As margins shrink, Ericsson is focused on the future

Ray Le Maistre
By Ray Le Maistre

Oct 20, 2022

  • Ericsson’s third-quarter earnings report was a mixed bag 
  • Revenues are up and the 5G pipeline looks healthy
  • With the Vonage acquisition closed, its management is bullish about the future of its new enterprise unit
  • But certain parts of its business are struggling and need restructuring
  • And as costs increase so margins are shrinking, sending Ericsson’s share price into free fall

As Ericsson’s management discussed the giant Swedish vendor’s third-quarter results early on Thursday morning, their comments were very much focused on the sunlit uplands of the telecom and enterprise infrastructure and applications future which, fuelled by the capabilities of fully formed standalone 5G networks, are set to deliver future economic benefits to telcos, business users and Ericsson alike. But that’s the future. The present is a bit trickier because, despite sales growth and a strong position in 5G mobile network infrastructure, there are nagging concerns and issues that are eating away at the company’s profitability and at its share price, which slumped by 15.6% on the Stockholm exchange to 60.93 Swedish krona (SEK) following the publication of the third-quarter financial results.

First, the positive news. Ericsson’s third-quarter revenues were 68bn SEK ($6.08bn), up by 3% in direct comparison with the same quarter a year ago (excluding changes in exchange rates and inorganic additions to the vendor’s portfolio). On a reported basis, so including currency fluctuations and the additional revenues delivered by Vonage – the company recently acquired by Ericsson, which has been generating revenues for the Swedish firm since late July – revenues were up by 21%. 

The main driver of growth has been the ongoing heavy 5G investments by the major operators in the US, though of course the vendor has lots of mobile infrastructure business all over the world. During this morning’s earnings webcast, CEO Börje Ekholm boasted that Ericsson has increased its share of the global radio access network (RAN) equipment market (excluding China, where Ericsson is now effectively vendor non grata) from 33% in 2017 to 39% now, “taking market share from all of our competitors… and we have continued to add to our global footprint during the past quarter. So we're really talking about massive gains in overall footprint for Ericsson. These achievements are based on our focus on technology leadership,” stated the CEO (though it’s worth noting that a major RAN product architecture error by key rival Nokia from which the Finnish vendor is only now recovering will certainly have helped Ericsson’s cause, as has Huawei’s demise in multiple markets due to political decisions and trade sanctions).  

And Ericsson hasn’t been resting on its laurels: It has been diversifying more and more into the enterprise sector through major M&A moves, having acquired enterprise wireless infrastructure specialist Cradlepoint for $1.1bn and, as mentioned, cloud-based communications platform specialist Vonage for $6.2bn. These two units have formed the backbone of Ericsson’s recently formed enterprise unit – see Ericsson restructures, creates Enterprise division.

Ekholm is bullish about the potential this offers his company. “Vonage will be a critical building block in our enterprise strategy. It will underpin a full range of cloud communication solutions. We aim to transform the way advanced 5G capabilities, such as speed, latency and network slicing are exposed, consumed, and paid for, and we believe this will ultimately help our customers to monetize the network. We expect the Vonage acquisition to be highly accretive, and it complements our enterprise wireless solution offerings [from] Cradlepoint and Dedicated Networks [which develops networking products for specific business vertical sectors, such as mining and aviation]. Overall, we expect our enterprise offering to have a growth potential north of 20% per year,” noted the CEO.  

But those sunlit uplands are shrouded by cost, margin and restructuring clouds, as well as nagging issues in a couple of the vendor’s lines of business, so much so that Ericsson’s third-quarter operating income (earnings before interest and tax) shrunk by 19% year on year to 7.1bn SEK ($635m) and were much lower than had been expected. That, and other factors, sent Ericsson’s share price plummeting.

Ericsson’s third-quarter margins were negatively affected by higher-than-expected costs and ongoing delays in sealing intellectual property/patent deals. Its Cloud Software and Services division, formed earlier this year by the merger of its Digital Services and Managed Services units, is losing money and underperforming, even though it includes what should be one of the shining lights of Ericsson’s business, its 5G standalone core platform line of business, which has been harder to sell and deploy than expected and, it seems, has burdened the vendor with significant systems integration costs. 

Ekholm admitted that the Cloud Software and Services division is still a problem child. “We have underperformed in this area [cloud software and services] for a long time. But we have also seen a relatively strong improvement compared to 2017 when losses were running much higher than today, so it's always a journey. We're not happy at this level. We need to fix this – it should be a profitable business. With our market position and the technology we offer, this has all the potential to be profitable,” noted the CEO, who called out the company’s business support solutions (BSS) as a line of business that has been revitalised. 

“But where we now have challenges is with our 5G core – that has taken a bit longer to get to market than we expected, and it has carried a lot more system integration costs than we anticipated a year ago. But we have also had a lot of geopolitical developments [the de facto ban in China] that have impacted the cloud software and services business very detrimentally, so it's a multitude of factors… that's why we combined managed services and digital services, to leverage the synergies between the two” in terms of operational savings but also “on the R&D side as we invest in AI and machine learning, and the distribution of software to our customers. That's where we get the big benefit [but] that will take some time.” Ekholm, while seemingly frustrated, appears to have more patience than investors and analysts when it comes to that division’s turnaround timetable. 

And other margins are set to come under even greater pressure in 2023, it seems, as Ekholm warned that 5G RAN investments by the major US operators in 2023, while still significant, would not match the levels seen this year. And while Ericsson says it has other new deals that will still drive RAN sales growth next year and beyond, such as the 5G deals recently announced in India, those deals come with lower margins and so will impact profitability.  

Inflation is going up, costs are rising, competitive pressure is increasing (especially now that Nokia once again has its act together in mobile infrastructure) and Ekholm still has to deal with the ongoing investigation into the vendor’s historical business dealings in Iraq that could land the vendor with a massive fine and possibly worse.

The list of challenges runs long, and Ekholm, to his credit, doesn’t shy away from talking about them, but his focus is on that fully formed standalone 5G and cloud-enabled enterprise communications future. But it’s a steep climb to get to those uplands. 

- Ray Le Maistre, Editorial Director, TelecomTV


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