Global Economics

Telecom Networks Get the Blues


Mature European markets and growth of home-team players in China lead mobile-network suppliers to go hybrid and sell services

It's a tough time to be selling mobile-phone network equipment. On Feb. 2, just over a week after Paris-based Alcatel-Lucent jolted markets with a profit warning, its Swedish rival Ericsson (ERIC) surprised investors with a tepid growth forecast for 2007. Even though the company reported strong fourth-quarter numbers, shares in the world's No. 1 supplier of wireless networks fell more than 6% over concerns for this year's prospects.

Ericsson says it is still gaining market share in Europe at the expense of competitors such as Alcatel-Lucent (ALU) and Nokia (NOK). But most of the big European contracts for third-generation (3G) mobile networks have already been awarded, and competition for new business is increasingly brutal, especially with Chinese newcomers ZTE and Huawei Technologies jockeying for position. That's putting pressure on prices.

"It has always been a challenging environment, but it's becoming even more so," says Philip Kendall, a wireless analyst at Strategy Analytics in Milton Keynes, England. "Mobile operators are tightening their belts and scrutinizing every penny."

Unexciting Outlook

Ericsson managed nevertheless to squeeze out impressive results for the fourth quarter. Thanks especially to strong growth in the Asia-Pacific region, revenues grew 18%, to $7.7 billion, and net profits hit $1.4 billion. For the year as a whole, revenues were up 17%, to $25.6 billion. "We see continued opportunities to outpace the market," said Chief Executive Carl-Henric Svanberg in a statement.

At the same time, price pressure was evident in declining gross and operating margins, and Ericsson's net earnings grew only 8% in 2006, to $3.8 billion. What spooked the market even more was that Ericsson said it now expects "mid-single digit" growth this year, which the Street interprets to mean 5%.

That's down from previous guidance of "moderate growth," which analysts had understood to mean 5% to 10%. "The outlook remains unexciting," says equity analyst Richard Windsor with Nomura Securities in London.

Waiting Around for China

Ericsson, however, is faring better than Alcatel, where fourth-quarter revenues fell 16% and profits were flat (see BusinessWeek.com, 1/23/07, "The Reasons for Alcatel's 'Shocking' Miss"). Nokia also reported lackluster performance by its network-supply business on Jan. 25. Fourth-quarter sales rose 12%, but operating margins fell to 5.9% from 13.7% a year earlier.

Ericsson and its rivals face similar opportunities and problems. Mature markets are mostly saturated and operators there have largely completed their most recent round of upgrades to support 3G technology. There is still huge potential in emerging markets such as China, India, Africa, and Latin America. But it's uncertain when China will award the licenses for 3G networks that would trigger a burst of investment by mobile operators. And even when it does, much of the work may go to Chinese players.

To escape sagging prices, telecom suppliers are trying to move upstream by delivering more "value-added" professional services, such as consulting, maintenance, and even outsourced network management. Ericsson, for instance, saw its services revenues soar 30% in 2006, to $4.6 billion—three times the growth rate for its mobile network equipment.

Hybrid Opportunities

Equipment vendors also are on the hunt for mergers and acquisitions to lower their costs and improve their positioning in global markets. Alcatel and Lucent wrapped up their big merger last November, while Nokia and Siemens (SI) hope to launch this quarter a delayed joint venture between their respective network businesses (see BusinessWeek.com, 6/19/06, "Nokia, Siemens Plan to Join and Conquer").

Ericsson may have a head start in this arena. To stake out turf in fixed-line networks, it snapped up Britain's Marconi in 2005. And in December, 2006, Ericsson announced the $2.1 billion acquisition of U.S.-based Internet router maker Redback. The two deals strengthen Ericsson's offerings for the core of emerging hybrid networks that handle fixed, mobile, and Internet traffic.

That lead should stand Ericsson in good stead this year, when the wireless infrastructure market worldwide could grow just 2% to 4%, according to Nomura Securities. As its rivals focus on integrating their operations, Ericsson can seize the opportunity to keep building market share, not only in Europe but also in China, where it is already No. 1. Still, 2007 is shaping up as a tough year for everybody in the business.

Matlack is BusinessWeek's Paris bureau chief. Norton is a BusinessWeek.com correspondent in London .

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