Significance: The mobile data explosion is creating all kinds of benefits for consumers and some returns for clever applications players. It is famously a mixed blessing for operators though, and even vendors are suffering as much as they are profiting from the rush to build out wireless capacity. Gone is the goldrush of capex investment which accompanied the upgrade to 3G, as this time around hard-pressed cellcos are opting for more gradual migrations and low margin modernization projects. Combined with the commoditization of RAN equipment and economic slowdown, the infrastructure vendors are all under intense pressure, and desperately seeking new sources of growth and profit.
The mobile data boom is not delivering the results that wireless infrastructure vendors might have dreamed of. Operators are expanding and upgrading their networks, but they are trying to reduce their own cost and risk by migrating only gradually to LTE, and engaging in network modernization and RAN sharing approaches which squeeze margins. Add to that economic crises and the decline of legacy technologies like CDMA, and the big OEMs are having a tough quarter.
The mobile infrastructure market is worth little more than it was in 2000, when it brought in $55bn, despite the explosion in networks and data usage. This is because of price reductions, Chinese competition and the commoditization of RAN gear. Now all that is exacerbated by global recession and by the transition to LTE. While 4G is the next source of new riches, upgrades are being undertaken gradually in most territories outside the US, and in the meantime older, more profitable businesses are in decline.
‘Ericsson’s 4G sales are going to expand very strongly in the coming years, but the drop in sales in GSM and 3G will be bigger than the growth in 4G,’ Martin Nilsson, analyst at Handelsbanken, told Bloomberg. The market ‘hasn’t grown in 12 years, despite the explosion of traffic we have seen over that period. 3G has come in, and 2G has dropped out. It is the same thing that is going to happen now.’
Indeed, according to ABI Research, the wireless infrastructure sector is at an eight-year low and things will not look up at least until year end. ‘Total revenues for wireless network equipment reported by the vendors for 1Q2012 were only $11.4bn,’ said principal analyst Jim Eller. ‘This is the lowest amount that we have seen since 3Q2003. First quarter revenues were down 17% from the previous quarter.’
The second quarter is not looking much better, with Ericsson and Nokia Siemens reporting weak results and Alcatel-Lucent and ZTE releasing profit warnings. In general in the sector, revenues are rising slightly, though below market expectations, but the real concern is with plunging profits, reflecting the intense price pressure in the market, and the fact that growth is coming from two areas with lower margins than traditional network sales ‘ modernization deals and services.
The first of those two was cited by Ericsson as it announced its second quarter results. Modernization contracts involve expanding coverage and often making existing equipment LTE-ready, but not big-scale new build-outs. This shift could depress margins for several years, but the impact on profitability will start to dilute gradually from the end of this year, said Ericsson.
The Swedish firm missed analyst estimates and saw its net income fall by 64% year-on-year, to SEK1.11bn ($158m), while gross margin fell to 32% from 37.8%. Sales were up just 0.9% to SEK55.3bn.
Ericsson has generally been resilient through the economic downturn because of its huge scale and the recent diversification of its business, but it was hit by a slowdown in carrier spending during the quarter and by tough competition and price pressures.
The company’s stock fell to a 3.5-year low on the quarterly report. Like Alcatel-Lucent, which has warned of a second quarter loss, Ericsson is hit by the debt crisis in its home territory in Europe, but the firms have also seen cutbacks in former boom markets like China and Russia, which are also putting pressure on Chinese suppliers Huawei and ZTE. Like Intel, ALU and others, Ericsson highlighted the slowing growth in China’s economy, which in Q2 grew at its slowest pace since the 2009 recession.
Its network revenue fell 17% year-on-year, particularly hit by the rapid decline of CDMA. This was a segment where Ericsson used not to play, but it gained these customers when it acquired much of Nortel ‘ mainly to position itself to migrate those cellcos to LTE. In March, Ericsson lowered its sales growth target for the years ahead, projecting compound growth of between 2% and 8% to the end of 2014.
Ericsson has been building up new revenue streams in anticipation of the pressures in its core wireless infrastructure space, and the shift to more commoditized gear. It leads in managed services and has branched out into video platforms, converged IP, hosted carrier software platforms and many other areas. Services sales rose by 26% on last year and support solutions revenue increased by 47%. Ericsson was boosted by its acquisition of Telcordia, which generated revenues of SEK1.1bn. Without that contribution, and other factors like currency fluctuations, its revenues would have been down by 6% on the year-ago quarter.
However, some analysts are concerned new growth will not be sufficiently rapid to offset declines in the core activities. Andy Perkins, an analyst at Societe Generale, told Bloomberg: ‘It’s not a great set of numbers as their core business is still shrinking. This is a big problem. The pick-up in network spending just isn’t happening.’
CEO Hans Vestberg said: ‘We just need to muddle through this and execute on our strategy, while also lowering our costs as we come out of this.’
Also muddling through is his counterpart at Alcatel-Lucent, Ben Verwaayen, who has many of the same challenges hitting his turnaround plan. Rising competition, Chinese slowdown and the eurozone crisis continue to hold back the company, which warned of a second quarter loss amid ‘slower than expected business mix improvement’.
The company, which already disappointed shareholders with an operating loss in its first quarter of 2012, said it will not now meet its previous guidance on full year operating margin, because of a ‘difficult macroeconomic environment’. It said the second half of the year would be an improvement on the first ‘ but, it seems, not a sufficiently good one to deliver the important margins target, which it had previously set at 3.9%. For Q212, ALU expects to make a loss of about €40m on revenue of around €3.5bn. It will report its official results on July 26.
Despite the warning, the company insists there will be signs of underlying strength in the Q2 results, pointing to ‘good sequential growth in sales with all geographies and divisions growing’, as well as good progress in its cost cutting program. It will report a reduction in costs of over €100m compared to a year before. CEO Ben Verwaayen has pledged savings of €500m in 2012, including €200m in fixed costs, on top of €3bn over the past three years.
The warning shows that ALU is struggling to recover from its admitted ‘slow start’ to 2012. In Q1, it suffered an operating loss of €289m on revenue down 12% year-on-year to €3.21bn. Despite a return to profit in fiscal 2011, the decline in the company’s share price has worsened since February amid worsening guidance.
As well as exposure to the troubled eurozone sector, the sales cycle in China is also against ALU, according to analysts, which note that the firm complained of ‘extremely weak’ GSM sales during the first quarter, a trend which is likely to have continued in Q2. And the CDMA business which was the heart of Lucent is declining as many operators move towards LTE. However, in Q1 ALU saw double-digit growth in W-CDMA and LTE.
Francisco Salvador, an analyst at FGA/MG Valores in Spain, told Bloomberg that China’s economy grew at its slowest pace since the 2009 crash during Q212. ‘During the last three months China has released macroeconomic data that shows the negative impact of the global economic slowdown and the lack of dynamism in consumption trends in the country,’ he said. ‘Today’s announcement could easily mirror what’s next for other equipment makers as well.’
Nokia Siemens did manage a better Q2 performance than in its awful Q112, but its ongoing restructuring program is still driving it into operating losses ‘ this time totalling €227m ($278.3m), up from $136m a year earlier (though the results are not directly comparable as it completed the purchase of Motorola Solutions’ networking arm on April 30 2011). NSN’s operating margin was -6.8%, worse than the year-ago figure of -3% but better than -34.1% in Q112. Revenues were down 8% year-on-year to €3.34bn ($4.1bn), though this was 13% better than in the first quarter of 2012.
China was a factor for NSN too, with sales in that market dropping by 16% year-on-year to
€340m ($418m). The company is also feeling the temporary affects of its major reorganization, designed to narrow its focus to mobile broadband only. This has seen the offload of various business units, and has inevitably hit total revenues. However, even without that change of business mix, NSN said there had been a drop in network infrastructure sales. There was, though, an increase in services revenues, though the company does not break down its sales from different activities. Its gross margin was 26.6%, unchanged sequentially or year-on-year and well behind Ericsson’s 32%.
Even the usually buoyant Chinese vendors are not immune to the trends. ZTE said last week that its net profit for the first half of 2012 will be down by between 60% and 80% compared to the same period in 2011, but denied reports that it could cut 12,000 jobs. Forecasting an interim loss of between CNY154m ($24.1m) and CNY308m, compared to CNY769m for the first half of 2011, ZTE blamed the eurozone debt crisis and the postponement of some tenders in China, as well as reduced investment income, following the disposal of shares and reclassification of its holding in Nationz Technologies.