Ericsson Cuts 2,200 Jobs To Save Over $1 Billion by 2017, Improve Networks Margins

+26.94%
Upside
5.33
Market
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ERIC: Ericsson logo
ERIC
Ericsson

Global networking giant Ericsson (NASDAQ:ERIC) announced earlier this year that it is planning to cut 2,200 jobs, as a part of its cost and efficiency program. In a recent update, the company said that this program was progressing, as over 1,700 employees (mainly in R&D) were given notices in June and were soon to leave the company. [1] Following the completion of this round of job cuts, Ericsson will have reduced its Swedish workforce by a sizable 10%, saving almost $301 million by the end of Q2 2015 and about $1.08 billion by 2017. [2] With R&D expenses increasing as a percentage of revenues over the past four years, Ericsson its trying to save money wherever possible in order to improve its networks EBITDA margins. [3] If incremental savings through job cuts and other similar strategies help the company suppress the rise in R&D expenses going forward, pushing networks EBITDA margins up about 1.5 percentage points from our current long term forecast, Ericsson can potentially see its value go up by around 5%.

Ericsson has been consistent in identifying redundancies in its R&D unit, with a fresh round of employee layoffs recurring every two years, in line with the change in technology. The most recent round of jobs cuts, coming after almost two-and-a-half years, appears to be prompted by a fall in operators’ interest in 2G and 3G, thanks to the arrival of 4G-LTE.

The company’s efforts to cut costs is in line with its strategy to excel in its core areas of “Radio, Core and Transmission” and “Telecom Services”, in addition to funding growth in some key areas of IP networks, Cloud, TV and Media, OSS and BSS. This forms the core of Ericsson’s plans to transition from solely being a major telecom equipment manufacturer to a leading ICT player. It currently leads the $44 billion global Mobile (Wireless) Infrastructure market with a share of around 32-33%, closely followed by Chinese major Huawei. [4]

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We have a price estimate of $13 for Ericsson, in line with the market price.

See Full Analysis For Ericsson Here

Motivation Behind Job Cuts

While looking for redundancies in its R&D and supply divisions, Ericsson likely targeted employees working on technologies that are unlikely to contribute much to its long term growth. In fact, a former Ericsson employee reportedly stated that 2G falling behind and 3G losing momentum, which has had a notable impact on Huawei’s growth, was the official motivation behind the latest round of job cuts. [2] According to a 2014 Telegeography reported, the number of global 2G subscribers is likely to decline going forward, while growth in number of 3G subscribers will slow down. [5] Growth in LTE subscribers will gain momentum, and that is where most operators and networking companies will divert their resources. Therefore it makes sense for Ericsson to cut some of the R&D jobs related to 2G and 3G, and focus on 4G (and potentially 5G) instead.

Telegeography

R&D: Improving Efficiency And Realigning Focus

The recent job cuts reflect Ericsson’s plans to improve the efficiency of its R&D unit and realign its focus towards core areas, such as enhancing capabilities in small cells technology and 5G, as well as targeted areas such as IP networks and Cloud. Excluding the recent job cuts, Ericsson has a 25,700 employee strong R&D unit with centers across the world including in Sweden, India, China and the U.S.

The company’s R&D expenses increased about 13% in 2014 to SEK 36.3 billion ($4.23 billion), which was about 15.9% of sales. Over the past four years, R&D expenses have grown relative to revenues and job cuts may have been a desperate attempt to bring this under control. The importance of the R&D unit cannot be undermined since it not only helps the company stay ahead of the curve in terms of technological advancements in the wireless and ICT industry, it is also a steady source of income. However, Ericsson can do with fewer R&D expenses related to 2G and 3G going forward given that it’s already the world’s largest holder of 2G (GSM/GPRS/EDGE), 3G  (WCDMA/HSPA) and 4G (LTE) patents, with about 37,000 patents under its belt.

Potential For Upside

Ericsson’s Networks EBITDA Margins have fluctuated between 26% (2009) and 16% (2012), settling near 21% in 2013 and 2014. Margins suffered in 2011 due to R&D expenditures, and in 2012 they were negatively impacted due to lower sales and an adverse product mix. More focus on coverage than capacity building, coupled with the modernization drive in Europe, also had an adverse impact on profitability. Going forward, we expect margins to decline slightly in the near term with more Chinese contracts coming in (which are lower margin) and stabilize at around 20% thereafter. However, if Ericsson manages to push its EBITDA margins to 21% over the next five or six years, driven by incremental savings in R&D and capacity building in Asia, Europe and Latin America, there can be an upside of about 5% to our price estimate for the company. While this is a plausible scenario, growing competition from lower-cost Chinese companies such as Huawei and ZTE remains a looming threat for the company.

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Notes:
  1. Implementation of cost and efficiency program in Sweden, Ericsson, Jun 24 2015 []
  2. Ericsson Lays Off Target R&D, Supply, EE Times, Jun 30 2015 [] []
  3. Ericsson’s SEC Filings []
  4. Infonetics Report, Telecom Lead, August 2014 []
  5. The Beginning of the End for 2G, TeleGeography, Feb 5 2014 []