Ericsson blip is unlikely to become a market flop
31 October 2007
Ericsson's third-quarter results may have been bad enough to force out the CFO, but do they signal a downturn in the mobile infrastructure market, as some have suggested?
The short answer is no, largely because earnings for one quarter from one vendor can easily be the exception rather than the rule, as suggested by the relatively good 3Q07 results at Nokia Siemens Networks.
But Ericsson's shocking 3Q07 results-with operating profit down 36 per cent on sales up 6 per cent--are an indication of the fundamental challenges that all vendors are facing as mobile growth continues to slow in developed markets, their traditional strongholds, but at the same time races ahead in emerging markets. How much should vendors cut prices in order to win new rollouts in emerging markets, thus securing a footprint that can generate higher margins in future from software and other upgrades? Each vendor is answering this question differently, but Ericsson's performance in 3Q07 shows how difficult it is to get the balance right. In essence the market's top vendor says sales held up in the quarter due largely to high-volume, low-margin deals in emerging markets, but margins tanked partly because major operators such as AT&T and Hutchinson delayed plans for significant network upgrades and expansions.
Although we'll all have to wait and see what the future holds, it doesn't hurt to take an educated guess of where the mobile infrastructure market is headed in 4Q07 and into 2008. First, expect Ericsson to bounce back in 4Q07, partly because the recent dive in its stock price after its 3Q07 results will put the vendor into overdrive while also forcing it to focus as much on margins as revenues, even at the expense of seeing its market share stagnate or even decline in some segments. Otherwise its stock price could continue to slide, which could put a stop to its strategy of moving into new fast-growing markets via acquisition.
Looking further ahead, the pressure on vendors will lead to more consolidation in 2008. Ericsson, Nokia Siemens and Alcatel-Lucent have established themselves as the top three vendors, but the networks businesses of a number of other vendors are still exposed. One possibility is that the long-mooted merger of the networks units of Motorola and Nortel will finally happen in 2008.
Overall we expect more deals throughout 2008 as smaller mobile infrastructure vendors make tough decisions about their core strengths. However some smaller vendors are unlikely to take part, including Huawei and ZTE, which are probably happy to continue gaining market share partly through fierce price competition. Others such as Samsung and NEC are part of larger conglomerates that do not have a history of selling off particular business units.
Next year will also be critical for mobile broadband, given that networks are now widely deployed and operators will need to see strong early subscribers takeup before they continue network expansions and upgrades. If AT&T and Hutchinson-two operators that have been firmly behind mobile broadband-are delaying network upgrades, is that a warning bell for the entire mobile broadband market? Our current view is it more of a breather-a pause in investment until revenues catch up-rather than a more fundamental shift away from the current phase of investment in upgrading networks to HSDPA and competing technologies.
It is also important to note that current mobile infrastructure revenues are dominated by 2G, 2.5G and 3G systems rather than mobile broadband systems, which is an emerging segment: GSM/GPRS/EDGE was the top selling technology group in 2006, ahead of WCDMA/HSPA and CDMA/EV-DO; HSPA and EV-DO currently only represent a small percentage of WCDMA/HSPA and CDMA/EV-DO revenues, respectively.
Mobile broadband deployments have taken off in the last year, with HSDPA deployments racing ahead and EV-DO continuing its steady expansion. However, HSDPA is mainly a software upgrade to WCDMA, just as EV-DO is largely a software upgrade to CDMA2000 1xRTT, which means that operators are likely to use their existing equipment vendors to provide mobile broadband upgrades. This helps to explain why the transition to mobile broadband may actually increase the dominance of the leading vendors in each technology camp, rather than creating an opportunity for tier 2 vendors to gain market share.
This is illustrated by the number of live HSDPA networks deployed by the leading vendors as of June 2007. At that time there were 148 live HSDPA networks worldwide, with Ericsson accounting for 54, or 37 per cent of all live systems. Nokia Siemens Networks followed closely with 53 live systems, or 36 per cent of the market. The next closest was Nortel, with 14 live systems for a 9 per cent market share.
The situation is similar in EV-DO, where a handful of vendors have broken away from the others to establish very strong positions in the worldwide market. Informa Telecoms & Media estimates that there were 76 live EV-DO networks worldwide in June 2007, with Nortel accounting for 25 of those, or 33 per cent of the market. The other two leading vendors are Alcatel-Lucent with 18 live networks for a 24 per cent market share and Huawei with 18 live networks for an 18 per cent market share.
Next year will also see the continuation of an interesting strategic battle as mobile infrastructure vendors evolve their strategies and product roadmaps for next-generation networks, particularly those based on OFDMA and MIMO. Mobile WiMAX will be the first major OFDMA and MIMO system to come to market in 2008, to be followed by LTE and, potentially, UMB systems in 2009-10.
The transition to next-generation networks is a high-stakes game given that it could be an opportunity for tier 2 vendors to gain market share on their larger rivals. Certainly vendors like Motorola and Nortel recognise this and have made major investments in Mobile WiMAX, in a bid to lead the development of all next-generation systems based on OFDMA and MIMO. In contrast, Ericsson, the dominant WCDMA/HSPA vendor, has said that it plans to focus exclusively on LTE given that it does not see a substantial market for Mobile WiMAX.
The transition from circuit-switched to IP networks is also a major trend that has an impact on the infrastructure vendors. Although this is an ongoing trend, it is accelerating and breaking down the barriers between the traditional telecoms and Internet infrastructure markets. One example is Ericsson's acquisition of IP infrastructure supplier Redback Networks.
Next-generation networks will often be converged networks providing both mobile and fixed services, and convergence is already a major trend in the infrastructure market. In fact, the ability to provide a more rounded portfolio of mobile and fixed infrastructure was one of the drivers behind the mergers that created Nokia Siemens Networks and Alcatel-Lucent, not to mention Ericsson's earlier acquisition of the fixed-line assets of Marconi.
But for now it will be interesting to see how the major mobile infrastructure vendors perform in 4Q07, and whether Ericsson's 3Q07 shocker (as it might be called in the UK tabloids) is a blip or a sign of tougher times ahead for the broader market. Our bet is it's a blip not a flop, but only time will tell.
Update: Alcatel-Lucent reported its third quarter results on Wednesday.
Mike Roberts is a principal analyst with Informa Telecoms & Media
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