TBR TECHNOLOGY BUSINESS RESEARCH , INC. Telefon AB LM Ericsson NETWORK BUSINESS QUARTERLY SM 4Q10 INITIAL RESPONSE Publish Date: January 26, 2011 Author: Chris Antlitz ([email protected]), NBQ Research Analyst Content Editor: John Byrne, NBQ Director Fourth Calendar Quarter 2010 Fourth Fiscal Quarter 2010 Ended December 31, 2010
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TBRT EC H N O LO G Y B U S I N ES S R ES EAR C H , I N C .
Telefon AB LM Ericsson
NETWORK BUSINESS QUARTERLYSM
4Q10 INITIAL RESPONSE
Publish Date: January 26, 2011Author: Chris Antlitz ([email protected]), NBQ Research AnalystContent Editor: John Byrne, NBQ Director
Ericsson’s engine is firing on all cylinders entering 2011
Ericsson’s Corporate Strategies• Translate LTE trials into commercial deployments• Leverage Managed Services business to build long‐term recurring revenue model
• Protect margins by avoiding contracts with questionable profitability
• Strengthen core business via targeted acquisitions and shed non‐core assets
• Scale global operations centers to drive better margins from outsourced network services
• Mitigate effect of parts shortages and rectify logistical and supply chain problems
TBR Position:Mobile broadband and RAN are fueling the recovery in network equipment sales, and Ericsson can better meet demand as parts scarcity issues are alleviated. • With mobile data traffic projected to double annually over at least the next three to five years, Ericsson finds itself at the early stages of a new wave in network investment that operators will be unable to ignore.
• Global Services revenue declined 1.2% from 4Q09 and eked out a 1% gain from 2009. Muted performance in 4Q10 was due to weakness in the Network Rollout unit, as well as slower growth in Managed and Professional Services sales compared to previous quarters in 2010.
• Multimedia sales rebounded from three quarters of double‐digit decline, but sustained traction in the unit will depend on operator appetite for revenue management and IPTV solutions, as well as Ericsson’s ability to compete with rivals such as Huawei and ZTE, who are building up their software assets.
• Ericsson continues to struggle in EMEA despite growth in Russia, Italy and Germany. Huawei and NSN loom large in these regions as operators contract with price leaders for equipment and, increasingly, services.
Equipment sales are on the upswing as component shortage issues abate
• The Networks division grew over 14% year‐to‐year as demand for mobile broadband and RAN grew. Better access to parts will also fuel growth in Ericsson’s Global Services business, where delayed network rollout projects resulted in a decline in Network Rollout (NRO) services.
• Though network rollout revenue posted its third consecutive quarter of revenue decline in 4Q10, TBR believes 2011 will be a good year for Ericsson’s Networks unit, with sales amplified as the vendor works to fill its sizable backlog accumulated over the past year.
The Multimedia division is back in business
• After struggling mightily through the first thee quarters of 2010, the Multimedia unit rebounded sharply in 4Q10. Revenue grew 3.5% year‐to‐year and adjusted operating margin expanded 250 basis points to 10.3%. Much of the improvement stemmed from revenue management software sales, though TV sales were also a solid contributor.
• Though the unit had a successful quarter, the challenges inherent in the market have not abated and it remains highly fragmented. In addition, a more aggressive posture by Huawei and ZTE to grow their software businesses adds a new threat to incumbent vendors.
Restructuring initiatives are winding down, but their legacy lives on
• Ericsson plans to spend SEK 2 billion ($300 million) on restructuring in 2011 – far less than the SEK 6.8 billion ($1 billion) spent in 2010 and SEK 11.3 billion ($1.7 billion) in 2009. Despite greater cost pressures brought on by Chinese vendors, Ericsson has managed to keep gross margin in the mid‐ to high‐30% range and boost profitability without losing its innovative edge.
• With the costs of its restructuring initiatives now largely behind it, Ericsson will see the benefits in the form of improved bottom‐line performance in 2011.
Restructuring has trimmed Ericsson’s cost structure and positioned the company to maintain solid margins amid the hyper‐competitive market
Once the network rollout picks up steam, all of Ericsson’s divisions will be in growth modeQuarterly Segment Performance
Segment Key Changes & Drivers 4Q10Revenue
Growth Y/Y Trends to Monitor
Networks
• Chinese spending on 2G RAN and growing demand worldwide for mobile broadband fueled growth.
• Ericsson landed a position in Sprint’s “Network Vision” restructuring project in 4Q10, strengthening the company’s position in the U.S. and adding another line of recurring revenue that will likely exceed $2 billion over the next three to five years.
SEK 36.4 billion ($5.4 billion)
14.4%
• Major LTE and RAN modernization contracts are starting to ramp up globally.
• Ericsson also benefits from new HSPA+ upgrades by GSM operators like T‐Mobile USA and AT&T looking to bring faster speeds while waiting for the LTE ecosystem to mature.
Global Services
• Of the 54 managed service contracts signed by Ericsson customers in 2010, 26 were extensions and/or expansions of existing agreements, while the remainder were with new operators.
SEK 22.9 billion ($3.4 billion)
–1.2%
• Managed services revenue fell 5% year‐to‐year despite solid renewal and new contracts. Managed services remains a key focus and will increasingly branch out to non‐telco enterprises.
Multimedia
• Strong demand for revenue management software stemmed from emerging markets.
• 1.2 billion customers are now supported by Ericsson’s revenue management systems – up 20% year‐to‐year.
SEK 3.5 billion ($512 million)
3.5%
• OSS/BSS modernization will create opportunities, especially as operators move to cloud‐based and M2M applications.
With sales growth returning, TBR believes Ericsson’s margins have more room to grow when factoring in restructuring efforts
Financial Model Strategy
Revenues• Total revenue grew 7.6% year‐to‐year to SEK 62.8 billion (or $9.3 billion) on strong demand for mobile broadband and a rebound in the multimedia unit.
Expenses• R&D comprised 13.7% of total revenue, down 230 basis points year‐to‐year, while SG&A fell 120 basis points to 11.4%.
• Ongoing cost rationalization initiatives have eliminated excess from Ericsson’s cost structure and created operational leverage, which means a larger percentage of sales can flow to the bottom line.
Margins• Gross margin increased 210 basis points year‐to‐year to 34.7% on cost reductions, but fell sequentially as 3G rollouts in India and less profitable network modernization projects comprised a larger proportion of the product mix compared to 3Q10.
• Aggregate adjusted operating margin more than tripled to 9.9% from 4Q09, driven by significant improvement in Sony‐Ericsson.
• Operating margin in Ericsson’s core business was 9.7% in 4Q10, up from 4.1% a year ago.
Ericsson was a big winner of infrastructure deals in 4Q10, capturing market share in India and expanding its relationships with Tier 1 carriersKey Developments
Networks
• One of the most significant deals Ericsson signed in 4Q10 was with Sprint for the operator’s “Network Vision” project. The $4 billion to $5 billion, five‐year project calls for Ericsson, along with Alcatel‐Lucent and Samsung, to consolidate Sprint’s network technologies onto one streamlined platform. Ericsson will employ its RBS 6000 multi‐mode base stations to integrate Sprint’s 2G and 3G CDMA networks, which operate on different spectrum bands. Ericsson will also help Sprint phase out its iDEN network, transitioning the spectrum to add capacity to the CDMA network. Work will commence in 2011, with Sprint delegating which markets to revamp on a market‐by‐market basis. In Phase 1, Ericsson will be responsible for Atlanta, Miami, Houston, Kansas City and Dallas.
• Ericsson was also a big winner in India in 4Q10, snagging large portions of 3G rollout contracts from three incumbent telcos: Aircel, Idea Cellular and Vodafone Essar. In each deal, Ericsson will provide a range of 3G solutions and services. Indian operators are reluctant to award contracts exclusively to any single vendor, instead picking several vendors and awarding contracts by territories, called telecom circles. As a result, the battle for contract work in the promising Indian market is being fought on a market‐by‐market basis. TBR believes this initiative is being pushed by the Indian government as a means of mitigating risk of over‐dependence on one vendor, while playing vendors off one another to encourage price competition.
Multimedia
• At 5.5% of total revenue, multimedia remains a small contributor to Ericsson’s overall business; however, TBR believes this unit holds some promising growth opportunities. First, Ericsson is a leader in TV software thanks to its acquisition of Tandberg. With a range of offerings tailored to broadcasters for HD and 3‐D content encoding and delivery, Ericsson is ahead of rivals in addressing this market, which is still at the infancy stage.
• Ericsson’s TV capabilities are reflected by the pay‐TV platform it rolled out for Global Village in Brazil in November. Ericsson deployed a flexible TV platform that Global Village can leverage to offer advanced IPTV services.
• Though TV holds promise for growth, TBR believes the space will not see sustained traction until new technologies like 3‐D become more prevalent in consumers’ homes.
Ericsson is well‐positioned to secure new managed services deals with Chinese operatorsKey Developments
Global Services
• Ericsson made further headway in services in China, winning a three‐year managed services contract from China Unicom subsidiary Anhui Unicom. Ericsson already counts China Mobile as a client via its Hebei subsidiary. Though Ericsson is securing deals one province at a time in China, each deal is significant because the population of Chinese provinces can be tens of millions of people – the equivalent of entire countries elsewhere. TBR believes the company has a golden opportunity to add hundreds of millions of mobile subscribers under its management should the Chinese telcos decide to award more provinces to Ericsson. Managed services represents an area of differentiation compared to incumbent vendors Huawei and ZTE, which lack the scope and expertise to undertake these large outsourced deals.
Sony Ericsson
• 2010 was clearly a turnaround year for Sony Ericsson, with strategic bets on Android smartphones the venture’s saving grace. Volumes have stabilized at around 11 million units per quarter and profitability has returned. ASP is also trending higher, boding well for top‐line growth in 2011.
• Sony Ericsson followed Samsung in abandoning the Symbian platform in September 2010. Going forward, the joint venture will focus its smartphone portfolio exclusively on Android. Its Xperia line will get a boost with the Xperia Play, which will incorporate aspects of Sony Playstation to appeal to gamers.
ST‐Ericsson
• Revenue has stabilized but profitability remains elusive. Operating loss widened from 4Q09 despite restructuring and cost‐cutting. Weak pricing of legacy products and adverse currency exchange movements contributed to the loss.
• HSPA+ is an area of growth for ST‐Ericsson. As many operators choose to upgrade their existing HSPA infrastructure rather than move straight to 4G, hundreds of millions of consumers worldwide will have access to faster service, which will fuel sales of both dongles and chipsets for compatible smartphones.
Ericsson is focused on integrating its R&D resources with its piecemeal Nortel acquisitions to drive efficiency and better coordinate innovation
Resource Management Strategy
Personnel Changes• As of January 2011, Jan Wäreby began his new role as Senior Vice President and Head of Group Function Sales & Marketing. Wäreby will remain as head of the multimedia unit through January. Wäreby replaces Torbjörn Possne, who became Head of Global Customer Unit Vodafone.
• Nina Macpherson was appointed Senior Vice President, General Counsel, and Head of Group Function Legal Affairs, replacing Carl Olaf Blomqvist, who will retire in March 2011.
• Ericsson added 2,201 employees sequentially, most of which came from the acquisition of Optimi and Nortel’s Chinese unit as well as managed services deals. Ericsson ended 2010 with 90,261 employees, of which 45,000 are services‐related.
Investments/R&D Focus• The purchase of Optimi in December bulks up Ericsson’s OSS and network management portfolio and adds multivendor expertise. One of Optimi’s focuses is automation, an area Ericsson can leverage to reduce base station deployment costs by up to 80%.
• Ericsson acquired Guangdong Nortel for $50 million in December, gaining manufacturing, R&D, network support and customer service facilities in China staffed with 1,100 employees. The bolt‐on acquisition gives Ericsson a stronger presence in China.
Ericsson’s Worldwide Operations
Ericsson’s employee mix is growing rapidly in BRIC countries and North America. Downsizing is occurring across most of Europe as labor costs are high on the continent and in Africa,
where Ericsson is struggling to compete against Huawei, ZTE and Nokia Siemens. In 2010, 5,000 positions were made redundant, primarily in Western Europe, while 6,000
positions were added across China, India and Brazil.
Research and Development 9,306,000 7,526,000 7,751,000 7,689,000 8,592,000 7,500,000 Selling and General Admininistrative 7,323,000 7,008,000 7,158,000 5,775,000 7,131,000 7,000,000 Other Operating Revenue and Costs 878,000 302,000 500,000 620,000 581,000 500,750 Share in Earnings of Joint Ventures (1,461,000) (372,000) (308,000) (90,000) (402,000) (330,000) Operating Income 1,786,000 1,981,000 3,020,000 5,210,000 6,244,000 4,604,210
Financial Income 314,000 278,000 470,000 168,000 131,000 261,750 Financial Expenses (719,000) (438,000) (596,000) (302,000) (383,000) (429,750) Income before Taxes 1,381,000 1,821,000 2,894,000 5,076,000 5,992,000 4,436,210 Provision for (Benefit from) Income Taxes 656,000 547,000 867,000 1,523,000 1,611,000 1,137,000 Net Income 725,000 1,274,000 2,027,000 3,553,000 4,381,000 3,299,210
PERCENTAGE OF REVENUERevenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of Sales 67.4% 63.2% 63.0% 61.8% 65.3% 61.5%Gross Margin 32.6% 36.8% 37.0% 38.2% 34.7% 38.5%Research and Development 16.0% 16.7% 16.2% 16.2% 13.7% 15.3%Selling and General Admninistrative 12.6% 15.5% 14.9% 12.2% 11.4% 14.2%Share in Earnings of Joint Ventures ‐2.5% ‐0.8% ‐0.6% ‐0.2% ‐0.6% ‐0.7%Operating Margin 3.1% 4.4% 6.3% 11.0% 9.9% 9.4%Financial Income 0.5% 0.6% 1.0% 0.4% 0.2% 0.5%Financial Expenses ‐1.2% ‐1.0% ‐1.2% ‐0.6% ‐0.6% ‐0.9%Income before Taxes 2.4% 4.0% 6.0% 10.7% 9.5% 9.0%Provision for (Benefit from) Income Taxes 1.1% 1.2% 1.8% 3.2% 2.6% 2.3%Net Margin 1.2% 2.8% 4.2% 7.5% 7.0% 6.7%
YEAR‐TO‐YEAR GROWTHRevenue ‐13.0% ‐9.0% ‐8.0% 2.3% 7.6% 9.0%Cost of Sales ‐11.7% ‐10.7% ‐12.4% ‐3.7% 4.2% 6.0%Gross Profit ‐15.6% ‐5.8% 0.7% 13.6% 14.7% 14.2%Research and Development 13.1% 6.3% ‐8.3% ‐6.4% ‐7.7% ‐0.3%Selling and General Admninistrative ‐11.7% 2.1% ‐3.8% 9.4% ‐2.6% ‐0.1%Share in Earnings of Joint Ventures ‐14.3% 83.4% 85.6% 94.2% 72.5% 11.3%Operating Income ‐71.2% 11.6% 149.0% 355.4% 249.6% 132.4%Financial Income ‐73.6% ‐77.9% 11650.0% ‐43.2% ‐58.3% ‐5.8%Financial Expenses 18.5% 4.2% ‐654.4% ‐2.7% 46.7% 1.9%Income before Taxes ‐78.8% ‐29.4% 154.3% 342.9% 333.9% 143.6%Provision for (Benefit from) Income Taxes ‐73.2% ‐26.6% 154.3% 307.2% 145.6% 107.9%Net Income ‐82.2% ‐30.5% 154.3% 360.2% 504.3% 159.0%SOURCE: TBR AND ERICSSON* Restated according to IFRS and IAS regulations
Total Assets 38,528,725 37,729,212 36,649,391 37,035,967 41,604,348
LIABILITIES AND EQUITYInterest‐bearing Liabilities 303,307 284,135 502,685 598,799 562,175 Accounts Payable 2,693,779 2,508,331 2,683,016 2,850,793 3,684,697 Other Current Liabilities 9,210,457 9,048,080 9,149,870 8,663,529 10,038,249 Total Current Liabilities 12,207,544 11,840,546 12,335,571 12,113,121 14,285,122 Pensions & Provisions 1,284,343 1,135,553 1,125,050 1,110,797 803,845 Long‐term Liabilities 4,898,183 4,826,629 4,598,037 4,681,717 4,845,512 Total Liabilities 18,390,070 17,802,728 18,058,658 17,905,635 19,934,479 Minority Interest in Equity of Consolidated Subsidiaries 165,220 163,832 280,005 230,275 247,871 Total Stockholders' Equity 19,973,436 19,762,652 18,310,729 18,900,056 21,421,999 Total Liabilities and Equity 38,528,725 37,729,212 36,649,391 37,035,967 41,604,348
FINANCIAL RATIOSDays Sales Outstanding 102.46 125.08 130.17 109.62 87.63 Turns on Inventory 6.36 4.87 4.52 3.93 5.45 Fixed Asset Turnover (Tangible Assets) 24.47 19.07 20.06 19.89 26.82 Days Inventory Outstanding 57.41 74.92 80.77 92.85 67.00 Days Cash Outstanding 118.37 155.32 126.81 144.39 124.93Total Asset Turnover 0.87 0.67 0.70 0.70 0.91 Debt/Asset Ratio 0.48 0.47 0.49 0.48 0.48 Current Ratio 2.13 2.17 2.00 2.10 2.05 Return on Assets 1.5% 1.3% 1.8% 2.8% 4.1%Return on Equity 2.9% 2.5% 3.4% 5.5% 8.0%Annualized Revenue per Employee ($US) 369,500$ 346,207$ 309,094$ 317,680$ 340,877$ Employee Count 82,493 86,537 87,413 88,060 90,261 SOURCE: TBR AND ERICSSON
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