This column was originally published on RealMoney on July 21 at 10:48 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.
No matter how much people talk about the importance of China and India for the mobile telecom sector, I don't believe the case is overstated, as demonstrated by
Ericsson's margins were a tad stronger than expected, but softness in North America, Latin America and Europe now leaves Asia as the last citadel of growth. Ericsson is going to attack the new India and China deals like a rabid lynx, meaning the rest of the vendors are going to face a real test over the next winter.
The big worry with Ericsson has been the margin decline -- gross margin slipped to 42% from 45.9% last year and Ericsson shares were recently down 2.1% to $31.28.
But the company scored a defensive victory by posting an 18.7% adjusted operating margin. That's down from 21.6% a year ago, but the margin would have been 19.6% without the impact of the Marconi acquisition -- a percentage point above consensus expectations.
The problem with the second quarter isn't hard to spot -- North American sales were down 42% and Latin American sales were down 14%. There were some special factors that artificially boosted second-quarter 2005, but even after accounting for these, North America would have been down 17% year over year. In Europe, mobile system sales were flat.
This leaves Ericsson very dependent on Asia, which was a blast -- 55% sales growth, driven by China and India.
highlighted China as a problem area, but Ericsson was busy partying in Shanghai like Paris Hilton.
Mumbai or Bust
The problem here is that several Chinese sources indicate that Chinese 3G auctions -- the holy grail of the sector -- may now be pushed into next summer. This latest delay will mean that the next Indian expansion deals will be perhaps the most intensely contested in recent years.
Ericsson may be close to landing the major Vivo GSM launch order from Brazil, but we can only guess how low the company went to get the deal. Landing Vivo would essentially lock in Ericsson's complete supremacy in Latin America for the next decade -- the continent has swung to Ericsson decisively over the past three years.
The tightening competition was what triggered the recent infrastructure mergers of Lucent-
But the overall Capex trends seem to be dimming faster than markets expected. Ericsson is likely to continue its very aggressive bidding strategies, trying to chip at the customer bases of the merger parties and scare the customers of the nonallied vendors like
into reconsidering their futures.
Overall, the picture is one of a network market cruising toward a very problematic second half of 2006, but Ericsson is probably building its lead in the crucial battleground of Asia. Ericsson's share price should get some support from investors both shocked by the PC market weakness and scared of the smaller vendors hitting real financial trouble later.
But if the infrastructure cycle passed its peak last winter, it's hard to claim that the whole coming downturn is priced in for Ericsson. A discreet decline toward $25 may be in the cards over the coming year.
Tero Kuittinen is a senior product specialist for Nordic Partners, Inc., a pan-Nordic brokerage firm. Although Kuittinen is an employee of Nordic Partners, Inc., the statements above are being made in Kuittinen's personal capacity and are in no way are the statements of Nordic Partners, Inc., nor attributable to the company. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Kuittinen appreciates your feedback;
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