For Ericsson (ERIC) - Get Telefonaktiebolaget LM Ericsson Sponsored ADR Class B Reportin particular, the mobile infrastructure giant's Q3 warning calls into question recent strategic decisions, as well as Ericsson's competitive standing and its ability to prop up margins via job cuts in the face of rapidly-declining sales.
For telecom equipment makers in general, the warning suggests equipment spending by carriers is even weaker than it looked a couple months ago. Especially among mobile carriers seeing little to no revenue growth.
Ericsson is down about 20% today, falling to its lowest levels in more than a decade after warning its sales fell 14% annually in Q3 to SEK51.1 billion ($5.8 billion), and its operating income (excluding restructuring charges) fell 73% to just SEK1.6 billion ($181 million). That's soundly below consensus analyst estimates of SEK53.6billion ($6.1 billion) and SEK4.3 billion ($490 million).
Rival Nokia (NOK) - Get Nokia Oyj Sponsored ADR Reportis down 5% thanks to Ericsson. Networking giant Cisco Systems (CSCO) - Get Cisco Systems, Inc. Report, which formed a major alliance with Ericsson a year ago, is down 2.4%. Other decliners include Cisco rival Juniper Networks (JNPR) - Get Juniper Networks, Inc. (JNPR) Report, application delivery controller vendor F5 Networks (FFIV) - Get F5 Networks, Inc. Report, network processor developer Cavium, optical networking equipment makers Ciena (CIEN) - Get Ciena Corporation Reportand Infinera (INFN) - Get Infinera Corporation Reportand wireless broadband equipment provider Ubiquiti Networks (UBNT) . The Nasdaq is roughly flat.
Echoing remarks previously made in the company's weak Q2 report, Ericsson says weak mobile broadband (i.e. 3G/4G infrastructure) equipment sales weighed on Q3 results. It added sales were particularly weak in markets facing serious macro pressures, such as Brazil, Russia and the Middle East, and that European capacity upgrades were limited by the completion of 4G projects in 2015.
All of that resulted in Ericsson's Networks (equipment) sales falling 19% annually in Q3 to SEK23.3 billion, easily a steeper decline than Q2's 14%, never mind Q1's 2% drop. It also resulted in gross margins dropping to 28.3% from 33.9% a year ago, in spite of the fact the company has been aggressively cutting jobs. Those job cuts did result in operating expenses dropping 6% to SEK14.1 billion, but that clearly wasn't enough to keep operating income from plunging in the face of major sales and margin declines.
With 4G networks largely built out in many developed markets, and 5G build-outs not expected to start in earnest before 2020, mobile carrier capital spending is clearly in the midst of a down-cycle. That's not exactly news. But it isn't helping that many big carriers are seeing minimal top-line growth, thanks to high smartphone penetration rates and the erosion of traditional voice and text-messaging revenue streams by web-based calling and messaging services.
It looks as if this phenomenon is driving some carriers to tighten their budgets even more than expected. Meanwhile, China's Huawei and ZTE have been gaining share against the likes of Ericsson and Nokia with the help of aggressive pricing, particularly in emerging markets.
At the same time, it's worth keeping in mind that equipment makers that aren't as mobile-dependent as Ericsson have also been having a rough time. Cisco's service provider orders fell 5% in the company's July quarter, which in turn weighed heavily on router demand. Shortly before that, Infinera plummeted in response to weak Q3 guidance that was blamed on several demand-related issues at carrier clients.
Here, it's worth noting that wireline equipment spending is also under pressure in many cases. While online video traffic serves as a growth driver, many wireline carriers continue to be pressured by declining voice revenue. Moreover, the Chinese equipment market, which is holding up relatively well, is dominated by local firms.
Amidst such a bleak demand environment, major Internet/cloud service providers remain a bright spot for equipment suppliers. Jefferies recently forecast capital spending from the top 5 hyperscale cloud providers -- Alphabet's (GOOGL) - Get Alphabet Inc. Class A Report Google, Amazon (AMZN) - Get Amazon.com, Inc. Report, Microsoft (MSFT) - Get Microsoft Corporation (MSFT) Report, Apple (AAPL) - Get Apple Inc. (AAPL) Report and Facebook (FB) - Get Facebook, Inc. Class A Report -- would grow 26% this year to more than $30 billion.
But this figure still pales relative to global carrier capex of about $300 billion. Moreover, the hyperscale firms have made heavy use of white-box hardware built by Asian contract manufacturers to the cloud firms' specifications. The growing popularity of the Facebook-led Open Compute Project, which creates open-source designs for power-efficient data center hardware, certainly isn't helping matters here.
All of this is a headache for Cisco, which has been investing heavily in developing high-performance switches -- along with chipsets to power them -- meant to win over cloud providers. It's an even bigger issue for a company like Ericsson, whose data center exposure is limited to begin with.
Ericsson could've grown its data center exposure and lowered its mobile infrastructure by making a big acquisition or two, as many expected it to after Nokia announced last year it was merging with Alcatel-Lucent. Juniper (JNPR) - Get Juniper Networks, Inc. (JNPR) Report and Ciena (CIEN) - Get Ciena Corporation Report were frequently viewed as potential targets. Instead, Ericsson decided to "play it safe" and merely partner with Cisco.
The company now appears to be paying a steep price for its caution. And with its shares having nosedived, paying for a big acquisition will be tougher than it would've been a year ago.