Scenarios That Could Impact Ericsson’s Stock

+26.94%
Upside
5.33
Market
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ERIC
Ericsson

Ericsson (NASDAQ:ERIC) is a global telecommunications equipment and services provider based in Stockholm, Sweden. It is the leading supplier of mobile networks with products in CDMA, 2G, WCDMA/3G as well as 4G/LTE technologies. It is also a strong player in fixed-network solutions including copper, fiber, microwave transport and Internet Protocol. Established in 1876 as a telegraph equipment repair shop, Ericsson today employs more than 118 thousand individuals in 180 countries generating revenues close to $33 billion. With a portfolio of more than 37,000 patents from its 25,700-employee R&D unit, Ericsson is also one of the leading providers of ICT services such as systems integration, m-commerce and consulting, which contribute about 40% of its revenues.

The company reported a sharp fall in its first quarter profit as revenue generation shifted from the more lucrative projects in the U.S. to lower margin contracts in China. The company’s net income fell 14% year-over-year (y-o-y) and 65% sequentially to SEK 1.5 billion ($170 million) in Q1 2015, much lower than Reuters’ compiled consensus estimates of SEK 2.23 billion. Income was also negatively impacted by higher restructuring charges and a higher share of Global Services sales, partially offset by favorable currency trends. This was also reflected in the company’s gross margin, which declined by 110 basis points y-o-y to 35.4% in the quarter.

In this note, we take a look at different scenarios which could significantly impact Ericsson’s valuation going forward. Specifically, we will focus on the company’s performance and threats in the mobile infrastructure equipment market and the impact of declining Networks margins on the company’s valuation.

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We recently launched coverage of Ericsson with a price estimate of $13, about 10% ahead of the market price.

See Full Analysis for Ericsson Here

Competition In Mobile Infrastructure Equipment Market

  • Impact of Market Share ( 5% Downside/Upside)

With a market share of about 32%, Ericsson leads the Mobile (Wireless) Infrastructure market (along with Chinese major Huawei), which totaled above SEK 300 Billion ($43-44 Billion) in 2014. Mobile infrastructure contributes about 40-43% of the company’s revenues, and this is expected to continue in the near to medium-term owing to Ericsson’s ability to evolve with the dynamic global market. Ericsson currently leads the global 4G/LTE marketplace with five out of seven tier 1 operators in North America among its customers.

We could see a potential upside in the company’s value if it consolidates its strong 4G position and effectively competes with other major players such as Huawei, Nokia (NYSE:NOK), Alcatel-Lucent (NYSE:ALU) and ZTE. If the company can arrest the decline in its market share and maintain the current 32% levels going forward, we could see a 5% upside to its valuation. However, if the company is not able to effectively compete with rivals such as Huawei and the new Nokia/Alcatel-Lucent entity and its market share keeps falling at the current rate of decline, we could see a downside of over 5% to the company’s valuation.

  • Impact of Margins ( 6-11% Downside)

Ericsson is likely to face intense competition for wireless equipment contracts in North America in the near to medium term, as demand is gradually picking up and the recent Nokia/Alcatel-Lucent merger is likely to significantly impact its bargaining power. In addition, tackling rising competition in the Asia-Pacific region, especially China and India, will be tricky as the company will likely have to walk a tightrope between bagging low-margin contracts to maintain or improve its market share and expanding margins by compromising on top line gains. If Ericsson is unable to maintain a healthy balance between the two and network spending in developed markets fails to find momentum, its Networks margins could decline going forward. If Ericsson’s Networks’ EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) margins decline from the current 20% levels to 18% by the end of our forecast period, our price estimate for Ericsson could drop by about 6%. However, if margins decline further to 16%, Ericsson’s price estimate could fall by over 11%.

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