India, the silver lining for Ericsson in Q3 2023

Ericsson on October 17 said it expected the uncertainty impacting its mobile networks business to persist into 2024, after reporting a fall in third-quarter revenue as demand for 5G equipment fell in North America.

However, strong margins in other markets and a robust performance in India helped balance the overall results. India has been a rare growth area with sales quadrupling to about 10 billion crowns, but that is expected to slow down next year. Net sales in India grew over 3.5 times to about Rs 7,400 crore (9.6 billion Swedish Krona) in Q3. Ericsson recorded 4 per cent of total net sales contribution of 2,721.6 million SEK (about Rs 2,100 crore) from India for the September 2022 quarter. The net sales in South East Asia, Oceania and India grew by 74 per cent on a year-on-year basis to 13,764 million SEK during September 2023 from 7,914 million SEK a year ago. India remained the second biggest market for Ericsson. The net sales in the country accounted for 15 per cent of the total net sales during the September 2023 quarter, implying a business of 9,671 million SEK, which at present exchange rate is close to Rs 7,400 crore.

The Swedish telecom equipment maker’s shares fell 9% in early trade to lows last seen in 2017, when the company was going through another downturn.

Ericsson, which pre-announced its results last week and took a $2.9 billion impairment charge on its Vonage acquisition, said it expects current quarter results to be similar to the third quarter. Ericsson had stated last week that market conditions had had an impact on the value of its Vonage unit and, as a result, its third-quarter numbers were being affected by an impairment charge of almost $3bn. At the same time, it had provided some preliminary financial numbers that told a story all too familiar to network technology vendors around the world right now: Customers have tightened their belts and are spending less. Now the company is desperate to reassure investors, analysts and customers that the $6.2bn acquisition of Vonage was the right thing to do and that its strategy still holds good.

While declaring the results, Chief Financial Officer Carl Mellander said, “We are not going to guide for 2024 specifically, because the timing of the recovery of the market is uncertain. The company has increased its previously announced 2023 cost saving target of 11 billion Swedish crowns ($1.01 billion), including the laying off 8,500 employees, to 12 billion crowns. We have built out at absolute record speed and some of the 2024 volumes have been preponed into 2023…volumes will come down in 2024 in India.”

Gear makers such as Ericsson and Nokia have been hit by a slowdown in spending by telecoms companies. Jefferies analysts said they expect a gradual improvement in market conditions and ongoing cost reduction to slowly improve overall profitability in the coming quarters.

Networks organic sales in North America were down by 60% from last year as telecoms customers adjusted their inventory and were slower to roll out new equipment. North America now accounts for 23% of Ericsson’s sales compared with 48% earlier. Ericsson has seen growth returning in the Middle East, however.

At the earnings call, CEO Borje Ekholm said, “Over the last two decades we’ve seen that investments in mobile infrastructure have had built-in cycles and, in aggregate, it’s been overall flattish. We believe this pattern will continue. We don’t believe the peak levels of 2022 will return, but we do believe that investments will normalise from current levels. And the reason for this recovery is that data traffic continues to grow… more capacity will be needed, as will modernisation of the networks. So it’s important to note that while data traffic continues to grow at a very high rate, this implies market normalisation, not an incremental market growth. The reason for a flattish market for mobile infrastructure is that the operators’ service revenues have only had very limited growth. And this is something we actually also see reflected in the operators’ market multiples.

The overall aim is that the global network platform, combined with the capabilities of their 5G networks, will provide mobile operators with the opportunity to develop innovative new services for enterprise users. The recent application programming interface (API) platform announcement with Deutsche Telekom as an example of how this will play out.

Last month, we announced the historic milestone in the network API journey together with Deutsche Telekom. Powered by the global network platform, DT is able to offer a globally scalable one-stop shop for communication APIs, such as voice, SMS, two-factor authentication and enhanced security, as well as network APIs, [such as] location, device status and quality on demand. Through the global network platform, we’re creating a new market for exposing 5G capabilities, an opportunity that… analysts estimate to be [worth] about $20bn by 2028. And we aim to capture a sizable part of the market as we are the front runner today.

We have started to see more positive discussions with operators about network investments, but it’s clearly too early to call this a turning point. We are, though, confident that the recovery will come but the timing is really in our customers’ hands – given that, we think it’s prudent to plan for current market conditions to prevail into 2024.”

Key takeaways from the call include:

• Ericsson aims to capture a significant share of the estimated $20 billion market for network APIs by 2028.
• Despite the uncertain market environment, Ericsson remains committed to its long-term EBITDA margin target of 15% to 18%.
• The company will not provide guidance beyond Q4 of this year due to cautious customer investments.
• Ericsson reported an impairment of SEK31.9 billion related to Vonage goodwill, which represents 50% of total goodwill and intangible assets attributed to Vonage.
• Sales in North America declined by 60% due to inventory adjustments and slower deployment pace, while sales in India quadrupled due to large rollout projects.
• Ericsson exceeded expectations for EBITDA margin due to cost-cutting efforts, achieving run rate savings of SEK10.5 billion year-to-date with a target of SEK12 billion in total savings by the end of the year.
• The company expects gross margin in networks to range from 39% to 41% in Q4, with a lower sales top line seasonality in Cloud Software and Services.

Ericsson executives also provided insights into the future of the network’s gross margins and market expansion, highlighting cost reduction efforts and the potential of 5G business models. They anticipate North America to grow by 15% next year, while India’s growth is expected to taper off after a record year in 2022. The executives acknowledged the market’s competitiveness and the need for efficient R&D and cost savings. They also emphasized the importance of tapping into new revenue pools, such as enterprise digitization.

In terms of specific business segments, the executives acknowledged a slowdown in Vonage’s core business, which led to a goodwill impairment. However, they remain optimistic about the growth potential of the global network platform. They expect growth in the Cloud Software and Services segment to continue, and they believe that 5G core deployments will pick up in the future. Despite the impairment due to Vonage’s slowdown, Ericsson expects its Global Communication platform segment to grow in line with or slightly better than the market in the coming years.

The call concluded with the executives expressing optimism for the future, looking forward to the next earnings call in January 2023.

Results.

Third quarter highlights – in line with guidance

• Group organic sales declined by -10% YoY. Segment Networks organic sales[1] declined by -16% while Enterprise and Cloud Software and Services sales grew organically. Reported sales decreased by -5% to SEK 64.5 (68.0) b.
• Gross margin excluding restructuring charges was 39.2% (41.4%) primarily impacted by changed business mix in Networks. Reported gross margin was 38.4% (41.4%).
• Reported EBIT was SEK -28.9 (7.1) b. impacted by a SEK -31.9 b. impairment of goodwill related to the acquisition of Vonage.
• EBITA excluding restructuring charges amounted to SEK 4.7 (7.7) b. with an EBITA margin of 7.3% (11.3%). Reported EBITA was SEK 3.8 (7.6) b. with restructuring charges amounting to SEK -0.9 (-0.1) b. The goodwill impairment does not impact EBITA.
• Cloud Software and Services achieved EBITA[3] break-even on a rolling four quarter basis.
• Net income (loss) was SEK -30.5 (5.4) b. EPS diluted was SEK -9.21 (1.56). Net income excluding impairment of goodwill was SEK 1.4 (5.4) b.
• Free cash flow before M&A was SEK -0.5 (2.5) b. impacted by lower EBIT and higher working capital related to large deployment projects. Net cash on September 30, 2023, was SEK 1.6 b. compared with SEK 1.9 b. on June 30, 2023.
• Long-term EBITA margin[3] target of 15-18% remains, and Ericsson aims to reach it as soon as possible, subject to market mix recovery.

Net sales by market area by segment

Comments from Börje Ekholm, President and CEO, Ericsson
“In a challenging operating environment, Ericsson delivered third quarter results in line with our guidance. Consistent with the rest of our industry, we expect the macroeconomic uncertainty to persist into 2024, which impacts our customers’ investment ability. We are addressing these challenges with a focus on elements within our control, namely cost management and operational efficiency. We are on a journey to fundamentally reposition our business and we continue to execute on our strategy to extend our leadership in mobile networks, grow our enterprise business, and drive lasting cultural transformation.

Q3 in line with guidance
Q3 performance was in line with guidance, with an EBITA margin of 7.3% and an EBITA of SEK 4.7 b. Group organic sales declined by -10%, with a -16% organic decline in Networks partly offset by 5% organic growth in Cloud Software and Services and 11% in Enterprise.

Networks organic sales in North America were down by -60% YoY from a record quarter in Q3 2022, due to customers‘ inventory adjustments and a slower deployment pace. Sequentially, Networks sales declined by -2% in line with previous trends. The decline in North America was partly offset by growth in India as well as some early 5G markets resuming investments.

Our efforts to increase resiliency and reduce sensitivity to mix and volume changes pays off. Despite large market mix shifts in Networks, where North America declined YoY from 48% to 23% of sales, our gross margin remained as high as 40%.

Future networks need to be increasingly resilient, open, sustainable, and intelligent. Open RAN plays an important role in achieving this vision, and we are leading the industrialization of cloudification, open fronthaul and open management for network programmability. More than one million Ericsson radios in the field are hardware prepared for open fronthaul which underpins our support for openness across our Cloud RAN and radio portfolios.

Cloud Software and Services continued executing on the turnaround. With an EBITA of SEK 0.4 b. in Q3, we have now achieved a positive EBITA on a rolling four quarter basis. While results fluctuate between quarters due to the nature of this business, we are well on track to deliver at least break-even for full-year 2023 and improving from there on.

In Enterprise we saw continued strong growth in Enterprise Wireless Solutions, and we had a second consecutive quarter of positive EBITA in Global Communications Platform.

Last week, we announced a SEK -32 b. impairment of goodwill attributed to our acquisition of Vonage. Since the announcement of our acquisition in 2021, macroeconomic headwinds, including rising interest rates and changing demand trends, have significantly impacted the market capitalization of Vonage’s publicly traded peers.

Vonage is key to our expansion in Enterprise where we are enabling the next wave of innovation in our industry. We recently announced a significant milestone, in partnership with Deutsche Telecom, to be the first in the industry to unlock a market opportunity estimated at USD 20 b. by 2028. By offering communication and network APIs to developers and enterprises, we are opening up new ways for operators to monetize their investments in mobile networks, and for developers to leverage network capabilities to create exciting new applications. We are seeing significant inbound interest from operators to further develop this market.

Free cash flow before M&A decreased to SEK -0.5 (2.5) b., mainly due to increased working capital for large deployment projects such as in India. Next year, with reduced build-out pace in these projects, we expect working capital to taper off and free cash flow before M&A to start gradually approaching our long-term target of 9-12% of net sales.

Looking ahead
For Q4 we expect similar market trends as in Q3, while the cost-out impact will increase. We expect a group Q4 EBITA margin at around 10%.

We expect the underlying uncertainty impacting our Mobile Networks business to persist into 2024. We are proactively addressing the challenges in the current environment and are focusing on what we can control, including reducing costs. Our cost-out actions are already impacting the P&L and we are now expecting to yield SEK 12 b. in run-rate savings by year end, which is an increase of SEK 1 b. compared with previous indication. We will continue to take decisive cost-out actions to ensure Ericsson is well positioned to deliver value for our shareholders. Key to our strategy execution is to keep investments in technology leadership and long-term transformation intact, while managing our balance sheet.

The mobile networks market has been flattish for two decades, but with cyclicality, and we expect that to continue. However, the high paced mobile data growth, further spurred by new use cases, is the underlying driver for the market to recover to a more normal level. We are also relatively early in the 5G cycle with 75% of all radio base station sites, outside China, not yet updated with 5G mid-band. Competitive dynamics in our customer markets tend to lead to relatively sharp increase in investments when the market turns, and we are seeing some positive signs in early 5G markets.

Our long-term EBITA margin target of 15-18% remains, and we aim to reach it as soon as possible, subject to market mix recovery. Given current uncertainty we will not give guidance beyond Q4, 2023. As timing for the market mix recovery is in our customers’ hands, we prudently plan for current market conditions to prevail into 2024. We are managing our business accordingly, with focus on cost management and operational efficiency. When the market recovers, we will have significant operating leverage following the actions we are taking.

While near-term dynamics are uncertain, we are convinced that the recovery will come. Our goal is to make Ericsson a more profitable company, returning to our cash flow target level and capturing the next major wave of networks innovation with a substantial platform business,” Börje Ekholm, President and CEO, Ericsson.

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