Ericsson’s poor strategy rings in fresh pain

October 12, 2016

The author is a Reuters Breakingviews columnist.  The opinions expressed are his own.

Ericsson investors might be forgiven for wishing they had disconnected 18 months ago. The Swedish telecoms company, which sold its mobile phone business four years ago, issued a third-quarter profit warning on Oct. 12 that it blamed on falling demand for network equipment in emerging markets and Europe. These trends may also hurt industry peers, but much of Ericsson’s pain is of its own making.

The company’s share price has more than halved in the past year and a half, and may sink further. Even by its recent record of undershooting estimates, Ericsson’s latest miss stands out. Operating profit for the three months to September was 300 million Swedish crowns ($34 million), a far cry from analysts’ consensus forecast of 4.3 billion Swedish crowns. Its gross margin slumped by a massive 5.6 percentage points from a year earlier. By contrast, rivals such as Finland’s Nokia and China’s Huawei have increased theirs in recent quarters.

There are several ways Ericsson could improve its market standing. First, by speeding up the recruitment of a new chief executive to replace Hans Vestberg, who was pushed out by the board in July. Cutting expenses more deeply is a close second. In the past two years Ericsson has reduced its workforce slightly, but rival Nokia has less than half its headcount.

A change of strategy could also help. Winding down its IP routing business would save Ericsson research and development expenses of up to 8 billion Swedish crowns for the loss of only 2.5 billion crowns of revenue, according to Bernstein analysts. This was a notable misadventure, with Ericsson paying $1.9 billion, or about 17 billion Swedish crowns, to buy a U.S. operator in 2006. Yet in a business where clients are sticky, Ericsson could only muster a 2 percent market share last year, Bernstein says.

Even under the most optimistic scenario, Ericsson’s 2016 dividend might be cut. The company’s net cash position fell by 25 percent in the first half of the year, it has missed analyst forecasts for five consecutive quarters, and it faces more restructuring charges. Ericsson has much to do to keep its own shareholders on the line.

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