Ericsson: In Need of a Recharge

Can CEO Hellstrom reverse its fading fortunes?

Kurt Hellström looks as if he hasn't been sleeping very well. His suit collar is turned up, and his temper is brittle. "I have explained this so many times," grumbles the CEO of Swedish telecom giant Ericsson (ERICY ) when asked the reason for his company's declining profit margins.

The last few weeks have been brutal for the 57-year-old Hellström, who became CEO in the summer of 1999. The global tech crunch has slammed Sweden's largest company, sending shockwaves through the country. The company expects the world market for its key mobile networks business to grow at 5% to 15% this year compared with 25% last year. Sales in the troubled mobile-phone unit fell 52% in the first quarter, leading to a $570 million loss.

Hellström has little choice but to embark on a program of cost-cutting that will bite deeply into the Swedish workforce. All told, Ericsson is shedding 22,000 of its 107,000 staff in an effort to save close to $4 billion. That has brought yowls of protest and demands for Hellström's ouster in Sweden. Hellström says he has become "philosophical" about being the bearer of bad news, but the criticism has clearly gotten under his skin. "We haven't fared any worse than our peers, except maybe one," he says, clearly referring to Nokia. "Look at Cisco, Nortel, and Motorola. We are more or less following each other. But that is not noticed very much in Sweden."

So Hellström was happy on Apr. 24, when he finally got the opportunity to announce something more cheery. Ericsson is to join forces with Japan's Sony Corp. in the mobile-handset business. The two companies plan to pool marketing and development of future handsets in a company to be headquartered in London. The move will bring Ericsson a well-heeled partner. And it will allow Sony to apply its marketing and design savvy to Ericsson products, which are well engineered but almost universally panned as ugly.

DISTRACTED. It remains to be seen whether Hellström's new moves are enough to save a company that was once a global leader in the mobile industry from being permanently relegated to the second tier--or worse. Mobile telephony, Ericsson's forte, is entering a brave new world called third generation mobile. The new technology promises to offer fantastic services to customers and a pot of gold for equipment suppliers. But

Ericsson is distracted with problems and financially troubled just as this new dawn is breaking. "They are having to focus on retrenching, not growing," says Mark Davies Jones, an analyst at Schroder Salomon Smith Barney in London. These financial struggles could also put Ericsson at a disadvantage in the new game of providing loans to network customers.

Hellström hopes the Sony deal will turn into a consumer-electronics home run. It's not at all clear, though, that the two companies can quickly develop a killer brand in mobile like Sony's Walkman family of portable audio gear or its PlayStation computer games. They don't expect to begin operations until October. And they will be medium-size players with about 12% of the world market.

Ericsson's existing handset division is a disaster zone. It lost $2.4 billion last year and $570 million in the first quarter of 2001. Hellström says he's confident that cutting the handset workforce of 16,800 to fewer than 5,000 and outsourcing manufacturing to Flextronics International Ltd. will make the business profitable by the fourth quarter, whether or not Sony is on board.

Others are not so sure. Douglas Smith, analyst at Credit Suisse First Boston in London, projects red ink through the first quarter of 2002. He estimates that Ericsson will report an operating loss of $1.4 billion on sales of $26 billion for 2001, compared with a profit of $3.1 billion on sales of $27 billion in 2000. That's causing cash flow worries. Cash outflow was more than $2 billion for the first quarter, slashing cash on hand to around $2 billion. "The thing about negative cash flow is that it can't go on forever," says Smith.

Handsets aren't the only problem. Ericsson is starting to see its margins slip in the vital network equipment business, which earned the company about $3.3 billion last year on $19 billion in sales--offsetting the losses in phones. In the first quarter, those margins were just 4%, compared with a robust 14% a year earlier. Ericsson's archrival, Finland's Nokia, meanwhile, boosted margins to 18%. The slowdown in the U.S., Ericsson's biggest market, was one problem. In addition, debt-strapped phone companies were using Ericsson as a de facto credit agency by delaying payment. "The situation in the marketplace made customers try to draw on our balance sheet" instead of theirs, says Hellström.

AGGRESSION. Nokia may well try to steal a march on Ericsson in the battle for 3G market share by discounting and providing finance. Ericsson has about $2 billion in outstanding loans to customers, says Hellström, and going forward it is going to take a "cautious, conservative" approach to lending. He condemns what he calls a more aggressive approach by Nokia, which has $3.8 billion in outstanding loans to customers. The bulk of the loans, $2.7 billion, were extended this year. "They are taking very heavy risks," Hellström says.

Worldwide delays in 3G services make it hard to tell just how the companies are doing. But some analysts believe Nokia has picked up 2% to 3% market share in systems this year while Ericsson may drop a couple of percentage points. There is a long way to go, however, before Nokia, which had 12% of the mobile systems market last year, catches Ericsson, which had 32%. Mats Dahlin, chief of Ericsson's mobile systems unit, says Ericsson is a main contractor on 27 of the 47 3G deals announced so far. "Our strategy is to be an engineering company," says Dahlin. "I don't think any vendor can be a finance company."

Indeed, Hellström's goal is to ditch distractions, including the bulk of manufacturing, and focus on what Ericsson does best: selling and servicing systems for big telecom operators. "What we will keep is testing and systems integration," he says. Hellström says it would put Ericsson at a competitive disadvantage to dump handsets because customers for networks such as 3G want the vendor to supply handsets as well.

It's too early to count Hellström out. He's a determined guy who is well respected inside the company. Ericsson's two key owners, the Wallenberg family and the Handelsbanken group, will be reluctant to sack him because that would be the third change of CEO in about three years. The company, after all, has been rocked by a series of unexpected shocks: It doesn't need more boardroom turmoil. But it needs a rebound more than anything else.

By Stanley Reed, with Ariane Sains, in Stockholm, Heidi Dawley in London, Ken Belson in Tokyo, and Stephen Baker in Paris

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