Why We Revised Our Price Estimate For Ericsson To $6.50

We have cut our price estimate for Ericsson (NASDAQ:ERIC) from about $8.50 per share to $6.50 per share, on account of the shrinking radio access network (RAN) equipment market and mounting competitive pressures from rivals such as Nokia and Huawei. Below we outline some of the key reasons for our price revision.

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Wireless Equipment Market Seeing Sharp Declines

Ericsson’s networks division, which accounts for over two thirds of its revenue, has been facing headwinds as operators scale down their investment in 4G technologies, which appear to be approaching saturation in most markets. Moreover, competition has also been mounting, with Chinese companies such as Huawei and ZTE emerging as formidable competitors, garnering share via their low-cost hardware, particularly in emerging markets. This mounting competition has been hindering Ericsson’s pricing power, as networking companies sell to a relatively concentrated number of carriers. During Q2 2017, its most recent quarter, Ericsson’s swung to a net loss on account of lower sales volumes (13% down in comparable currency terms), high overhead costs as well as a less favorable sales mix, with lower software sales. Things are likely to remain challenging going forward. While the company initially projected that the wireless equipment market would contract by 2% to 6% this year, it indicated that the declines could actually approach the high-single digits. Ericsson is focusing on pruning its costs, targeting run rate cost savings of roughly $1.2 billion by mid-2018, though this may not be enough given the mounting competition and declining sales.

5G Can Drive Next Wave Of Growth, But Competition Will Remain Intense

5G is touted to drive the next big investment cycle for telecom carriers, as it operates on the so-called millimeter spectrum which requires more base stations to provide the same level of coverage as 4G. Ericsson has indicated that its 5G revenue opportunities could increase from 2019 onwards, and we believe that the company could have some advantages in the space. Firstly, Ericsson has been carrying out 5G trials for close to two years now. Moreover, data security and privacy are becoming increasingly important themes in the wireless space, and this could work in Sweden-based Ericsson’s favor, as it could be viewed more favorably compared to its Chinese rivals, particularly in Western markets. That said, Chinese players such as ZTE and Huawei have built strong relationships with carriers in markets in Asia, Africa, and the Middle East. These companies could have an advantage in these emerging markets as carriers typically operate based on costs in the absence of regulatory pressures.

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