Ericsson’s slow crawl back to financial health continued in its fourth quarter, as CEO Börje Ekholm said the results justified his decision to pull the firm back from his predecessor’s strategy of diversifying into new markets.
Losses for Q418 fell year-on-year and the Swedish company reported its first full year of organic sales growth since 2013. Its headline figures were a net loss of $723.3m, down sharply on the year-ago loss of about $2bn; while sales were up 10% year-on-year to almost $7.1bn. For the full year, sales revenues grew by 3% in 2018, to SEK205.4bn ($22.6bn).
The largest division, Networks, increased its sales by 12%, and the faster recovery in the core business may encourage Ericsson to divest even more peripheral activities, perhaps including the BSS unit – last week, the company announced that it had shut down its new generation, virtualized BSS platform and would only sell its traditional products.
Most of the progress in Q4 and full year 2018 is being attributed, by Ekholm and by many analysts, to his swingeing program of cost cutting, which is still going on. Through that period of cutbacks, however, he has increased spending on R&D, which be believes is the best basis of future competitiveness, especially as the vendor has placed so many of its eggs – riskily – in the basket of 5G leadership.
“Increased investments in R&D for future growth, managed services contract reviews, combined with efficient cost control have proven to be successful, with improved competitiveness and profitability as a result,” the CEO said in his statement. “As the industry moves to 5G and IoT, we will now take the next step, focusing on profitable growth in a selective and disciplined way.”
While Huawei’s challenges in some of the major early 5G markets (USA, Japan, Australia, parts of Europe) may help Ericsson, Ekholm has previously expressed concern that the uncertainty will dampen enthusiasm for deployment altogether, especially as MNOs are concerned about the potential shrinkage of their supplier choices, and resulting lack of competition.
And so far, despite its problems (see separate item), Huawei is ahead on early 5G contracts. At the end of last year, the Chinese company said it has won 26 commercial 5G deals and shipped 10,000 5G-capable base stations. Ericsson said that, at the same stage, it had won 10 commercial 5G contracts, though it added that it was involved in 42 current trials.
Of course, just selling 5G RAN will not turn around Ericsson’s fortunes, with or without competition from Huawei. Operators are putting intense pressure on suppliers to reduce prices and adopt more open architectures this time around, and plans to virtualize the 5G RAN are heavily geared to reducing capex and opex with a software-first approach. So the most important R&D priority for Ericsson in 2019 is to invest in the 5G core network, in which there will be greater opportunity to differentiate and add value, enabling MNOs to implement new systems such as network slicing.
Also essential to any strong telco business case for 5G is integration with cloud platforms and virtualization, so another big priority for Ericsson is work on advanced cloud-native technologies to support 5G deployments that are capable of delivering brand new services and revenue streams.
Digging into the detail of Ericsson’s fourth quarter, there was considerable variation between regions. The two areas of strongest growth were North America, where sales were up 23% year-on-year (13% when adjusted for currency); and North East Asia, which includes China, up 30% (22%). While Ericsson (and Nokia) clearly benefit from Huawei’s virtual exclusion from network deals in the former region, fears of retaliatory restrictions on the European vendors selling in China have clearly not come true yet.
Michael Genovese, an analyst with MKM Partners, drew attention to this risk in a research note last week, focusing on Nokia (but clearly the danger is the same for Ericsson).
“The way things are headed, there is a chance Nokia could be banned from Greater China as Huawei is banned from non-Greater China,” he wrote. “We estimate this could cost Nokia 7-8% of its total addressable market given its market share limits in China.” However, he estimates that, “if Huawei were to be banned from all remaining countries outside of Greater China, then Nokia would pick up an additional 8-10% of total addressable market.”
Last year, Nokia made about 11% of its total revenues in China, while Ericsson said that 12% of its sales came from North East Asia. Huawei generates nearly 50% of its revenue outside its home country.
Ekholm would not be drawn on the risk of that situation, but said: “China will be one of the first markets in the world to deploy 5G. It’s going to be the first to do it on scale and it will most likely be the first with a standalone 5G network. We are investing heavily to make sure that we are a technology participant in that evolution of their network. It’s an important market for us and we continue to be there. We do the field trials needed. We do all the testing needed and our ambition is to continue to do that.”
Elsewhere, there was slight growth averaging 8% (3%) in Europe and Latin America, but Ericsson’s ‘South East Asia Oceania and India’ region was flat year-on-year, while Middle East and Africa fell by 14% (19%). In the former area, Ericsson said there had been decline in India, though growth in some other countries; while it blamed monetary restrictions in some markets in the Middle East for the poor MEA performance.
The closely watched gross margin figure was 32.3%, up sharply from23.3% last year, or 35.2% excluding restructuring charges, up from 25.9%. Ericsson said the main factors were cost reduction; the review of managed services contracts, with the company terminating unprofitable ones; and the accelerating roll-outs of its most critical product, the 5G-ready Ericsson Radio System, which promises to be software-upgradeable to support many 5G features such as Massive MIMO antenna arrays.
Full year operating margin was just 0.6%, though this was much improved from 2017’s -16.9% after the loss of thousands of jobs.
“If we look at all areas except BSS, we see improvements and they are tracking on turnaround,” says Helena Norrman, Ericsson’s outgoing CMO. “There is good traction and that has a lot to do with 5G pick-up and the cloud-native portfolio.”
All this was a far cry from 2017, when no product area was profitable. But the cost of its painful turnaround is still weighing on its results. The recent closure of the Revenue Manager BSS product involved writedowns totalling SEK3bn ($330m) and another SEK3.1bn ($340m) went on the latest round of restructuring in Q418. A further SEK1.5bn ($170m) in restructuring costs is expected this year.
Despite the BSS issues, the troubled digital services business was looking healthier in Q4 with sales up 10% year-on-year to SEK13bn ($1.4bn), (5% on a constant currency basis). A year earlier, revenues had fallen by 3%. The unit still reported a high operating loss of SEK7.1bn ($780m) because of the writedowns, though that was better than the year-earlier loss of SEK12.3bn ($1.4bn); but the operating margin was -27.2%.
But Ericsson has a big mountain to climb still, and that will be worse if 5G does not take off at the accelerated pace which early moves in the USA and south east Asia have indicated. Last week, Nokia CEO Rajeev Suri warned investors the 5G market would grow at a slower pace in 2019, especially the first half, than previously expected. Last year, the big vendors said there were clear signs that 5G roll-outs would start 6-12 months earlier than had been expected in many markets – but they also managed expectations by pointing to the risk that there would be an early flurry of spending and then a hiatus, as operators waited to find the business case to proceed to true scale.
Now the vendors’ expectations may be lowered once more – Suri said operators would “stagger” their roll-outs as the industry tackles some outstanding technical challenges. Despite a strong set of Q418 results from Nokia, the Finnish firm has reduced its outlook for its main market in telco networks to “flattish”, with the first quarter of 2019 set to be
“Part of that is that there will be staggered roll-outs of 5G in lead countries such as the US, Japan, China and Korea. You will not see full-year roll-out in these countries,” Suri told a press briefing. “Second is the ecosystem of 5G around standards and chipsets and devices at scale – and getting software to interoperate with all this – is still evolving.”
Nokia said that, for Q418, sales and net profit were both up by 3% year-on-year, to €6.87bn ($7.9bn) and €741m ($852m) respectively.
CFO Kristian Pullola told LightReading: “The 5G ecosystem is still evolving and we are still having updates to the 3GPP standards and as a result of that there is still a lot of work between different ecosystem players that needs to happen, be it ourselves, the chipset vendors or the device makers, to ensure interoperability is there and that we can start scaling the ecosystem and get it into broad-based use by consumers.” This may refer to the delay in finalization of 3GPP standards as interoperability issues are addressed.
For the full year, Nokia’s operating margin fell to 9.7%, from 11.1% in 2017, and at the low end of its target range of between 9% and 11%. The Networks business narrowly hit its target of 6% to 9%, falling from 8.3% in 2017 to 6% last year. These figures suggest that, unlike Ericsson, Nokia is not seeing as much as impact as it had hoped from its own cost-cutting program, which was just completed, and aimed to cut annual operating cost by €1.2bn ($1.4bn) between 2015 and 2018.
In October, the company said it would aim to cut another €700m ($804m) in overall annual expenses during the next two years.
An area of growth for Nokia is the enterprise – both selling enterprise-focused platforms to operators, but also offering services and products direct to industrial sectors. By contrast, Ekholm pulled Ericsson back from this area of expansion, and said his firm would only address enterprise and IoT systems via its telco customers. In October, Nokia said its enterprise business was generating about €1bn ($1.2bn) in annual sales annual growth of about 18%.
Suri said on the earnings call that Nokia now has about 1,000 enterprise customers and that the current rate of sales growth, in constant currency terms, was about 9%, but this would grow when 5G enters its “second wave”. By that, he means that, once telcos have built out their initial networks, there will be a new phase of spending by industrial customers deploying private wireless networks, directly or via neutral hosts, integrators and managed service providers.
“This will be of unique benefit to Nokia because we’re the only player with an end-to-end portfolio and presence in all key markets,” he said. Huawei also has a broad portfolio and a far larger dedicated enterprise division, but is increasingly unable to compete for large contracts in the USA and potentially some other countries, if governments restrict all large companies from buying critical equipment from the Chinese vendors, not just telcos.
In the Networks division, which accounts for about 90% of sales, revenues were up 7% year-on-year in Q418, to €2.65bn ($3.1bn), mainly thanks to strong sales of mobile equipment amid 5G preparation and 4G expansion. The operating margin for the Networks business 13.5% in the fourth quarter, compared to 5% in the third.
The new Software business reported sales growth of 12% in the fourth quarter, to €534m ($614m).