US-China stand-off looms large, but Huawei and Ericsson report strong results

The trade tensions between the USA and China hung heavily over the financial results of Ericsson and Huawei last week. Not that they were showing signs of hurting Huawei’s performance, so far at least – the vendor reported a 24.4% year-on-year rise in revenue for the first nine months of the year, and a slightly improved profit margin, despite being placed on the US entity list, and being subject to security reviews in some US allied countries.

But the question of how long Huawei would be able to remain impervious to the USA’s attempts to isolate it from western customers and suppliers overshadows the strong results, and forced the Chinese firm to issue a string of defensive statements about its resilience. Its supply chain has not been affected by the entity list action, it claimed; it can work around any US supplier which is barred from selling it components; it is still signing 5G contracts at the same rate as before.

On Ericsson’s part, however, a key message to investors was that it would be stepping up its efforts to increase its Chinese market share, regardless of geopolitics – some investors fear that Ericsson (and Nokia), though not American, may suffer if sanctions against Huawei encourage Chinese government agencies and operators to favor homegrown equipment for 5G.

Huawei reported a notional net profit of CNY53.14bn ($7.52bn) for the first three quarters of 2019 on revenues up 24.4% to CNY610.8bn ($86bn). The year-on-year revenue increase was higher than in comparable periods in 2018 (when it was 19.5%) and 2017 (15.7%). Net profit margin was 8.7%, up slightly on 2018.

Although Huawei does not break out its results at this stage in the year, it said it had shipped 185m devices so far this year, 26% up on the same period last year, which suggests its devices business may have consolidated its position as the vendor’s largest division and growth engine – in full year 2018 it accounted for 48% of total sales.

The continuing strong performance is despite hesitation by some western operators about carrying Huawei smartphones, because it has been denied access to the full Google Android platform, which will be essential to many customers as it enables services like Google Search and Maps. Huawei claimed 1.07m registered developers for its Harmony OS, its inhouse alternative to Android. It did say it had seen “rapid growth” in new and non-smartphone products such as PCs, tablets and wearables, which suggests it is trying to diversify its portfolio to be less reliant on the carrier-sourced handsets.

In its carrier business, Huawei said it had now signed more than 60 commercial deals and shipped 400,000 5G Massive MIMO active antenna units (AAUs) worldwide. Last month, CEO Ren Zhengfei said Huawei expected to build 1.5m 5G base stations in the first half of 2020.

However, the US situation still looms large. In the summer, Huawei came up with the creative idea of licensing its 5G technology to a US vendor, so that US operators could access its platforms without breaking sanctions, and it could restore some US revenues. It claims several organizations are interested in this route to build a domestic US network provider again, and that talks are in their early stages, but Huawei SVP Vincent Pang admits the US bar on its companies trading with the Chinese giant is a major barrier.

“There are some companies talking to us, but it would take a long journey to really finalize everything,” he told Reuters.

Meanwhile, Ericsson raised its sales targets for 2020 amid the growth in 5G deployments, insisting it would do better in China in 5G than it had in 4G, despite political tensions. “We want to be stronger in China in 5G than we were in 4G,” said CEO Börje Ekholm on the results call with analysts. “The 4G market in China is really more than 60% of the global market and we have no reason to believe 5G will be less.”

However, he acknowledged that “no awards have been made and we have no way of knowing potential market shares or price levels”. Nokia recently warned that it had received indications that Chinese operators would favor local suppliers. Major deployments will begin in late 2019, including a shared network to be rolled out by China Telecom and China Unicom – which in itself will reduce the total addressable market in the country.

Ericsson had been targeting revenues of between SEK210bn and SEK220bn next year, but has raised this to a range of SEK230bn to SEK240bn ($23.5bn-$24.6bn), citing a “stronger 5G market” than previously expected and favorable currency movements. Even at the low end of the new forecast, sales would be 9.1% up on the 2018 full year figure.

We will not know the 2019 full year figure until after the new year, but the third quarter, which Ericsson announced last week, will have improved the chances of a solid showing. For the quarter, net sales were up 6% year-on-year to SEK57.1bn ($5.8bn) or 3% at constant currency. However, the company swung to a net loss of SEK6.9bn ($710m), reversing last year’s profit of SEK2.7bn ($280m).

That loss was inflicted by a contingency of SEK11.5bn ($1.2bn), which Ericsson had to set aside for a $1bn US fine that Ericsson expects to pay following corruption charges in several countries, related to previous management. That charge also depressed operating profits and operating margin, which was negative 7.3%, compared to 6% a year earlier. Ekholm insisted he was “confident” of hitting the 2020 target of 10%, and Ericsson is aiming for margin of between 12% and 14% in 2022, an uplift to previous targets.

Outside the core Networks business, the Digital Services unit achieved 10% year-on-year revenue growth, reaching SEK9.9bn ($1.01bn) after many ailing quarters, and it reduced its operating loss to SEK700m ($71.7m) from SEK1.8bn ($180m) a year ago. This was managed partly because of an ongoing process of exiting or renegotiating unprofitable contracts – Ericsson says it has applied its new rules to 29 of the 45 agreements it targeted in 2017.

“We are resolving contracts one by one and what is encouraging is the strong development in underlying business,” said Ekholm. “We did not target the fastest possible turnaround in digital services. The priority was to build a strong unit and create a create a strong product portfolio.” The unit is on track for a low single-digit operating margin next year, he said.

In Managed Services, third quarter operating income rose to SEK600m ($61.4m), from SEK400m ($41m) a year earlier, though sales were down 2% to SEK6.4bn ($660m), and down 5% organically, Ericsson citing “earlier communicated customer contract exits”.

In Networks, analysts say Ericsson is gaining market share after several years of intense pressure, a result of the company taking a reportedly aggressive approach to pricing contracts, combined with restoring its reputation for advanced technology – Ekholm has been consistent in ringfencing R&D from the cost-cutting program, and increasing investment in engineering.

Fredrik Jejdling, the head of Ericsson Networks, claims the firm’s share of the mobile infrastructure market is now growing about 1% a year, and according to analysts at Dell’Oro, the company’s RAN share rose by 1.2% between 2016 and 2018, and as much as 6% in its strongest market, North America, where it is working with all four major MNOs, and does not have to deal with competition from Huawei.

But two major risks remain to Ericsson’s medium term growth strategy – its over-reliance, compared to Nokia and Huawei, on excellence in mobile infrastructure, especially 5G, rather than end-to-end solutions; and its potentially over-optimistic plan for Chinese growth, which could be scuppered by political pressures beyond its control.

Jejdling says the goal is to boost Chinese market share from the current level of about 10%, in a market that accounts for about 60% of 4G (and likely 5G) network sales. Ericsson is taking part in trials with the three Chinese MNOs and has invested in extra R&D and supply chain partnerships to entrench itself in the country. But in July, Nokia’s CFO, Kristian Pullola, warned that he saw a growing tendency for Chinese operators to support local vendors. “That is something we need to recognize when we look at where to invest and when to back away from some of the competitive situations that hinder us to deliver profitable and longer term growth,” he told Light Reading.