Has Ericsson Hit Bottom Yet?

Profits may be a year away. But there are flickers of hope

It's as bleak as anything ever conjured up by Ingmar Bergman. With every passing day, the news about Swedish telecom-equipment giant Ericsson (ERICY ) seems to get worse. After laying off 20,000 employees--one-fifth of its entire workforce--last year in a scramble to cut costs, the company now plans to shed another 20,000 by 2004--5,000 in Sweden alone before the end of next year. "You run into a friend on the street who works for Ericsson," says Christer Palmgren, chief executive of Swedish telecom-services startup Spinbox, "and the next day he's gone." Adds another Stockholm technology executive: "It's a panic situation."

That's a chilling sign of how far the Swedish technology star has fallen. Few doubt that Ericsson, a key holding in the sprawling empire of Sweden's powerful Wallenberg clan, will be one of the survivors of the global telecom shakeout. But investors are wondering just how much worse things could get before they get better. This year is already looking pretty dismal. On Apr. 22, when Ericsson announced disappointing first-quarter results, CEO Kurt Hellström, 59, predicted that the wireless-equipment market would shrink more than 10% this year. Delays in the rollout of new third-generation services are partly to blame. "We don't see any uptick in the near future," Hellström says. That means Ericsson will likely end 2002 in the red for the second year running. Analyst Per Lindberg of brokerage Dresdner Kleinwort Wasserstein is forecasting a $357 million loss--an improvement on last year's $2 billion shocker--on $18 billion in revenues.

Hellström's downbeat forecast confirms fears that the beleaguered telecom sector won't rebound this year, or even the next. Faced with staggering debt loads, slowing growth, and industry consolidation, telcos "are spending the minimum possible, waiting and waiting," says Spinbox CEO Palmgren. What's more, they're not investing as fast as expected in speedy new third-generation services. After laying out $120 billion for 3G spectrum licenses in Europe alone, mobile operators are queasy about having to spend an estimated $150 billion more to build new networks.

Nobody feels that foot-dragging more than Ericsson. It's the world's leading seller of big-ticket gear for mobile networks, with a 33% market share. But the company now predicts that less than one-tenth of its 2002 revenues will come from 3G systems. So Ericsson has little choice but to slash costs as fast as possible. Last year, it trimmed nearly $2 billion from overhead by cutting workers, outsourcing some manufacturing, and divesting its mobile-handset business to a 50-50 venture with Sony Corp. The recently announced layoffs aim to pare back an equal amount by 2004.

Grim indeed. But there are also some small signs of improvement. Although first-quarter shipments were down 26% compared with the same period last year, new orders for 2G and 3G networks gear grew more than 10% from the previous quarter--the first such rise in a year. The Sony joint venture reported it had reached breakeven thanks to its wildly popular T68 mobile phone, which features a splashy color screen. Most impressive, Ericsson managed to boost gross margins by 4 percentage points. If this continues, Ericsson should return to profitability sometime next year, say analysts.

To strengthen Ericsson's balance sheet in the meantime, Hellström is making a controversial move. On Apr. 22, he revealed that Ericsson aims to raise $3 billion by the end of the third quarter through a stock-rights issue--selling additional shares at a discount to existing owners. The money isn't needed to fund day-to-day operations: That would be a real sign of desperation. Instead, Ericsson says it will bolster its $5.5 billion cash hoard and pay down debt. Fund managers, though, worry about the dilutive effect on Ericsson's equity. And they're rankled that the rights issue will do nothing to fix Ericsson's complicated ownership structure, under which the owners of just 7% of its capital--the Wallenbergs and an investment arm of banking giant Svenska Handelsbank--exercise 67% of voting control. Hellström defends the rights issue as a "prudent" move to improve Ericsson's financial position.

That he needs to justify himself in the first place is a painful comedown for a 126-year-old company long seen as one of Sweden's crown jewels. Ericsson accounts for 10% of the country's gross domestic product. At the peak of its market capitalization, in March, 2000, the company was worth more than $190 billion--about 37% of the value of the entire Stockholm bourse. Now, that figure is down to $20 billion. No wonder that when the stock went into a free fall last year, a Swedish tabloid printed a picture of Hellström done up to look like a wanted poster. "It's a major blow to Sweden," says Magnus Melander, investment manager for Stockholm venture fund BrainHeart Capital.

It's a dent in Hellström's reputation, too. An 18-year Ericsson veteran, Hellström was viewed as a corporate hero in Sweden for helping propel the company's meteoric rise over the past two decades. He admits he needed a bit of persuading from the board to trade in a plum assignment in Hong Kong for the job of president in 1999. Hellström was promoted to CEO 17 months later. Even now, say acquaintances, his typical Swedish reserve leaves him uncomfortable in the limelight. "He's not the sort of person who stands on the barricades and shouts `follow me'," says Ulf Avrin, a former Ericsson manager who now runs Stockholm e-mail startup Mobeon.

Hellström has a new partner to help straighten out the mess. In March, former Electrolux CEO Michael Treschow, 59, became the company's new chairman. Closely tied to the Wallenbergs, Treschow replaced Lars Ramqvist, who resigned last October. Treschow's cost-cutting zeal earned him the moniker "Mike the Knife" at Electrolux. The telecom industry neophyte is expected to deploy a similar strategy at Ericsson.

Cutbacks won't solve all of Ericsson's problems, however. Observers say the company is still painfully slow to make and implement decisions. For instance, layoffs often take four or five months to complete, leaving employees in a state of prolonged anxiety. And there's a danger that cuts could go too deep. After telling analysts that research and development was sacrosanct, the company has trimmed R&D spending by 20%, or about $800 million annually. Hellström insists the cuts were for nonessential or discontinued projects. But Ericsson can't risk its future if it intends to emerge stronger from the downturn. No doubt, it will be forever transformed by this ordeal. The question is whether it will emerge a champion.

By Andy Reinhardt in Paris, with Stanley Reed in London and Stephen Baker in Helsinki

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