More on 3G: Mixed Signals
Ericsson dominates the wireless-equipment market. Handsets
are another story
By Richard Evans
The genie is out of the bottle when it comes to wireless communications,
and there's no putting it back in. This year an estimated 425 million wireless
phones will be sold worldwide. And as microchips grow smaller and batteries
grow more powerful, wireless operators everywhere are preparing for the
next generation of wireless equipment, which could increase data speeds as
much as 200-fold. Fast connections will, in turn, open the door to the wireless
Internet. By the end of 2003, industry experts predict there will be more
phones hooked up to the 'Net, worldwide, than PCs, unleashing a torrent of
wireless e-commerce.
Building out the infrastructure for the wireless Internet will cost money -- big
money. J.P Morgan predicts the world's telcos will spend up to $200 billion
during the next four years building 3G, or third-generation, wireless networks.
Today it is not a U.S. or Japanese conglomerate that dominates the huge and
growing wireless infrastructure business, but rather Sweden's L.M. Ericsson
Telephone, an early telephone and telegraph pioneer founded in 1876. With a
30% global market share of today's existing wireless systems and an
estimated 50% share in new contracts to develop tomorrow's 3G networks,
Ericsson has succeeded by a combination of business vision and solid
engineering.
"Our mobile-systems business is growing at 40% a year and we are the size
of the next three largest competitors," claims Ericsson President Kurt
Hellstrom, appointed to the top job a year ago. "We think we can further
increase market share over Nokia, Motorola and Lucent Technologies."
That's tough talk, but with a basis in fact. Analysts maintain that Ericsson has
won part or all of 16 of the 21 3G contracts agreed to so far, including a $1.3
billion deal with Germany's Mobilcom. It has also earned the envious position
as lead supplier to Vodafone, the world's largest mobile-phone operator.
Demand will rise in coming years as perhaps 100 major wireless operators
build thousands of earth transmission stations worldwide in order to expand
their international mobile-phone coverage.
Unfortunately, Ericsson's reputation
has been tarnished by its inability to
turn around a once-profitable
consumer-goods division, which will
manufacture some 45 million mobile
phones this year, around 11% of the
world market. While producing in
such volumes should be profitable, the
company expects to lose around $1.9
billion in mobile-phone handsets this
year, according to estimates by J.P.
Morgan. That's a huge loss for a
division that accounts for only around
20% of the firm's expected $30 billion
in total sales this year. And it offsets more than half of an anticipated $3.9
billion operating profit by the company's successful mobile-systems division
and other businesses.
By contrast, analysts project operating profit of $4.8 billion on sales of $25
billion for Nokia for the current year. Nokia's and Ericsson's positions in their
two key markets are virtually mirror images. For while Nokia dominates the
world handset industry with 34% market share, it has managed to grab only
11% of the mobile-systems market.
Trading at a recent 10.75, Ericsson's American depositary receipts are off
more than 55% from their March high of $26.31. And the worst may not be
over. "Given management's guidance, we expect that losses in the fourth
quarter may be double what they were in the third," says Brantley Thomson,
head of J.P. Morgan's European communications-technology team.
While firmly believing in Ericsson's continuing leadership as a builder of
wireless transmitters, earth stations and other heavy infrastructure, Thomson
wonders if the company can ever succeed in handsets. "Their engineers have
continually tried to create leading-edge phones that are better than everybody
else's," he explains. The trouble is, the company has been chronically late in
getting to market with its new phones. So rather than being able to skim the
cream off the market, charging high prices for the latest innovations, it has to
match the prices of its competitors, whose products are already moving fast
down the cost curve.
"The Volvos of the phone world"
Such enormous price erosion is crippling in a business where even Ericsson's
management admits they will probably never be able to post more than a 10%
profit on selling handsets. (By contrast, Ericsson's wireless-system margins
are a healthy 25%.) The company has lost more money trying to adapt
over-engineered phones for the entry-level market rather than designing cheap
and cheerful products right from the start. And while Ericsson has traditionally
turned out phones that look bland and chunky ("sort of the Volvos of the
phone world," quips one critic), Nokia has developed a steady stream of
sleek and colorful phones that appeal to the sweet spot in the market, hip
young consumers. To stem the tide, the Swedish electronics giant has
appointed a new management team staffed by marketing and design experts
rather than engineers. And the company's top executives are expressing a new
sense of urgency about doing the fix in a finite period. "By next summer we
have to break even in handsets," stresses Ericsson's marketing chief, Torbjorn
Nilsson. "We realize there is not a lot of time."
"Their new strategy is solid, and they are making the right moves," concedes
Sean Faughnan, European wireless analyst with Goldman Sachs, "but the
question is whether it's now too late for them to go it alone. My guess is that it
is." Faughnan believes Ericsson's only choices may be to find a joint-venture
partner such as Sony, which combines brand strength, strong designs,
consumer savvy and worldwide distribution, or to get out of handsets
altogether. The latter, however, seems unlikely, as operators migrating to 3G
networks may demand that their infrastructure providers also supply them
with handsets to ensure compatibility.
"We've had so much bad news that any positive developments, like the
announcement of a joint venture, could push the stock up by 20% or more,"
believes John Bennett, investment director for European markets at
London-based Global Asset Management. Already a holder of Ericsson
stock, Bennett plans to go overweight in the first half of 2001. "This could turn
out to be one of our biggest positions," he predicts.
"I'm a long-term fan of Ericsson," Bennett adds. "In
2001 they'll either fix the problems in handsets or
joint-venture them out. One way or another, they'll
put this behind them. But the main attraction in the
company is that I see their mobile-systems business
growing by 25%-30% over the next four or five
years." He believes the stock can double over the
next two years, provided the current strong
momentum in new orders and contracts continues.
Two main factors will determine how full Ericsson's
order book will be over the next year or two: the
telcos' continuing ability to finance the build-out of their networks, and the
eventual level of consumer demand for wireless data services.
We are likely to get a picture of how the rollout of 3G services will unfold
over the next six months or so, as 50-60 major 3G contracts go out from the
likes of Deutsche Telekom and Sprint. That's about all the time the newly
licensed carriers will have to begin next-generation network development if
they are to keep pace with the established Japanese and European leaders,
which are already developing their new wireless infrastructure.
And therein lies the rub. Credit Lyonnais Securities Europe predicts that
carriers may have to spend as much as $140 billion for their licenses. Add to
that the $200 billion cost of building out the systems and the financing strain
could slow the process considerably. Indeed, the debt markets have all but
shut down for financing telecom infrastructure. And the pressure on the
equipment makers from financing their customers has already begun to take a
toll. Uncertainty over the quality of Lucent's loans to its customers is one of
the factors that has driven Lucent's shares down by more than 80% ("Loan
Moans," September 4).
"Logically you would expect operators to finish building their new networks as
quickly as possible so they can launch their new services and start to make
money from them," says Susan Anthony, wireless industry analyst with Credit
Lyonnais Securities. "But no one really knows for sure what will happen."
The demand side, however, is far clearer. We've already gotten a preview of
3G in Japan, where NTT DoCoMo is offering its iMode services, which
deliver data speeds that are 12 times as fast as current wireless services. Up
and running since February 1999, iMode, which offers always-on Internet
service, has already attracted 11 million subscribers -- 58% of Japanese
wireless users -- and is adding subscribers at a rate of 300,000 a week. And
with the first full-blown 3G networks set to appear in Japan in the spring of
2001 and in Europe at the end of 2002, all of the major wireless-equipment
makers are attempting to hop on the bandwagon. "It's all a great land grab,"
says Robert Gensler, telecommunications fund manager with Baltimore-based
T. Rowe Price, "and Ericsson is the clear leader."
Adds Marc Cabi, senior wireless equipment analyst with Credit Suisse First
Boston: "The technology standards that Ericsson has created will almost
certainly become the standards for tomorrow. The carriers have already paid
so much money that the last thing they want will be any kind of revolutionary
new technology which will require further adaptations or slow their time to
market." Given that scenario, the likely outcome is that today's market
leaders, Ericsson and Nokia, will continue to gain share against second-tier
players like Alcatel, Lucent and Motorola.
In the meantime, President Kurt Hellstrom must contend with Ericsson's
handset problem. In a recent interview, Barron's asked if he would bite the
bullet and sell or joint-venture the business. "Sure, we are talking to people,"
Hellstrom said. "Everyone is talking to everyone." Any such announcement
would surely give a healthy boost to the company's flagging stock. Beyond
that, the company's firm grasp on the wireless infrastructure business could
make Ericsson a smart stock to own over the long haul. |
