcy as a result of US sanctions (some subsequently lifted).
In a preliminary results statement the second Chinese vendor said it expects net profit for its third quarter to be about twice as much as last year, in the range of RMB1.5bn ($230m) to RMB1.9bn ($300m). Last year, it made RMB855m ($133m).
In the first half of 2021, its net profit leapt by 120% year-on-year to RMB4.1bn ($640m), and sales were up 12.4% to RMB53.1bn ($8.3bn). This restored first half revenues to their level before the 2018 disaster, but ZTE’s profitability is much improved, with its operating margin at 10% in the first half of 2021, compared to 6% in 2017.
The profitability has been driven by several years of cost cutting, and by a string of large 5G-related contracts in China, a market on which ZTE has always been more reliant than Huawei, a risk factor, but one that has made it less exposed to the impact of western sanctions than its larger compatriot.