ot. you didn't ask for another Bernstein analysis of networking sector for Ericsson, but here it is. i've highlighted those sections which Ericsson disagrees with. Here Sagawa is postive regarding Nokia. In a later report, not sure regarding handset sales. No report since Nokia blew away estimates and gave a glowing infrastructure outlook:
* Based on interviews with numerous European contacts, we believe 3G
infrastructure deployments will a) start later, b) be smaller, c) involve more
vendors, and d) reduce vendor margins more than most investors currently
assume. As a result, we believe Ericsson may deliver infrastructure results
considerably below consensus expectations for 2001. Furthermore, we do not
believe Ericsson will achieve hoped for improvements in its money losing
handset division, adding to the drag on performance. We are reducing 2001 EPS
from SEK 2.76 to 2.49 ($0.28 vs. $0.38 consensus). As a result, we are
downgrading Ericsson from Market Perform to Underperform and setting a target
price of $13, which is 45 times our 2001 EPS estimate.
* Based on comments from Ericsson, Nokia and several service providers, we do
not expect vendors to begin recognizing revenues from 3G installations until at
least 2H01. With the 6 month delay in GPRS as an example, there is a
significant risk that realization of these revenues may not begin until 4Q01 or
even 2002. As most carriers will complete major voice capacity expansions by
year-end 2000 - 2000 wireless spending grew 35%+ YoY - Ericsson may face
relatively weak sales vs. tough compares in 1H01.
* 3G deployments may not be as extensive or as costly as originally assumed.
Carriers are expected to implement 3G networks only in high-traffic areas,
choosing to use much less costly 2.5G technologies for the majority of
geographic coverage. Given the limitations of a handheld platform, a hybrid
solution will deliver equivalent user services at less than half the cost of a
full 3G implementation. Overall, we believe that initial 3G equipment spending
will be less than $60 billion through year-end 2002, considerably below
industry estimates of better than $100 billion. To wit: BT CellNet this week
reported a capital budget of $2.1 to $2.8 billion per year through March 2003,
considerably lower than previous annual spending projections of more than $4
billion.
* Given extraordinary license fees and tough competition, carriers are making
timely deployment the most important consideration in awarding vendor
contracts. While Ericsson is enjoying a strong winning streak early on, we
believe carriers will turn to secondary vendors if a primary supplier cannot
keep to schedule. Ericsson, which does not have a reputation for strong
manufacturing or logistics, has a history of long delivery intervals in busy
times. This could result in lost orders and is a strong obstacle to Ericsson
meeting its goal of delivering 40% of industry 3G orders.
* We also expect a margin squeeze once 3G revenues begin to materialize.
Pricing for new 3G contracts is significantly more competitive than the network
expansion orders fueling strong 2000 sales. Furthermore, Ericsson must absorb
significant ramp up costs in introducing a new technology. We project
operating margin declines of 300-500 bp on infrastructure sales by 2002.
* We have commented on Ericsson's poor performance in handsets many times. We
do not believe that Ericsson's strategy of outsourcing design and manufacturing
to Asian OEMs will stem the tide of losses and market share declines.
Investment Conclusion
We believe Ericsson will fail to meet consensus expectations for revenue and
profitability in both wireless infrastructure and handsets. Our 2001 EPS
projection of SEK 2.49, reduced from 2.76, is more than 25% below consensus.
As a result, we are downgrading Ericsson, which trades at a rich 74 times 2000
earnings, from Market Perform to Underperform. We have set a target of $13,
which is 45 times our 2001 estimate.
Details
To date, wireless service providers have pledged nearly $100 billion worldwide
in exchange for licenses to offer 3G (third generation) wireless services in
recently cleared swaths of high quality spectrum. When the auctions and beauty
contests are done, vendors selected, technologies tested, designs completed,
and equipment deployed, we expect more than 80 new 3G networks begin service by
2003. Eyeing this apparent bonanza, investors have clung to wireless
infrastructure leader Ericsson as the surest way to participate in the next
gold rush. We are not so sure this is a good idea.
We believe investors may have to wait until mid to late 2001 to begin to see 3G
spending show up in equipment providers quarterly results. Meanwhile,
lucrative 2G capacity expansion projects will be complete by the end of 2000.
We also fear that actual 3G deployments will be limited to densely traveled
geographies, resulting in lower overall spending levels than many are assuming.
Moreover, we are concerned that the confluence of so many network
deployments, albeit smaller than expected deployments, will create a
significant premium for rapid delivery and installation - favoring a
fragmentation of market share rather than further concentration. Finally, we
believe competition for orders, combined with the costs of testing and ramping
production of a radically new product will compress vendor margins.
As a result, we project industry revenues for wireless infrastructure will
actually decelerate from 35% in 2000 to less than 30% growth in 2001 and 2002.
At the same time, we believe industry leader Ericsson will experience
difficulties achieving aggressive market share targets and could also suffer
significant margin deterioration in its core business. On top of this, we
believe Ericsson's handset division, which still accounts for 20% of sales, is
unlikely to return to profitability or sustain double digit market share.
Given this perspective, we are downgrading Ericsson from market perform to
under perform and setting a price target of $13.
3G Infrastructure Revenues At Least a Year Away
Although more than 25 3G spectrum licenses have already been awarded
world-wide, actual revenues from 3G contracts outside of Japan will not begin
before 3Q01 and could be delayed even further. The leading vendors have not
yet finalized their equipment designs and will not complete testing for several
months. Elements of the W-CDMA standard are still subject to change and a
major patent dispute with Qualcomm has not yet been resolved. Handsets are
unlikely to be available before 2002. Finally, installation personnel must be
recruited and trained and manufacturing must ramp to full capacity.
Equipment providers agree that all of these items will take time to resolve and
could be subject to delays, potentially considerable delays if GPRS is any
guide. GPRS technology, which is considerably less complicated to deploy than
W-CDMA, has seen delays of 6 months or more. Indeed, late changes to the GPRS
standard mean BTCellNet and T-Mobil must upgrade their early-bird
implementations to comply with the standard.
Deceleration in Infrastructure Spending Growth
Instead of an industry bonanza, we project that 2001 wireless infrastructure
spending will show a modest deceleration to 29% growth from 2000's 35% growth.
Global spending on voice capacity expansion will decline versus difficult
compares. 3G spending will not kick in until the second half and even then may
be disappointing to bulls that are expecting a major windfall. Spending on
2.5G technologies like GPRS will not make up the difference, particularly in
the first half of the year, when we expect carriers to conserve as much capital
as possible. While we expect 2002 global wireless spending growth to sustain
2001 levels, it should decelerate sharply thereafter.
Importance of Rapid Deployment Opens Opportunity for Second and Third Suppliers
The key decision criteria for carriers choosing a 3G equipment provider is
delivery. About 80 different operators will be deploying 3G networks in the
same 18-month period, with 3 to 6 networks in each country. This will put
enormous pressure on the leading infrastructure vendors Ericsson and Nokia to
deliver and implement networks on schedule. Our research suggests that
carriers will not hesitate to shift business to a secondary or even tertiary
supplier if the primary vendor starts to fall behind schedule.
We are particularly concerned about Ericsson, as its promise to capture 40% of
world-wide 3G deployments appears unattainable, given a history of long
delivery intervals during busy times. We suspect Ericsson will take care of
its biggest customers, but Orange and One-to-One will not sit and wait while
Vodaphone takes regular monthly base-station deliveries. We do not have faith
that Ericsson can make sufficient improvement in their manufacturing and
logistics to avoid losing business.
As a result, we look for second tier suppliers like Lucent, Nortel and Motorola
to pick up incremental business later in the deployment process. Moreover, we
believe Nokia, which has won the most GPRS awards and is the dominant player
with the newer GSM1800 operators, may be better positioned and better capable
than Ericsson to deliver on 3G contracts. Nokia has demonstrated superior
manufacturing and logistics skills, necessary to contemplate share gain in a
market where delivery lead times are so critical.
New Network Builds Mean Lower Margins
Competition for new contract awards have insured that network build-outs have
always carried lower margins than capacity expansion orders - somewhat
following the razor and razor blade analogy. 3G network build-outs are likely
to follow the same pattern. While carriers may pay a premium for an
accelerated deployment, this is likely to be offset by the costs of ramping
production on a new technology. As such, there is a strong likelihood of
margin pressure as 3G infrastructure revenues become a significant part of
industry revenues. We believe Ericsson's operating margins on wireless
infrastructure will fall 300 to 500bp by 2002 as a result of this phenomenon.
Ericsson's Handset Business: Past the Event Horizon
Ericsson's handset business is losing 20% on every unit it sells. Its market
share has dropped from 13.5% in 1998 to 10% in 2000. It is reducing its
product line at a time when its competitors are making even finer distinctions
in market segments and carriers are demanding increasingly customized products.
It is outsourcing both the design and manufacture of its low-end and
mid-range phones to a variety of Asian OEMs at a time when its brand is already
deteriorating and the need to engender customer loyalty vis a vis handset
upgrades is increasing. It has expressed a willingness to accept pain from
this business, which is still 20% of revenues, for the foreseeable future, in
order to support sales of its infrastructure. We do not expect Ericsson to
achieve its goals of profitability by 2Q01 or to sustain its market share, and
believe that this unit will be a significant drain on earnings in the future.
Risks
The key risks to our perspective are three-fold. First, our conclusion that 3G
deployment will not spread outside of densely traveled geographies could be
over-conservative if user demand for yet unforeseen high-speed applications
emerges more quickly and strongly than we have anticipated. We do not believe
this is a likely scenario, as no killer application for such high speed is
apparent and handset power limitations will remain a gating factor for several
years. Nonetheless, this would result in increased spending in 2002, adding as
much as SEK 0.60 to Ericsson's projected 2002 EPS of SEK 3.37.
Second, our conclusion that market leader Ericsson will have difficulty meeting
its goal of 40% share of global 3G deployments could be overly pessimistic.
If Ericsson were to add 10 percentage points to its current 27% share of world
wireless infrastructure sales over the next two years, it would increase its
2002 EPS by over 30% or SEK 1.10.
Third, our view that 3G contracts will result in reduced margins could be
overstated if delivery and performance requirements prove difficult obstacles
for second tier vendors. If Ericsson could sustain current operating margins
in its infrastructure business, it would increase its 2002 EPS by 23% or SEK
0.85.
Investment Conclusions
We believe Ericsson remains a considerable risk. Expectations are running very
high, as evidenced by Ericsson's P/E of 74 times 2000 earnings. Curiously,
investors appear to have chosen to ignore Ericsson's hopeless handset business,
still 20% of sales and losing 20% on operations, in favor of the industry
leading infrastructure business. We believe Ericsson's handset business could
yield a sufficient downside surprise to miss any quarter. As we believe
industry infrastructure revenues may not be as strong as many suggest and that
Ericsson may not meet its goals for market share advances, our 2001 EPS
estimate of SEK 2.49 or $0.28 is more than 25% lower than consensus. As a
result, we are downgrading Ericsson from market perform to under perform and
setting a target of $13 despite possible near-term upside from 3G contract
announcements.
Comments
Based on interviews with numerous European contacts, we believe
although the "contacts" are never given, in a conversation with Ericsson, they stated the analyst spoke with mainly operators. the reports from IDC, Forward Concepts and Strategis which differ largely from these assumptions deal with interviews from IPR holders, Manufacturers, and Operators. a fuller picture is obtained in this manner.
reduce vendor margins more than most investors currently
assume.
it is the "hope" of the operator to have manufacturers squeezed into lowering their profit margins. it is always their goal. but, what they say publically to analysts and how they are generally pushed by their customers privately for products is two separate events. the operators just spent $100 billion on spectrum in Europe - and that is less than 1/2 of the expected spending for Europe the Americas and Asia. Operators obviously need to get as quick a return as possible in order to appease shareholders. getting products as quickly to market as possible WON'T require squeezing margins from the FEW 3g suppliers that are out there. You squeeze margins when you have plentiful suppliers. For 3g that is definitely NOT the case. it is NOT the case because "3g" technology is owned by a very limited number of suppliers. Ericsson disagrees with these assumptions that Bernstein is making.
3G deployments may not be as extensive or as costly as originally assumed.
You, the Operator just spent $100 billion on spectrum. You have govt. clauses which state "use it or lose it" through out Europe...i.e., deploy products to the spectrum or lose the spectrum. So, you just spent $100 billion to buy the spectrum. Do you think that Operators will risk losing the spectrum by NOT deploying extensive 3g projects? Govt. clauses in ALL spectrum auctions to date state that ONLY 3g applications and upgrade paths must be utilized in the spectrum - no 2g applications (without an upgrade path present). So, the Operator couldn't purchase the spectrum with the hope of extending his 2g operations in a 3g designated space. In conversations with both Nokia and Ericsson, they are not at all in agreement with Bernstein's assumptions here.
Carriers are expected to implement 3G networks only in high-traffic areas,
choosing to use much less costly 2.5G technologies for the majority of
geographic coverage.
This, of course, is a rather deceitful assumption. "High traffic areas" comprise nearly 80% of all the revenue that mobile operators derive from their business. This Bernstein analysis makes it sound like deploying ONLY to high traffic areas will result in FEWER deployments. Since "high traffic" comprises 80% of the revenue generation already, you can bet that deploying 3g networks in such areas will generate "high amounts of revenue".
Given the limitations of a handheld platform, a hybrid
solution will deliver equivalent user services at less than half the cost of a
full 3G implementation.
This is silly. The Operators CAN'T use 3g spectrum for "hybrid" operations without 3g or its upgrade paths being one of the components (per Govt. regulations); so if 3g is one of the components, you just have 3g systems in place to handle the operations. There are plans to deploy BOTH TDD and FDD within the designated spectrums along with bimodal GPRS/TDD or GPRS/FDD; but 3g is always one of the components. The Operators upgrade path MUST clearly lead to 3g deployment within the government's specified timetable. For TDD deployment, ONLY TDD can be originally deployed in that spectrum as only TDD works in the designated spectrum. Without a TDD piggyback you can't deploy GPRS or GSM to it (2g technologies) as the potential for signal degredation could increase too much it.
Overall, we believe that initial 3G equipment spending
will be less than $60 billion through year-end 2002, considerably below
industry estimates of better than $100 billion.
These "industry estimates", by the way, came mainly from the Operators themselves. So, on this note, even Bernstein departs from their own Operator spending designs. $100 billion average was a figure developed by Strategis, IDC and Forward Concepts, independently arrived at. After reading this report it is doubtful that Bernstein has deeper connections than either of these firms to come to a more 'reasonable' infrastructure spending level.
To wit: BT CellNet this week
reported a capital budget of $2.1 to $2.8 billion per year through March 2003,
considerably lower than previous annual spending projections of more than $4
billion.
But, BT CellNet is NOT expected to win many 3g applications relative to their operations. How can they use a company with little 3g exposure as their "example" of decreased 3g spending?
Given extraordinary license fees and tough competition, carriers are making
timely deployment the most important consideration in awarding vendor
contracts.
this is true.
Ericsson, which does not have a reputation for strong
manufacturing or logistics, has a history of long delivery intervals in busy
times. This could result in lost orders and is a strong obstacle to Ericsson
meeting its goal of delivering 40% of industry 3G orders.
* We also expect a margin squeeze once 3G revenues begin to materialize.
Pricing for new 3G contracts is significantly more competitive than the network
expansion orders fueling strong 2000 sales. Furthermore, Ericsson must absorb
significant ramp up costs in introducing a new technology.
Ericsson disagrees with much of this. For one, Operators' requests for product are ramping up quickly, but the potential suppliers are limited due to "ownership" of 3g air interface designs (i.e., Qualcomm with CDMA2000 and Interdigital with WCDMA). Margins are squeezed when suppliers are plentiful and the buyers didn't just spend $100 billion on air space to introduce new products. The Operators are the ones being squeezed, not the limited suppliers. They're being squeezed for TIME! The "significant ramp up costs" are mostly being funded by the Operators...THROUGH THEIR INTIAL ORDERS.
As a result, we project industry revenues for wireless infrastructure will
actually decelerate from 35% in 2000 to less than 30% growth in 2001 and 2002.
This is a bad assumption given that Operators have spent over $100 billion on spectrum (with about $175 billion to go) and are given only a comparative short time in which to deploy 3g product and utilize the "whole" spectrum (use it or lose it). These wireless infrastructure comparisons to optical are useless. They don't give any basis for this assumption, other than their overall negative tone.
Elements of the W-CDMA standard are still subject to change
I'd like to know which elements he thinks are still subject to change that are of any significant importance? 95% of the needed structure has been decided on. There remain a few elements which are not considered "essential".
While we expect 2002 global wireless spending growth to sustain
2001 levels, it should decelerate sharply thereafter.
What? He gives absolutely no support for this statement. Throws it out there. By 2002 only 5% of the wireless world will be on 3g infrastructure based systems (50 million). Where does he think the other 950 million users are going to begin to transfer? This is NOT like TRYING to get someone to use a PC for the first time, by 2003 there WILL BE nearly ONE billion wireless users worldwide. It is a matter of transferring these users to the speakeasy 3g infrastructure base.
We are particularly concerned about Ericsson, as its promise to capture 40% of
world-wide 3G deployments appears unattainable,
obviously, Ericsson heartily disagrees with this statement. i believe Nokia will capture a larger share, but Ericsson obviously would prefer not.
Moreover, we
believe Nokia, which has won the most GPRS awards and is the dominant player
with the newer GSM1800 operators, may be better positioned and better capable
than Ericsson to deliver on 3G contracts. Nokia has demonstrated superior
manufacturing and logistics skills, necessary to contemplate share gain in a
market where delivery lead times are so critical.
this represents about the most knowledgeable piece of data the man has given in the report. it is now clear that Nokia through its FDD and TDD 3g plans are moving ahead of the pack in generating much faster 3g based time to market equations.
the rest of his comments are well written but appear mostly ill-founded based on initial false premises. it would take another ten pages to go into each one and there isn't time to do that. |
