Ericsson Still Has A Dial Tone

But the company's future lies in networks, not handsets

Only a year ago, Ericsson's board brought in Kurt Hellstrom, a straight-talking Harley rider, to rescue its hurting mobile-phone division. Hellstrom promptly moved to rip out paperwork, speed up product development, and add some zip to Ericsson's notoriously gray repertoire of handsets. Yet on Oct. 20, a day after archrival Nokia Corp. revved up the tech market with a stellar earnings report, Hellstrom came up with some stunning bad news. Ericsson lost $407 million on handsets in the third quarter--and will lose $1.6 billion on phones this year. Amid a welter of analysts' downgrades, Ericsson shares plummeted 20% in the next three days of trading.

In the Scandinavian heavyweight bout that has been raging for a decade, rule the latest dustup a knockout for Nokia. While Hellstrom insists that Ericsson will claw its way back in handsets, the company is more likely to cut its losses by farming out production--and perhaps even selling the unit. Likely buyers could include any consumer electronics company eager to grow in wireless, from Sony Corp. to Apple Computer Inc.

Dire news? Not necessarily. Ericsson may be destined for the sidelines in mobile phones, but its core business, accounting for 54% of its estimated $19 billion in sales this year--and more than 90% of operating earnings--is wireless telephone network equipment. In this market, Ericsson dominates the world with a 30% market share, double Nokia's. It's growing at 43%, with healthy 18% margins.

And as global telephone companies frantically borrow billions and issue stock, gearing up to invest $200 billion in the next phase of wireless networks --the so-called Third Generation, or 3G --Hellstrom and company are positioning themselves for a windfall. "We've been preparing for this for 10 years," says Mats Dahlin, Ericsson's executive vice-president for mobile systems.

BIG STAKES. The race for 3G represents a make-it-or-break-it test for Ericsson. If the Swedish company can extend its leadership into this next generation, sales will explode. 3G, after all, is one of the biggest infrastructure projects in history. The winners will dot the globe with hundreds of thousands of base stations, all of them positioned to transmit high-speed data into every pocket, purse, and glove compartment from Buenos Aires to Beijing.

But to clean up in 3G, Ericsson, a company that has specialized for a century in voice networks, must take on the data champs from North America, including Nortel Networks, Lucent Technologies, and Cisco Systems. Nortel and Lucent made massive Silicon Valley acquisitions, buying Bay Networks and Ascend Technologies, to bulk up for this data market. And Cisco embodies the Net. "As customers migrate to 3G," says William Nuti, Cisco's Europe president, "they move to New World equipment, like ours."

Nevertheless, with the 3G market just getting started, Ericsson is already a serious player. By the company's count, it has at least a part in 16 of the first 21 3G contracts. These include a $1.35 billion deal in late October for German phone company MobilCom.

Opponents say it's too early for Ericsson to proclaim victory. The announcements so far, says Nokia Chairman Jorma Ollila, "are just scraping the surface." Ollila, whose company is teaming up with Cisco in 3G, says the real winners will emerge as nearly 100 contracts are announced over the next six months. Most networks will then be stitched together over the next three years, first in Japan and Korea, followed closely by Europe, and then America.

INCENTIVES. While the business should be massive, profits could prove elusive. Competitors eager for a piece of the wireless market are already sweet-talking phone companies, offering them bargain prices and even financing deals. This should spread, forcing even the market leader to offer incentives. "Ericsson eventually will need to provide vendor financing," predicts Mark Davis Jones of Salomon Smith Barney in London.

An equally big challenge is logistics. For Ericsson to maintain its share of a ballooning market, Hellstrom must jack up production in a hurry. Already, he's ripping out phone-making machinery in plants in Sweden and the U.S., reconditioning them for the network business. At the same time, he'll be outsourcing manufacturing work to Asia and America and signing big construction companies, such as Scania, to help roll out the 3G systems.

And the battered handset business? Here Ericsson is likely to be a marginal player, if that. During the '90s, Nokia redefined mobile phones as a consumer product, much like athletic shoes. And the Finnish company spun out generations of these snazzy machines while Ericsson, an old-line engineering company, never caught up. With this year's loss in the phone business, Hellstrom has had to scale back sales growth projections five points, to 25%, with operating margins of 7%--a far cry from Nokia's 50% growth and 18% margins.

Hellstrom still insists he can turn phones around. His plan is to farm out manufacturing of cheap models to Asia and to trim back the number of lines Ericsson produces. That at least should cut costs. But if Ericsson can play to its strengths, winning the network battle for 3G, few will care that the Swedish giant no longer makes phones.

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