Tech

Leila Abboud is a Bloomberg Gadfly columnist covering technology. She previously worked for Reuters and the Wall Street Journal.

Finland's Nokia, fresh off buying smaller rival Alcatel-Lucent,  is proving a new noisy neighbor for Ericsson, pressuring the Swedish firm to up its game just as growth in mobile network equipment slows.

Second Place
Shares in Nokia move ahead of long-time sector leader Ericsson
Source: Bloomberg

The sales and profitability comparison between the two publicly traded telecom equipment makers is beginning to skew in Nokia's favor, as consensus shows for this year and next. (China's Huawei is a strong, profitable number two but remains private.)

That's because in addition to cost savings from the deal, Nokia will benefit from Alcatel's portfolio of Internet network gear, known as routers and switches. As app-crazy consumers grow ever-more addicted to their smartphones, such products are growing faster than traditional mobile equipment, which is Ericsson's stronghold.

Demand for mobile towers is fading as telecom operators have largely completed 4G networks in China and the U.S. To compensate for slower sales growth, Ericsson is betting on expanding in services, such as running networks or features like pay-as-you-go for the likes of Verizon and China Mobile, but those projects are lower margin. The mobile gear market is to decline 0.9 percent a year through 2018 versus 2.2 percent growth for the overall telecom equipment market, according to IDC.

Ericsson is expected to see revenue growth shrink by 0.3 percent this year before recovering to an anemic 1.3 percent growth in 2017, says Bloomberg consensus. At the same time, Nokia-Alcatel's combined revenue growth estimate is 5.1 percent in 2016 and 8.3 percent in 2017, according to Bloomberg Intelligence analysts.

Revenue Projections
Nokia's growth could be helped by Alcatel deal, leaving Ericsson behind
Source: Bloomberg estimates, Bloomberg Intelligence

Nokia, helmed by CEO Rajeev Suri, also has a lead on margins that will lengthen if the able cost-cutter delivers the promised 900 million euros ($1 billion) in cost savings from the Alcatel deal by the end of 2018. To be sure, this won't be easy, but Suri has a good shot, as Gadfly explains here.

Investors are understandably wary given the woeful track record of combinations in the sector, so aren't giving Nokia full credit yet. (Both Alcatel and Nokia destroyed billions in shareholder value with their earlier tie-ups from 2006 to 2007.)

Its operating margin in its network business was 9.5 percent in 2015 compared with 8.9 percent for Ericsson. Bernstein Research predicts the new Nokia-Alcatel could have operating margins of 10.5 percent this year, moving up to 12.3 percent later.

Reversal of Fortune
Nokia's steaming ahead of Ericsson as mobile business grows more slowly
Source: Moody's Investors Service

This is all a big change from the old days when Ericsson was the obvious top dog compared with Nokia and Alcatel-Lucent, which were both basket cases trapped in endless cycles of restructuring.

For Ericsson, the new reality means that it might have to consider bolder measures on cost cutting and M&A. It has promised 9 billion kroner ($1.1 billion) in savings by end 2017; investors are already clamoring for more. The company said it would keep an open mind on the issue and act if needed.

Much will depend on whether Ericsson can reap the benefits of a joint venture with U.S. giant Cisco to cross-sell and develop Internet-network gear such as routers and switches. The partnership was announced in November and is Ericsson's attempt to address its own tiny market share in this area, while avoiding risky, disruptive mergers. It aims for $1 billion or more of additional sales by 2018. 

Nokia has pooh-poohed Ericsson's Cisco partnership as too little, too late, and argues that jointly developing products rarely works because it complicates R&D efforts. Some investors believe Ericsson would've been better off buying smaller U.S. players Juniper Networks or Ciena Corp.

Ericsson shares trade at a roughly 30 percent discount to Nokia's on a price to earnings basis. Quieting the noisy neighbor may take a change in approach.

 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net