We have to go back to the old mainframe days to find out what happens to technology monoliths which have, like Ericsson, passed their sell buy date. They cannot go bankrupt, and perhaps no-one wants to buy them.
Ericsson is in a kind of double bind. It needs to report increased sales with customers buying from it once again, or at least not a further collapse in revenue. And at the same time it has to cut costs in order to lift profits, and has isolated some key markets to exit, such as video and media. Investors will forgive it, if it falls out of the TV market, and its revenue only falls in that sector. But not if it leaves a variety of extraneous markets and its core revenues continue to fall.
But as the new bean counter CEO, Borje Ekholm, has pointed out to investors and debt rating companies, he is aware that he must maintain R&D spend in the key future market of 5G. Shame bulk revenues from 5G won’t arrive in time to save him.
It makes sense then for Nokia, Huawei, Qualcomm and others to accelerate investment in 5G, simply to force Ericsson to spend even more on R&D to keep up – in the hope that it will fail and they will get more market share. But right now no-one is really talking about volume 5G procurement before 2020, and contracts are not likely to get signed until 2019, after which time Ericsson, if it has any of them, can at least allude to them. So, Ericsson has to somehow show increased revenues at a time when every operator in the world is holding off on spend, awaiting 5G developments. It’s just not possible and so it needs to manage the expectation of shareholders on this point.
That also would be fine if all Ericsson’s rivals were seeing the same “spending freeze” but the truth is that Nokia is going from strength to strength, its share price is on a high after results that have almost eliminated its backward steps, with revenues off just 2% over a year ago. For Ericsson, it was a fall of 11% last quarter. For Huawei, quarterly growth was 32% over this time last year, and 35% the year before.
Cisco is not really in the same precise cellular RAN markets as Ericsson, but it is in many other related markets, but its revenue is dead flat, not falling. So we can conclude that what Ericsson is doing wrong, it is doing it wrong alone, and others are not sharing in its missteps.
Last week it suffered the indignity of having Moody’s cut its credit rating down to Ba1, the first rating that is considered junk. This is code for, do not lend this company money, and if you must, do it at a high interest rate. This effectively cuts Ericsson off from all but the most loyal of banks, and then they would impose difficult terms, which in turn would have a further effect on its share price.
But is Ericsson about to run out of money? And if it is, what can it do about it? It has the equivalent of $3.7 billion in the bank, about $450 million less than it had prior to this quarter. On the current spend, as long as similar or better revenues come in, Ericsson can survive for about 8 quarters or two years. If it found a buyer for the divisions it has on the block, that could stretch out to 3 years or more. So it has at least two years to solve its problems. It should be long enough, but how far can it fall in those two or three years?
The trouble is that the problem is widespread. Its revenues fell 13% in networks, and services associated with that also fell, its core activity. Its revenues even fell in Cloud (which other rivals are growing fast) but fell further in Media, down some 20%. It has virtually no product or services area that is making money right now.
As we say, if you go back to IBM, when that company was flying high, it came to a bump in 1992 when it lost over $8 billion in its first loss ever. The following year Lou Gerstner, Nabisco CEO, was poached to come and get IBM out of the hole. This, in our experience, is a problem of the same order of magnitude, in the searing hot tech space.
Similarities to Ericsson of IBM of yesteryear, include a recent history littered with corporate corpses in its core (mainframe) markets including the Bunch (Burroughs, Univac, NCR, Control Data and Honeywell) all of whom IBM had beaten out of mainframes, and with the exception of a few new competitors in the minicomputer and PC era, such as Hewlett-Packard and Digital Equipment, it had few peers. That pretty much describes Ericsson of 3 or 4 years ago.
IBM had earlier been the most profitable companies in the computer industry and the largest, but the industry had moved on to commoditization. And yet today IBM is flourishing in cloud, because it got out of servers entirely, along with storage and PCs. But it took its main customers with it.
Gerstner’s predecessor felt IBM needed to be broken into silos – PCs, Storage, enterprise software, large servers, security – that kind of thing, Gerstner took it the other way and went heavy into services, embedding itself into the lives of its customers. They could not thrive unless IBM thrived.
Gerstner was famous for saying “the last thing IBM needs right now is a vision”, as the media (us included) foisted a variety of visions upon him, and he ignored them all. His focus was execution through simplifying the organization. He changed key leaders, the CFO, the HR chief, and the leaders of each major line of business. The reason for the last move was that his predecessor John Akers had let the lunatics take over the asylum. This was based on the assumption that the mainframe business was about to become obsolete on the back of Unix servers, which delivered twice the price performance. We may see parallels with today’s macro base stations about to become all but extinct, now that we are all chasing NFV and small cells.
Akers was presiding over in-fighting whereby the mainframe division, which brought in most of the revenues in the past, made calls about how the rest of the businesses ran. His plan was to let each division head come up with their own strategy. It was anarchy and a disaster and Gerstner reversed it by sacrificing those very same department heads. Funnily enough IBM suffered a Moody’s debt ratings cut in 1992, for the first time, a bit like Ericsson has multiple times over the past year.
So while IBM had the mainframe market to itself by then, commoditization and a pricing squeeze on the more important server and PC markets caused most of IBM’s problems. Perhaps IBM’s answer might work at Ericsson too. It is embedded in many operator accounts. – it has major management or implementation deals or it has 5G or IoT trials, at Vodafone, Orange, NTT DoCoMo, KDDI, Telstra, Verizon, AT&T, Korean Telecom, Telefonica and China Telecom – it’s almost a full global set. It is said to be onboarding 1 million customers a day at Reliance Jio, with its BSS/OSS service. Can you imagine halting that kind of progress, just to change suppliers? It’s just not going to happen. These MNOs could only extract themselves from Ericsson’s grip by doing themselves damage. It reminds us of the executive in the dentist’s chair who just before the drill goes into his mouth, reaches forward, grabs the dentist’s testicles and says, “We’re not going to hurt each other are we?”
What IBM had was control of the top 100 global IT accounts, what Ericsson has is being embedded at 40% of the world’s largest MNOs. So what it needs perhaps is not a vision of how technology will change over the next 5 to ten years and leading products, perhaps it needs what IBM delivered, a full understanding of what its clients want to do and a commitment to install it, whoever builds it. Ericsson should ensure these operators can progress efficiently, and profitably, but decrease the need to ship its own products to them, and instead help them choose best of breed. It’s boring, but ask IBM if it likes its survival now – valued as it is at $141 billion today.
What IBM did was listen to what those customers were asking for, and supplied it bespoke, as a services contract, and Ericsson should perhaps do the same. We should then not be asking who is going to drive the product vision at Ericsson if not its CEO, but instead ask if Ekholm has been out to consult with any clients lately.
It is still true that Cisco might buy Ericsson, or even just the Canadian/US part of it, that was once Nortel. But that would remove Ericsson from a seat at the 5G table in the US and lose it key customers. It is also true that Nokia is kicking Ericsson’s butt in the market technically speaking delivering more advanced architectures more rapidly, and Huawei is buying deals from under its nose with savage SLA promises and low pricing. Neither of those companies (Nokia or Huawei) could buy Ericsson without creating an anti-trust issue in Europe, but they might each buy parts of it. Operators won’t want that, because it takes one supplier out of the market.
At Rethink in January we suggested that Cisco may want to wait until it could behave more like a white knight and buy Ericsson for less money. The value of Ericsson at that time was $18.5 billion, today it is closer to $22 billion – it’s actually gone up. Cisco may have missed its moment and may not want the problems it brings.
There are however some differences worth pointing out. The first is that IBM was being killed off by standardization – open source Operating Software meant that IBM could no longer charge proprietary hardware pricing on a technology lock-in. Ericsson has been working with standards forever and this is part of the problem. Standards mean you have to execute cheaply – Ericsson has failed to do this. Not sure it knows how to.
Another difference is just what pool the CEO was chosen from. In IBM’s case it was the wider pool of US public CEOs – in Ericsson’s case it was an inward looking board which selected from among themselves. Is it any wonder that they only see the same way out which Ericsson has previously tried and wished to discard.
Also IBM went through its crisis before China was a force to be reckoned with, and before manufacturing had all shifted to China, driving down equipment pricing. Today China and Huawei and ZTE are the main problems (along with Nokia’s successful integration of Alcatel Lucent).
Moody’s accompanied its fourth credit rating cut in 7 months by saying, “A strategy premised primarily on cost-cutting is not sustainable over the long run.” No it’s not, but how long is the long term? Even if the new CEO came in and set in place aggressive technology targets for an existing in-house team of design engineers, he still would not have had any new products to show yet, and cost cutting to get revenues and costs in alignment is an okay first step, as long as revolutionary new products, and more importantly, lower product pricing, arrives in time.
Sure we criticized the appointment of an internal candidate as CEO (from a finance partner) but let’s suppose for a moment that he is doing a good job and we were wrong. Even so we would not be able to tell until new products hit the streets and operators began buying them in volume. Perhaps an engineering leader like Ben Verwaayen was, when he took over both BT and then later Alcatel, would have pleased the market better. But given that this was not the route chosen, does that mean Ekholm should just resign and give up the role after 6 months?
Anyone who has been in a turnaround situation will know that in 6 months you barely have time to come up with a plan, never mind execute on it.
In the end, given its cash and the amount of money that is tied up with major MNOs and their networks, a falling debt rating cannot, of itself, kill Ericsson. It just makes a turnaround trickier, because customers have to ask themselves if they want to be tied to a brick which may bring down their networks with a future bankruptcy.
But we are clear that a company like Ericsson knows that it cannot go bankrupt, and companies of this size, embedded this deeply into a market, cannot be allowed to, because of their customers’ interests.