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27 October 2020

Swedish ban on Huawei could kill Ericsson’s biggest golden goose

The shift in the 5G networks balance of power from Huawei to Ericsson might seem to be a one-way process, given the number of countries that are putting restrictions on purchasing from the Chinese vendor. Last week, Ericsson’s home country, Sweden, barred Huawei or ZTE equipment from its 5G networks, while Ericsson itself announced robust financial results that were boosted by business from China.

But if that looked like unqualified bad news for the Chinese vendors, the situation remains more complex than that. The day after the Swedish regulator’s decision,  China’s foreign ministry spokesman Zhao Lijian called on the country to reverse the ban, or rish a “negative impact” on its own companies.

Zhao said: “Sweden should uphold an objective and fair attitude, and correct its wrong decision, to avoid bringing a negative impact to China-Sweden economic and trade cooperation and the operations of Swedish enterprises in China.”

This came just as Ericsson announced its third quarter figures, and its CEO Börje Ekholm boasted: “Our growth in China is particularly strong …. Strengthening our position in China is critical for our long term competitiveness.”

Yet Zhao’s words conjure the prospect of Ericsson being pushed out of the Chinese market which has propelled recent growth. Although the Swedish firm has won far smaller deals than the local suppliers, the market is so huge that these tidbits still add up to significant revenue (far more than 5G deals are likely to deliver in Sweden, a market where Ericsson has incumbent advantage anyway).

Ericsson reported revenues of SEK57.5bn ($6.58bn), up 1% year-on-year, or 7% when adjusted for currency fluctuations. Gross margins improved to 43.1% from 37.7%, and the vendor reversed last year’s operating loss to make an operating profit of SEK 8.6bn ($984m). And Ericsson reported a net profit of SEK5.6bn ($640m), reversing last year’s Q3 loss of SEK6.9bn ($790m). Ericsson said it was confident of meeting its operating margin target of more than 10% this year.

The increase in revenues was driven “mainly” by 5G sales in China but also by “high activity levels” in North America, said Ericsson. The Networks division saw a 49% increase in sales (adjusted for currency exchange) in its North East Asia region, and 6% in North America, while the Networks business overall reported a 13% organic increase in revenues.

The company has targeted China’s huge 5G build-outs aggressively since launching its 5G-ready Ericsson Radio Systems (ERS) there in 2017. It was reported to be pricing its systems very keenly, and even as loss-leaders, in order to win market share in China, and Ekholm hinted at this willingness to take an early-stage profitability hit when he said the Chinese 5G business had “now reached the volume level where it is profitable and will continue to be so in the fourth quarter”.

Executives said China had turned profitable a few months after Ericsson won a $593m 5G contract with China Mobile, as well as 5G deals with China Telecom and China Unicom, earlier this year. Ericsson has invested large sums in buying 5G share in China, a gamble which led to a $108.5m inventory writedown related to pre-commercial 5G equipment provided as part of the bid to win Chinese contracts. The popularity of Ericsson’s 5G-ready equipment in China, and its willingness to offer keen pricing, have both been credited with its increase in sales to the country, despite the geopolitical tensions surrounding Huawei.

“It’s very important for us, strategically important for us to be in China, and that’s because it’s a global powerhouse for innovation and technological change, and driven by many great entrepreneurs,” Ekholm added.

He refused to be drawn on the risk of retaliatory sanctions in China. “We focus on doing what we can and what we can impact,” he said. “And what we really can impact is actually the competitiveness of our portfolio.” Chinese operators “will continue to build out on the spectrum bands that we have awarded contracts now,” he added. “But of course, over time, they will award other spectrum bands as well with contracts. And we’ll have to compete there to seek to win there as well, and we will do so.”

Ekholm was in conciliatory mood towards Huawei, stressing that while they were “fierce competitors”, the two firms also cooperated in some areas, such as 3GPP standards. By contrast, he claimed that growing market share in mobile networks was mainly coming “from non-Chinese competitors … We’re not winning due to geopolitical situation. It’s all about winning in front of the customer and delivering the best portfolio and cost-competitive portfolio.”

However, despite the apparent sanguinity, Ericsson will be keeping a sharp eye on China’s Export Control Law, which comes into effect on December 1 and could impact companies doing business in China or with Chinese companies.

There were negatives in Ericsson’s results too. Networks growth was offset by decline in the ailing Digital Services unit, flat performance in Managed Services, and slow progress in Europe.

Revenues at Digital Services fell 12% year-on-year to SEK8.7bn ($1bn), and its operating loss narrowed slightly to SEK600m ($68.6m). In Managed Services,

revenues fell 14% to SEK5.5bn, and operating profit was down 13% to SEK500m ($57.2m). The tiny emerging business division recorded flat sales at SEK1.6bn ($18m), but is expected to grow significantly in the coming years thanks to Ericsson’s recent $1.1bn acquisition of Cradlepoint, and the renewed focus on enterprise markets this signifies.

In addition, Ericsson is grappling with the transition from old to new architectures, which as in any new generation of networks, is slower than hoped. “In the legacy portfolio, sales are falling faster than we previously expected,” Ekholm told the analyst call. “In order to combat this we have increased our investments in the new cloud-native 5G portfolio and we are seeing a good win ratio, but it’s also fair to say it has not yet generated any significant sales and therefore does simply not compensate for the fall in the legacy portfolio.”

In future, part of that transition may get bound up with open RAN architectures. Ekholm told the analyst call: “I don’t really see Open RAN to have a major impact in 2021-22 timeframe, but after that I think it will start to impact revenues for us – it will start to impact the way business models evolve going forward”

Meanwhile, over at Huawei, its third quarter figures were showing the impact of US sanctions as well as Covid-19’s depressing effect on consumer spending. For the first three quarters of this year, the company made $98.57bn in revenue – still up almost 10% year-on-year, a better growth rate than its competitors are enjoying, but that growth rate was down sharply from 24% in the first nine months of 2019.

For the third quarter, revenue was RMB217.3bn ($31.91bn), up 3.7% year-on-year. Net profit margin period was 8%, compared to 9.2% in the first two quarters of this year and down from 8.7% in the same period a year ago.

“As the world grapples with Covid-19, Huawei’s global supply chain is being put under intense pressure and its production and operations face significant challenges,” Huawei said in a statement. “The company continues to do its best to find solutions, survive and forge forward, and fulfil its obligations to customers and suppliers.”

Brazil, Sweden and Italy line up against Chinese 5G:

The US government has often hinted at financial support for countries which agree to bar Chinese 5G technology from their networks. It has followed through on this in Brazil, where it is promising $1.5bn in financing for imports of US telecoms equipment.

The deal reportedly includes loans, guarantees and insurance for the Brazilian import of US goods and services, “especially in the telecommunications area”, according to National Security advisor Robert O’Brien.

China is Brazil’s largest trading partner and Huawei is present in nearly all its telecoms networks. But the country’s president Jair Bolsonaro is a close ally of US president Donald Trump and hostile to China.

In Europe, Huawei is facing pressures even without the USA’s direct intervention. Italian authorities have blocked a 5G core contract between Huawei and broadband provider Fastweb, the newest mobile operator in the country.

The Eastern European nations of Bulgaria, Kosovo and North Macedonia have reportedly joined the USA’s ‘clean network’ initiative (for which read non-Chinese). And Sweden has banned Huawei and ZTE from 5G infrastructure tenders, just ahead of its auction of 5G spectrum. Also, Chinese equipment must be removed from operators’ existing networks by 2025. China is Sweden’s largest Asian trading partner, and Swedish carmaker Volvo is owned by China’s Zhejiang Geely.