Can Ericsson Return to Profitability With New Strategy?

Ericsson’s top management stood before investors Wednesday during its capital markets day to explain why the provider of communications technology posted five quarters of consecutive losses and how its new strategy will turn the company around from one focused on growth to one focused on profitability.

Explaing loss, Ericson said that one of its main businesses has been building radio access networks (RAN) for customers such as AT&T and Verizon. RAN provide a connection between mobile devices and their core network. However, demand for this equipment dropped 8% in 2017, much faster than the decline of 2% to 6% that Ericsson had anticipated in the first quarter.  It also saw weaker performance in its IT and Cloud segments due to past contract commitments.

The previous management team’s strategy had emphasized growth through acquisitions and scope expansion. It prioritized services-led revenue growth over profitability and risk. However, the acquisitions and scope expansions did not deliver the expected net sales growth, which led to a lack of competitiveness and price pressures. Meanwhile, consistent dividend increases led to declining margins.  

Chief Executive Borje Ekholm said the near-term plan for profitability was to stabilize and simplify the Swedish company’s structure and cut 10 billion Krona in costs by mid 2018. It will do this by removing 18% of the managerial positions and 2,500 other positions, divest some businesses, closing 83 sites, review all contracts and turning around the Digital Services business by focusing on software-led solutions.

“The growth strategy has been part of the problem,” said Peter Laurin, Ericsson’s head of business area managed services. “We have taken in deals and risk we shouldn’t have taken. “

Laurin said the company was going to limit certain markets, no longer offer stand-alone field services and institute stricter sales directives. He said the company planned to either exit, renegotiate or transform 42 of almost 300 contracts by 2019.

In addition, the company has invested in research and development by hiring 1,100 new engineers. The main drivers of growth will be focusing on building the next generation 5G telecommunication network, increasing market share in China and investing in emerging businesses such as the Internet of things. 

“We will run a very tight ship now and be much clearer on accountability,” said Chief Financial Officer Carl Mellander. “I believe we will be more transparent than we have ever been. The transformation will take time, but I feel very confident of the robustness of the plan.”

Mellander said a stronger dollar vs. the krona and the faster decline in the RAN market led the team to lower its financial targets for operating margins by 2020 to be around 10%, but he has a long-term target of 12%. The other financial targets for 2020 are sales between 190 billion krona to 200 billion krona, gross margin between 37% and 39%, and positive free cash flow. (Graphic – long -term operating margin target or group financial targets)

“Yet another restructuring more focused on streamlining the company rather than expanding the product offerings,” said Edward Snyder, managing director of Charter Equity Research, a sell side research house in Colorado Springs, CO. “It was an excellent articulation of what happened and what they learned from the past. But they still face the same end market, same risk, the same competition and price erosion. So while they are focusing on stabilizing margins to improve profitability, they have to do it in a declining market environment. That is a difficult proposition that many companies before them have not mastered.”

Snyder added that  of particular interest was Ericsson’s growth and profitability targets for 2020. Most comes from better pricing, which is a pretty tall order in a market as competitive as this one. “They have the right idea, but it’s not clear they can make it happen considering the industry peaked in 2008,” he said.