Ericsson shares fall on lukewarm outlook

July 22, 2008: 3:21 PM ET

By Johan Anderberg

What happens when emerging markets don't bail you out of a flattening mature market? Ask LM Ericsson, the world's largest telecommunications equipment maker. Shares in the Swedish tech giant sank more than 10% Tuesday after the company announced that net profits fell 70% from the same quarter last year.

Ericsson's net income of SEK 1.9 billion ($319 million) for the second quarter was slightly better than expected. Net sales were up two percent to $8.1 billion, but shares fell on lower gross margins and low expectations for the year to come. The company reiterated its murky outlook for 2008: Customers in higher-margin markets such as the United States and Europe aren't likely to order wireless network upgrades in a weakening global economy. And the company's growing business in developing countries in Asia and Latin America is unlikely to offset slowing sales.

Last week's break-even report from handset maker Sony Ericsson didn't exactly reassure investors either. Ericsson CEO Carl-Henric Svanberg, in a conference call Tuesday morning, said this year will be a "challenging" one for its Sony Corp. (SNE) joint venture.

Tuesday's drop in Ericsson (ERIC) shares did not erase all of its 20% gain last week after Nokia reported better-than-expected results, offering a glimmer of hope about the telecom market ahead.

There was some good news in Ericsson's earnings report. Analysts were upbeat about the company's improved cash flow and ongoing cost-cutting. Ericsson is cutting expenses by $672 million this year, including 4,000 jobs worldwide (and not including an additional 2,000 layoffs Sony Ericsson announced last week.

At the same time, Ericsson is investing more in research and development in the hopes of boosting revenues through patent licensing. "We're walking a thin line," Svanberg said. "We plan for a flattish networks market ahead, but also try not to compromise with R&D."

Svanberg also tried to focus analysts' attention to Ericsson's growing market share in mobile networks. "We're expanding our footprint," he said, boasting that Ericsson now has 40 percent of both the GSM and 3G markets. "It will be good for us in the long run."

And despite the slowdown in mature markets, Ericsson is still betting heavily on growth in developing countries. The company continues to roll out networks in India, China, Latin America and all other places where growth is strong. Svanberg said Tuesday that India will become the company's largest market in the next quarter.

The problem is, Ericsson doesn't make much money in the emerging markets - yet. More than 42 percent of revenues come from Asia Pacific and Latin America, but most of these projects are turnkey and not nearly as profitable as the upgrading of existing networks. And prices are falling. "The competition is fierce. Everyone wants to be a part of the market," Svanberg said.

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