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22 July 2019

Despite tensions, China and 5G were highlights in Ericsson’s unremarkable Q2

Ericsson turned in a respectable second quarter, and claimed to be on course to hit the targets its CEO, Börje Ekholm, has set for 2020.

The Swedish company reported a 10% year-on-year increase in total revenues to SEK54.8bn ($5.83bn) for the quarter. On an organic basis, accounting for changes in currency exchange rates and reporting only comparable business units, revenues were up by 7%. Operating margins were improved at 6.8%, compared with just 0.3% a year ago, and the firm turned in a net profit of SEK1.8bn ($192m), compared with a net loss of about the same amount last year.

The Networks division accounted for 69% of the revenue and much of the growth, with 5G the key driver. Net sales were up 11% year-on-year to SEK37.8bn while operating income was up from SEK4.3bn to SEK5.7bn. Operating margin was 15%, down from 16.4% in the first quarter of 2019 but up from the year-ago figure of 13.3%. The better income figures were somewhat offset by higher R&D and 5G trial costs, said Ericsson.

Ericsson was particularly keen to highlight that the strongest regional growth was in North East Asia, which includes China and Korea, despite the fears that western vendors might be frozen out in China because of the ongoing trade wars and disputes over Huawei.

Fredrik Jejdling, head of the Networks division, told journalists that clients have just recently shifted their attention to 5G upgrades and he claims the interest in 5G is more global than it was in 4G at the same stage.

However, margins fell in Networks, on a sequential basis, as Ericsson hits the old problem – familiar from early 4G days too – of signing “strategic contracts” which deliver early 5G market share and credibility, but are not immediately very profitable. In many cases, operators want to ‘modernize’ their networks in the early stages, rather than replacing old equipment entirely. Jejdling said these contracts would continue to put pressure on the Networks division’s margins for the rest of 2019. However, he insisted that the deals would be profitable eventually and are not a sign that Ericsson is initiating a price war with its rivals in order to buy market share.

Ekholm said in his statement: “We see strong momentum in our 5G business with both new contracts and new commercial launches as well as live networks. To date, we have provided solutions for almost two-thirds of all commercially launched 5G networks. 5G momentum is increasing. Initially, 5G will be a capacity enhancer in metropolitan areas. However, over time, new exciting innovations for 5G will come with IoT use cases, leveraging the speed, latency and security 5G can provide. This provides opportunities for our customers to capture new revenues as they provide additional benefits to consumers and businesses.

The other two main divisions are Digital Services and Managed Services, about which Ekholm said: “In Digital Services, we continue to execute on the plan to reach low single-digit margins for 2020. In Managed Services the strategy is to enhance the customer offering by relying more on automation, machine learning and AI, which will longer term change and improve the margin profile of the business.”

In Digital Services, Ericsson is looking to renegotiate or exit 45 contracts which it deems non-strategic, and has so far done this for 27 deals. The division is still losing money, reporting an operating loss of SEK1.3bn ($139m) for the quarter.

The Managed Services division has also been exiting contracts while also investing in new capabilities such as AI-enabled automation to win new, more profitable business in the medium term. This unit had lower year-on-year sales and margins, but reported a small operating profit of SEK200m ($21m).

Ekholm pointed out that margins are being squeezed in the near term by increased R&D associated with 5G and related services. However, in Ericsson’s ‘emerging business and other’ unit, growth was 24%, justifying some of the investment in solutions for untapped use cases and sectors such as industrial automation. The small division includes offerings such as Red Bee Media and the iconectiv business in interconnection and number portability. While the unit as a whole is unprofitable, reporting an operating loss of SEK700m ($75m), iconectiv is in the black.

One growth area is likely to be enterprise and industrial networks, though Ekholm pulled back from his predecessor’s activities in building a direct-to-enterprise business, which could have bypassed the MNO in some situations. Nokia, by contrast, is building platforms to support private and industrial networks, often from its cloud core, which do not restrict it to MNO-enabled roll-outs. As the value chain diversifies to support the wide variety of 5G users and applications, Ericsson may come to regret its greater loyalty to the traditional MNO base.

Also looming over Ericsson is the investigation by the US Securities and Exchange Commission and the US Department of Justice into alleged corrupt practices by Ericsson staff. “Material” financial penalties are expected, but there were no updates in the quarterly report.