Ericsson’s miserable quarter makes Nokia’s look respectable

Once again, Ericsson and Nokia reported contrasting sets of quarterly results. While Nokia showed signs of improvement in revenue and profit, its Nordic rival was still steeped in misery, with its fifth quarter in a row of operating losses and a full-year drop in revenue of almost 10%. In addition, it has failed to offload all of its media unit, though it is selling a 51% stake, and former CTO Ulf Ewaldsson is being sidelined, having failed to turn around the troubled digital services unit.

For the full year, Ericsson reported revenues of SEK201.3bn ($25.66bn), down 9.6% on the 2016 figure, with an operating loss of SEK38.1bn ($4.86bn), reversing a year-earlier profit of SEK6.3bn ($803m). The revenue figure is particularly depressing when compared with that of Huawei for 2017 ($92bn, though of course, the Chinese market leader has a far broader portfolio, including data center and device operations).

For the final quarter of 2017, Ericsson reported revenues down 12% year-on-year (7% on constant currency terms) to SEK57.2bn ($7.3bn). Its operating loss grew from SEK300m ($38m) to SEK19.8bn ($2.5bn), far higher than expected (analyst consensus was about SEK17.3bn ($2.2bn).

Gross margin for the quarter was down from 26.1% a year earlier to 21% and net loss expanded from SEK1.6bn to SEK18.9bn. However, adjusted gross margin was up to 29.9%, from 29.4% a year earlier.

Ericsson insists there will be “tangible improvements” in 2018, and that the string of writedowns and impairments that hit recent results are now over, but it will not comment on when it might end its run of five quarters of operating losses. The share price fell by 6.9% in morning trading after the results were announced, a drop that was exacerbated by the failure to sell the media unit.

Ericsson is selling a 51% stake in the division to One Equity Partners for an undisclosed sum but will retain the other 49% of a business which is seen by many analysts as an albatross, and which fits poorly with CEO Börje Ekholm’s plans to end the diversification strategy of his predecessor and focus on core strengths like 5G. Ericsson is also keeping the broadcast and media services unit, Red Bee Media.

A spokesperson insisted that the company never intended to divest all of the media unit, but admitted keeping Red Bee had not been the plan, but that no reasonable bids were received.

A bigger headache is turning around the digital services business. Since this includes many highly strategic items of the modern carrier platform – OSS/BSS, NFV, cloud and packet core, as well as associated professional services – it can hardly be sold off, but it has been hurting the top and bottom lines in recent quarters. Growth in the higher growth areas of cloud and NFV are not compensating for stagnation in the older OSS/BSS sector – indeed, both the old and new offerings are in decline, admitted the firm. One objective, set by the previous CEO Hans Vestberg, was to shift the balance from professional services to software sales, since the latter are more repeatable and profitable, but that has not been achieved.

In 2017, the digital services business generated revenues of SEK41bn ($5.23bn) but, due to writedowns and project adjustments, reported an operating loss of SEK27.7bn ($3.54bn). Some of the contracts are weighing on results and may have to be abandoned (something Nokia also went through a few years ago). In its most recent financial report, Ericsson said of Digital Services: “A key activity for profitability turnaround is to manage and complete 34 identified critical multiyear customer contracts and to either exit or complete 11 identified non-strategic contracts. These 45 contracts had a significant impact on reported results in 2017. During the year, the governance of contracts has been strengthened and in Q4 2017 two of the 45 contracts were finalized (either completed or exited). A number of contracts are multiyear commitments with strategically important customers. However, the plan is to finalize approximately half of the contracts in 2018.”

Ewaldsson, who was given the thankless task of turning around Digital Services almost a year ago, has now been removed from the senior management team and is now an advisor to the CEO. A replacement has not yet been found and in the interim the role will be taken by Jan Karlsson, head of BSS.

Such results are only intensifying speculation that Ekholm – who, as a long-serving board member scarcely looked like an agent for change – was really hired to make Ericsson fit to sell, perhaps to strategic partner Cisco (especially now that company may have more cash to spend, following the US tax reforms). The news that 10,000 jobs had been axed since October could fuel this argument – or just look like part of a painful process, which has already been going on for years, of adjusting to a far tighter and more price-competitive market.

Ekholm continued on the 5G theme he has pursued for the past two quarters, saying: “We see also that we need to make sure we are well positioned for 5G. The race is heating up in North America as well as North East Asia and we need to invest to make sure we are a leader.”

The company is hoping 5G will reverse the falls in the RAN market, which it believes shrank by 8% in 2017. This was reflected in the Q4 sales performance at its core Networks business unit, which saw sales down 9% year-on-year to SEK36.3bn ($4.6bn). This was blamed in particular on the slowdown in LTE deployment in China, though Ericsson also said it had increased market share in China on the back of its 5G-ready base stations. This has provoked investor fears that the firm is offering hefty discounts to gain share, hence the decline in Q4 gross margins.

Ericsson said it expects the RAN market to shrink by 2% this year and 1% in 2019 before stabilizing in 2020.

The managed services business reported a 3% fall in sales, in constant currency terms, to SEK6.2bn ($790m), and an operating loss of SEK300m ($38m), while the ‘Other’ unit – which includes Media and Red Bee – saw sales fall by 14% to SEK2bn ($250m), with an operating loss of SEK800m ($102m).

Meanwhile, Nokia announced fourth quarter sales up 5% year-on-year, at constant currency terms, to €6.67bn ($8.26bn) – but this was a 1% drop after currency adjustments were made.

The biggest improvement was seen at the smallest business, Nokia Technologies, which houses intellectual property and technology licensing, and was benefiting from a patent deal with Huawei. Its sales rose by 79%, to €554m ($686m), with operating profit up 146%, to €389m ($482m). It recognized €210m ($260m) in non-recurring net sales from the Huawei deal, and that contributed directly to a boost in Nokia’s overall Q4 operating margin, from 14% to 15.1%.

At the main Networks business, which accounts for 87% of revenues, operating profits fell by 25% to €647m ($802m). Within that:
• mobile networks accounted for 37% of the total, and were down 4%, to €2.47bn ($3.06bn), but up 3% in constant currency terms.
• Fixed line equipment revenues were down 6% to €526m ($652m), or flat in constant currency terms.
• Sales from IP networks and applications dropped by 1%, to €1.71bn ($2.12bn), but were up 5% without foreign exchange effects. Most of the growth came from optical networks.

Like Ericsson, Nokia expects the networks market to decline by between 2% and 4% this year, at a time when it is investing heavily in 5G. This will put pressure on profits, but margins should recover in 2019 and 2020, it said, predicting operating margin of 9%-11% in 2018 and between 12% and 16% in 2020.

“For 2019 and 2020, we expect market conditions to improve markedly, driven by full-scale roll-outs of 5G networks,” said CEO Rajeev Suri. “As those roll-outs occur, Nokia is remarkably well positioned … 5G requires a coordinated, holistic approach across all network elements, far beyond radio. That requirement plays to the strength of our end-to-end portfolio.”

That portfolio will be increasingly software-driven, and Nokia was the first of the major network vendors really to grasp and commercialize the concept of a software-heavy network – with offerings like its Liquid Net, which predated its customers’ conversion to NFV/SDN. Against this background, Nokia plans to rename its applications and analytics unit Nokia Software from the current quarter and aim to build a significant standalone software business, which would greatly enhance overall margins.

Nokia’s global services business was the only major division to report a revenue decline in constant-currency terms, down 1% (down 7% on a reported basis), to €1.64bn ($2.03bn).

Finally, ZTE was back in profit for its 2017 fiscal year, reversing a 2016 loss inflicted by fines to US trade authorities, and reported sales growth across all three of its major business units – carrier networks, consumer and enterprise.

In a preliminary statement, ZTE announced a net profit of CNY4.55bn ($720m), reversing a loss of CNY2.36bn ($370m) for 2016. Operating revenues were up by 7.49% to CNY108.82bn ($17.3bn). Accused of violating US trade sanctions against China in 2016, ZTE last year agreed to pay a fine of nearly $900m to settle the dispute.

ZTE also said it planned to raise CNY13bn ($2.1bn) through a placement of shares, and invest CNY9.1bn ($1.4bn) of those funds in 5G R&D. According to Reuters, the company plans to invest CNY42.9bn ($6.8bn) in 5G technology over the next three years.

Last month, Huawei said it expected to report about CNY600bn ($95.2bn) in sales for 2017, an increase of 15% over 2016, though that is only half the rate of growth (32%) it managed in the previous year, as operators’ capex reductions started to hit even the Chinese vendors.