China losses hurt Ericsson Q3 sales, supply chain issues surface

Missing out on significant 5G contracts in China hurt Ericsson’s sales in the third quarter, but the vendor partly offset that with growth in other markets, despite starting to feel impacts from supply chain issues.

In the latest quarter network and digital services (which includes 5G core) sales in mainland China were down by SEK 3.6 billion in Q3, with a negative 6% impact on organic growth.

Ericsson’s woes in China have been well publicized, as its market share recently diminished, though expected, with blame largely placed on tensions between its home base of Sweden and the use of Chinese vendors. Ericsson had already warned of hits from losses in China (which also showed up in the second quarter) and the vendor continued to see its share of contract wins slashed in the most recent 5G tenders with major Chinese operators.

“It’s clear this is a consequence of the decision Sweden took to exclude Chinese vendors in the build out of 5G networks,” said Ericsson President and CEO Börje Ekholm during Tuesday’s earnings presentation.

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With less presence in China, Ericsson closed one of five R&D centers in the country in September, though at the time insisted it remained committed to 5G development for the market.

Ekholm on Tuesday said the company has to “right size” its sales and delivery channels in China, which starts in Q4 and will add to restructuring costs.

However, the vendor still hopes to compete in China down the line.

“I like to think when you lose a contract, the day after you start to fight to win it back. The same is the thing with China, I do believe we have a chance to win back the trust to deliver products in the future, so we’re focused on regaining that,” Ekholm said, while noting that short-term the company still needs to adjust its cost structure.

Overall Ericsson saw organic sales drop 1% year over year due to China and supply chain issues started to surface.

RELATED: Ericsson is caught in cross-hairs between China, Sweden

In the first half of the year and up until recently Ericsson hadn’t seen much impact from widespread supply chain constraints, but late in the third quarter saw a squeeze on individual components. Ekholm said it resulted in the loss of some sales as well as higher inventory in Q3. Supply chain issues continue to pose a risk and are likely to have some impact to Ericsson in the fourth quarter, he said.

Despite the significant losses in China, Ericsson partly offset it with wins in Europe, Latin America and North America – markets where sales increased 9% to SEK 14.4 billion and 13% to SEK 20.2 billion, respectively. In the U.S. the vendor now has 5G contracts with the three Tier 1 operators, Verizon, T-Mobile, and AT&T (the latter just announced a new 5-year deal that includes C-band gear) – which Ekholm said are the largest in Ericsson’s history.

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Excluding China, organic sales growth was 6% overall in Q3 and 8% in the networks business. Ericsson’s networks segment reported a 3% drop in sales year over year to SEK 40.6 billion.

Still, the company’s overall gross margin increased to 44%, and improved in the networks segment to 47.8% from 46.7% - partly from higher IPR revenues from licensing its patent portfolio.

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Sales for managed services were down 8% in Q3 to SEK 5 billion. Revenue for Ericsson’s smaller emerging business segment was up 26% to SEK 2.0 billion, with 4% growth after a boost from last year’s acquisition of U.S.-based Cradlepoint (which has a focus and expertise on enterprise).  Ekholm attributed gross margin strength in the segment largely to Cradlepoint, which he was encouraged also was “one of the key drivers of the overall strength in gross margin for Ericsson” as a group.

Overall, third quarter net income increased 4% to SEK 5.8 billion and free cash flow was SEK 13 billion versus SEK 3.9 billion a year ago.

5G core and digital services

Ericsson continues to invest in R&D for cloud-native 5G core and related services, which CFO Carl Mellander said is a cornerstone to its profitability and growth targets for the digital services group.

The vendor expects to break even in digital services in the fourth quarter, after reporting a 1% year over year decline in the most recent quarter and 1% organic growth (6% year over year excluding China). It expects a limited loss in 2022 but is targeting long-term EBIT margin of 10-12%.

Part of the early loss has to deal with initial deployment costs – as Ericsson doesn’t start to actually see 5G core revenue until networks go live (it’s starting to see early revenue from 5G contracts). That revenue grows as more subscribers are added to those networks.

Early and initial 5G rollouts have largely used non-standalone 5G, which still relies on 4G in the core – but shifts to standalone are a coming and next step as networks mature. In the U.S. T-Mobile was the first and only to launch a nationwide SA 5G network, and just today Japan’s Softbank announced it started to offer SA 5G services.   

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During the latest earnings call, Mellander emphasized the strength in its 5G core portfolio, highlighting business moment with 45 standalone 5G contracts to date and eight live networks. 

“The standalone 5G core market window is open and customers now make long-term commitments in their choice of vendors,” said Mellander. Investments are also focused on so-called attached services, such as spending on orchestration for services, as well as automation to help Ericsson be more efficient in its own delivery of software.

The core strategy is also key to an emphasis on enterprise going forward and helping CSP customers serve the segment, including with network slicing, dedicated networks and 5G edge solutions.

For Ericsson, the packet core, including 5G standalone core, represents 20-25% of total digital service revenue – the other 75% is from the other areas which are become more software-based and industrialized, according to Mellander.

In particular, he called out the BSS, where Ericsson scored 70 new deals in 2021.

By 2023 Ericsson expects to see revenue from CSP enterprise and service orchestration, as dedicated networks start to scale up and edge solutions and network slicing start to be commercialized.