Nokia’s Q1 suffers from 5G transition, Ericsson and Huawei look robust

The most recent financial results from the big mobile network vendors saw Nokia taking a hit on 5G, while Ericsson continued its turnaround with the best quarter since CEO Börje Ekholm took the helm in early 2017. Meanwhile, despite the uncertainty over how many countries may ban Huawei from 5G contracts (see separate item), the Chinese giant turned in strong results, though the enterprise, not the flat carrier division, was the engine of growth.

Ericsson boasted of double-digital growth in its main Networks business, though its strongest quarter for two years was overshadowed by a warning of “material” financial penalties as a result of a US investigation into alleged corrupt practices. That probe, by the US Securities and Exchange Commission and Department of Justice, was made public during Ericsson’s third quarter results last year. This time around, Ericsson also had to announce that Chinese authorities had launched a separate investigation into the company’s licensing activities following local complaints.

Ekholm said of the US action: “We can say that we can rule out that there will be no consequences.” In his statement to accompany the earnings report, he enlarged on that, saying: “Based on the current status of the discussion it is our assessment that the resolution of these matters will result in material financial and other measures, the magnitude and impact of which cannot be reliably estimated or ascertained at this time.”

However, the company has not made a provision for the charges because, as Ekholm said, “we have no basis for calculating a number” as settlement negotiations are still ongoing.

Details are sparse, but last year, Ericsson sacked 50 executives after its own internal investigation revealed evidence of corruption dating back to 2007, reportedly in markets in Africa, Asia, Europe and the Middle East.

The Chinese investigation, reported by the Wall Street Journal, relates to a different topic and can be seen against the backdrop of worsening trade relations between China and the West, and a growing determination on the part of China to be less dependent on western intellectual property. Reportedly, this probe concerns the patent fees Ericsson charges phone makers. Four years ago, Qualcomm settled an antitrust and patent licensing dispute with Chinese authorities at a cost of $975m, and a reduction in its royalty rates for the country.

As for Ericsson’s figures, the news was far better. First quarter sales were up 13% year-on-year to SEK48.9bn ($5.3bn) – 7% on an organic basis. After years of restructuring, the cost-cutting programs seem to be bearing fruit too, as Ericsson made a net profit of

SEK2.4bn ($260m), reversing a year-ago loss of SEK700m ($76m). It also improved its operating margin to 7.2%, excluding gains from the divestment of some media assets. Its goal is to hit 10% next year.

The biggest division, Networks, was the star, with 17% revenue increase to SEK33.5bn, fuelled by the start of 5G, as well as 4G expansion, mainly in north America and north east Asia. Without the effect of currency changes, the rise would have been 10%. Ericsson, more than its rivals, has put most of its eggs in the 5G basket – Ekholm has actually reversed many of his predecessor’s efforts to diversify into enterprise markets, by contrast with Nokia and Huawei, and has been offloading some weak or non-core assets such as the media business.

The two smaller divisions, Digital Services and Managed Services, had mixed fortunes. The former saw sales grow 8% to SEK7.8bn but the latter’s revenues dropped by 1% to SEK5.9bn. However, that unit greatly increased its profitability as Ericsson pulled out of some unprofitable contracts and turned in operating income up a huge 1200% to SEK1.3bn. The improvement was also partly down to the reversal of a provision for impairment of trade receivables, and from restructuring activities – about 8,000 of Ericsson’s 17,000 job cuts since 2016 have come from this division.

Operating income at Networks was up 62% to SEK 5.5bn while at Digital Services, it was still negative, though the loss of SEK1.8bn was lower than last year’s SEK2.6bn.

Despite the improvement in margins in the Networks and Managed Services areas, Ekholm warned that these could be under pressure again, at least in the short term, as large-scale 5G deployments got underway in Asia.

“It is no secret that we are taking contracts that can challenge profitability initially but are attractive in the longer term,” he told analysts during the earnings call. “Those will come in the rest of the year more than in the first quarter but at the same time we are not saying we are falling off a cliff. It is a strategic imperative and we will continue to do that.”

He also warned that the 5G outlook in Europe in the short to medium term was challenging because of a lack of spectrum and poor investment climate. “Regulators are trying to maximize revenues from spectrum auctions instead of considering the macro economic benefits from building out the telecom network,” he commented.

He also referred to “additional uncertainties related to future vendor market access”. Ironically, as he has said before, Huawei’s troubles are not good news for Ericsson and Nokai either in the immediate future, because they risk delays in operators procuring equipment and building out networks.

Ericsson said it expects the RAN market to grow by 3% this year, improving its previous forecast of 2%.

While Ericsson was looking shiny, Huawei was even more upbeat, predicting that, despite a 1% decline in sales at its Carrier division last year, it would turn in double-digital growth in that unit in 2019 thanks to 5G and other trends such as virtualization and 4G expansion. In the first quarter, its revenues were up 39% year-on-year to $26.8bn, a far steeper rise than the 19% it managed in Q118. Net margin was up slightly to 8%.

The company said it had signed 40 commercial contracts for 5G globally and provided more than 70,000 5G base stations by the end of March, which will help breathe growth into its Carrier division, whose sales declined slightly last year.

But Nokia had the worst quarter among the big three, surprising the markets with an operating loss of €524m ($584m) – far worse than last year’s figure, and investor expectations for this year. Revenues were up slightly because of favorable currency movements, to just over €5bn ($5.57bn).

The problems stemmed from the main mobile networks activity, providing further justification for Nokia’s efforts to expand its direct-to-enterprise, software and fixed-line activities. They may also create worries for Ericsson and Huawei, who fared better in this quarter, but will be subject to the same overall headwinds.

There were several aspects to Nokia’s shortfall, all 5G-related to some extent. One was that revenues from new 5G-related contracts are not being recognized as quickly as expected. The company said it had been “unable to recognize approximately €200m ($222m) of net sales related to 5G deliveries, mainly in North America”, in the first quarter. CFO Kristian Pullola said: “Some people have reached the wrong conclusion that this means we have lost deals. That is not the case.” Nokia has 5G deals with AT&T, T-Mobile, Sprint and US Cellular in the USA.

Nokia also talked about the “evolving readiness of the 5G ecosystem”, which may have been a veiled reference to reports – scarcely denied by the vendor – that it has been late in delivering some 5G systems, notably in South Korea, and that it may have struggled to get all the elements in place for delivery in time. Nokia has spoken of the fact that major 5G roll-outs have begun a year earlier than it had originally anticipated.

Another important factor was, according to Nokia, the effect of aggressive competitive pricing among RAN vendors as they chase early 5G relationships. Rather than the new networks commanding a premium, as they might have done in earlier generations, they have sparked a new round of price wars because suppliers are so desperate – amid the general slowdown in the RAN market – to stake a strong claim in 5G. Both Ericsson and Nokia warned of the impact on margins of having to agree to low margin (even loss-leading) deals in the first instance – though both insist that, having established the relationship with the operator, they will then build on the initial engagements with more profitable network expansion and services deals in future.

At the start of 4G, Ericsson in particular suffered from the fact that many customers decided to do network modernization, overlaying 5G on existing networks in a cost-effective way at first, and only engaging in full upgrades later on.

Pullola acknowledged to analysts that Nokia “had anticipated some aggression in early [5G] deals and that is coming through. There is intensity in selective customers, and there may be a need for us to respond in a disciplined way.” He admitted that, if the market intensifies further, Nokia’s margin guidance might be put under pressure.

But he added that Nokia was playing a “long game” as this was “a long investment cycle”, and emphasized the fact that the company is offering more than 5G RAN (the really price-competitive element) but has a broader 5G portfolio that includes optical, routing, fixed broadband and virtualized network functions.

Nokia sought to reassure investors that the poor results were a blip, not the start of another downturn. “It’s fair to say the quarter was weak, as anticipated. We expect to see a soft first half followed by a more robust second half,” Pullola said, admitting the weakness was in the RAN business – despite signing 36 commercial 5G contracts so far. Stronger areas included IP routing, optical transport, licensing and enterprise.

In the Networks division, which accounts for 80% of revenues, IP routing sales were up 12% year-on-year to €645m while optical networks were up 7% to €400m. But fixed access and mobile access both fell – the former by 8% to €426m and the latter by 2% to €2.47bn.