Ericsson Drags Its Feet on Path to IP

Rivals are buying their way into Internet protocol, but Ericsson remains cautious, perhaps to a fault.
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European telephone equipment companies have made big data networking acquisitions recently to catch up with their U.S. counterparts, but Sweden's Ericsson (ERICY) appears to have been left behind.

Just last June the Stockholm-based telecom supplier started its

Datacom

division in Burlington, Mass., a hub for data-networking entrepreneurs. Its mission: leveraging Ericsson's 40% share of the global cellular-phone market and preparing its full line of wireless and wireless network products for the Internet. Many expected the company to quickly develop strategies to acquire small startups operating in the Northeast corridor.

But rival Europeans have pounced on Ericsson's turf in the U.S., which has become the proving ground for European companies trying to close the American lead in global data communications.

Parisian giant

Alcatel

(ALA)

is anteing $2.4 billion cash for the switch-maker

Xylan

and the startup

Assured Access

, both headquartered in California. Germany's

Siemens

has launched a loose-reined division,

Unisphere

, in Burlington, Mass., and snapped up

Redstone

,

Castle Networks

and

Argon

, all based northeast of Boston, for roughly $1.1 billion in cash.

What about Ericsson? "They are somewhat behind" in the Internet protocol race, says Pete Peterson, an analyst with the investment bank

Volpe Brown Whelan

in San Francisco. Internet protocol, or IP, is the next wave of communications technology. (Peterson rates shares a hold; his firm has no banking relationship with Ericsson.)

"They need to establish the capability to offer IP or data-type protocols over their networks," Peterson says of the Swedish firm. The problem: "Ericsson very well might not have the time to develop the products in-house."

Volpe Brown estimates that data traffic is growing 40% to 50% annually on large carriers' wireline networks, vs. less than 10% for voice traffic. Wireless data traffic is poised for huge growth, although it is tough to gauge right now; wireless voice traffic is growing 40% or more.

But overall, Ericsson is forming close friendships rather than jumping in the sack. "We're not going out there and doing M&A just for the sake of marketing cachet," says Laura Howard, a marketing vice president at Ericsson.

Ericsson has bolstered its stock recently by wisely choosing to end a long-running legal battle and set a cross-license deal with

Qualcomm

(QCOM) - Get Report

for CDMA, its data-friendly wireless technology. At the same time Ericsson is selling another wireless technology called general packet radio services, or GPRS, that uses packets of data to transfer messages.

Still, Ericsson hasn't fully repaired its stock (ADRs are trading at 25, down from 34 last summer) because it was slow to develop advanced new wireless handsets, and because sales of its wireline voice switches have ebbed a bit. Those challenges point up the need to develop new Internet protocol technology, which will prove hugely important to upgrading both its network offerings and emerging wireless-Internet products.

It's a sound strategy, says Peterson. "The question is their implementation."

So far Ericsson is taking small bites. In November it snapped up

ACC

, an affiliate of

Newbridge

(NN)

and a supplier of "access" products that connect consumers to the Internet, for $285 million. ACC's Tigris product allows carriers such as

Sonera

, formerly

Telecom Finland

, to sort individual IP messages.

In March, Ericsson added to its minority stake in young startup

Juniper Networks

and agreed to distribute its M40 network routers that compete with leading networker

Cisco

(CSCO) - Get Report

and Siemens' Argon. One potential problem: Ericsson must share with rival Juniper investors

Nortel

(NT)

, Siemens and

Lucent

(LU)

-- all of whom have standing offers to distribute Juniper products (to date, none have taken it). For the record, Juniper wants to go public, rather than be acquired.

The company has had modest success in the data networking field. In January,

British Telecom

(BTY)

agreed to pay Ericsson $440 million over five years to install its ATM switches. Howard says that contract compares favorably to the the $360 million run rate of ATM leader

Cascade

before it folded into

Ascend

(ASND) - Get Report

in June 1997.

One observer sees a positive side to Ericsson's cautious approach. The company intends to build IP "without blowing their earnings" on a costly acquisition, says Tom McIntyre, president of the money manager

Dessauer & McIntyre

in Orleans, Mass. McIntyre has no plans to exit Ericsson -- roughly 3.5% of his portfolio -- because it has a great brand name and consistently adjusts to technology waves.

Five years ago McIntyre correctly wagered that Ericsson would reap rewards from its costly R&D commitment to wireless technologies. The stock is up more than 300% since then. But McIntyre doesn't see the same commitment to the next wave, Internet protocol. "We don't expect much out of

the stock in the near term."

That is because Ericsson warned last month that restructuring costs will drag on sales in the first two quarters of the year. Equity analysts trimmed the

First Call

survey 2 cents to 9 cents per share for the first quarter. Ericsson earned 12 cents a share a year earlier.

The future is in IP. British Telecom plans to use Ericsson technology to fuse its old phone-circuit switches with its Internet systems. This is the path that investors need Ericsson to rush, not step gingerly, toward.