March 10, 2009
Ericsson soared in 2008, but can it win in 2009?
PHILADELPHIA — LM Ericsson had a banner year in 2008 as revenues rose 11 percent and cash along with short-term investments soared by 30 percent. Last year's performance was even more impressive as rivals like Alcatel-Lucent and Nortel Networks Inc. struggled with declining market share and financial distress.
Now the Swedish telecommunications equipment maker must prove its extraordinary performance during a major industry downturn was not a fluke, and that it can repeat the success even as the global economy continues to weaken.
Ericsson appears to have the resources to again outflank the competition in its key network equipment market. But it faces significant challenges in other industry segments, including its Sony Ericsson wireless handset business and a new joint venture with STMicroelectronics. The ST-Ericsson joint venture will require significant cash outlays on the part of Ericsson in the short-term, according to the companies.
Industry analysts see Ericsson performing strongly in 2009 despite the potential for further contraction in the telecommunication equipment market. They point to the company's large cash reserves, attractive and extensive product lines, wide geographical customer base and its rivals' financial problems.
"Although Ericsson will face what is likely to be a challenging telecom infrastructure market for 2009, its strong business and financial positions are likely to provide credit support," Standard & Poor's analyst Patrice Cochelin said in a report in which he also revised the company's outlook to stable from negative.
Ericsson closed 2008 with a boatload of cash in the bank, a healthy line of credit and strong sales growth—up a formidable 23 percent even in an otherwise terrible 2008 fourth quarter—while many of its major competitors are in financial distress.
This year, Ericsson expects to increase its market share in the network equipment market despite the prospect for continued pricing pressure, reduced capital spending by service providers and stiff competition among the top players in the sector.
"There are uncertainties and it's not easy to predict exactly how things are going to develop," Carl-Henric Svanberg, president and CEO of Ericsson, said during a conference call announcing the company's fourth quarter results. "There are lots of opportunities to take market share, and I think it will come because there are weaker players out there."
Bucking the negative sales trend
Ericsson surprised the market in 2008 with solid performance in the midst of what is turning out to be the worst global economic environment in decades. Results were boosted by a major contract wins at service providers in the United States and elsewhere.
The company continued to garner similar wins in 2009, including a major contract in February with Verizon Wireless to supply equipment for the telecom service provider's Long-Term Evolution (LTE) network. Contract agreements like this will help Ericsson maintain its revenue growth in 2009, according to analysts.
"Most of this new business—representing both new wins as well as upgrade and expansion work—is centered overseas, at a time when capital spending by North American vendors is increasingly constrained," said Argus analysts in a report. "Yet Ericsson has even won [a] prime place in the major domestic network upgrade to 4G LTE planned by Verizon Wireless."
Ericsson's 2008 revenue rose to $22.7 billion from $20.4 billion in 2007 while cash and short-term investments rose to $8.1 billion from $6.3 billion, positioning the company to finance required expansion and joint venture activities, including its interest in ST-Ericsson and Sony Ericsson.
"Cash is a matter of strategic importance in this time of the banking and financial crisis," Svanbverg said. "It is important that we have the strength and the capabilities for different scenarios."
Ericsson outperformed the competition in 2008 because the company instituted a major cost-reduction program ahead of its rivals, and also because it was able to secure major contracts with the leading telecommunication service providers.
Last year, Ericsson set out to reduce costs by $434 million, but ended up slashing operating expenses by $706 million. In response to continued market weakness, Ericsson said it is planning to further reduce costs by as much as $1.1 billion by the second half of 2010, because "we are experiencing in the world today the most severe economic decline that we have seen since the 1930s," according to Svanberg.
"It seems unreasonable to assume that our industry would be untouched, and that is why we're taking precautionary action," he said.
Analysts said the slowing global economy will definitely affect Ericsson negatively, especially because of its exposure to the weakening mobile handset market through its 50 percent stake in Sony Ericsson.
The JV paid Ericsson $482 million in 2008, according to Standard & Poor's, which forecasts the troubled mobile handset vendor might not be able to pay dividends in 2009 as it strives to conserve cash.
"We anticipate a meaningful slowdown in telecom carrier capital spending in 2009, including potentially longer assessment and tendering processes, some delays in capacity expansion and heightened pricing pressures," according to Standard & Poor's. "However, we also anticipate a number of key contracts to be awarded in Ericsson's area of expertise of mobile infrastructure, while the fast-growing adoption of mobile broadband should continue to require a relatively high level of operator investment."
As a result, Standard & Poor's estimates "Ericsson's free operating cash flow should remain positive and significant in 2009, although at a lower level than in 2008, based on our anticipation of no dividends from Sony Ericsson and additional provision outflows."
In addition, the company's extensive product lineup and diversified global customer base helped shield it from the intense market pressure that built up in the last half of 2008, according to analysts. This situation will likely persist even in the tough 2009 economic environment, allowing the company to maintain a strong market presence, they added.
If Ericsson has an Achilles' heel in 2009, it is the 50-50 mobile handset joint venture with Japan's Sony. The JV is losing money; a cash infusion may be needed if it fails to recover from the current doldrums.
Sony Ericsson is, however, taking steps to lower operating costs and reduce cash utilization. However, even these actions could be compromised by reduced demand for its products in the key European market, according to Standard & Poor's.
Argus, however, believes Sony Ericsson could bounce back in 2009 by expanding its presence in the smart phone market, an area other analysts predict could deliver strong growth for the entire wireless handset industry.
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