Slowing sales growth and increased margin pressure are shaping up to be the major concern for investors in mobile telecommunications equipment makers in 2005.
Market leader Telefon AB LM Ericsson’s (ERICY) fourth quarter 2004 gross margins Thursday came in below expectations in the face of intense competition. The company said the effect was specific to the fourth quarter – an assertion some investors appeared to doubt as the shares were marked down 7.8% to close at SEK20.20.
Market research firm Gartner forecasts the market for mobile network gear, which accounts for the majority of sales, will grow 5% in 2005.
That compares with estimated 10% growth in 2004, which helped major players show good revenue growth and recovering earnings to offset massive losses and falling revenue in previous years. Ericsson’s shares were up 64% in 2004.
Ericsson projects the market growing between 2% and 5% – both Gartner and Ericsson measure in dollars – and Gartner analyst Jason Chapman said he sees industry margins coming under pressure short term as there will still be a fairly high proportion of hardware sales during at least 2005.
Hardware sales typically attract lower margins than software. Competition for new contracts is fierce and vendors are forced to accept wafer-thin margins, hoping to increase them over time.
“Later, margins should be helped by a growing share of software as upgrades to third generation equipment show up in sales,” Chapman added.
Currently many new networks are being rolled out generating sales of hardware such as base stations and other network equipment. In emerging markets such as Russia, India and Brazil it’s primarily second generation networks using Global Systems for Mobile communications technology that is driving sales. In Europe, third generation network rollouts are now taking place on a large scale.
In connection with the fourth quarter earnings releases Alcatel SA (ALA), Nokia Corp. (NOK) and Ericsson all said that margins have been or will likely be negatively affected by low prices on some new orders the companies have signed for rolling out those networks.
Analysts are worried about the implications of these signs of margins weakness.
“We remain concerned that margins, both gross and earnings before interest and taxes, will remain under pressure through 2005,” said CSFB in a comment to Ericsson’s fourth-quarter earnings.
The bank sees Ericsson’s operating margin coming down to 20% in 2005 from 22% in 2004.
CSFB added that the mobile systems market remains one of the most competitive global industries.
Number two player Nokia said after its fourth-quarter earnings release on Jan. 27 that its targeted 14% operating margin in the infrastructure business will likely not be met short term, also blaming new network rollouts.
Ericsson, Nokia, Motorola Inc. (MOT), Alcatel and Lucent Technologies Inc (LU) showed a combined 14.5% sales growth from its mobile infrastructure and services businesses in 2004 measured in euros, according to calculations by Dow Jones Newswires.
Measured in dollars that growth was around 26%, implying that the major vendors gained market share at the expense of smaller ones.
Ahead, sales growth is seen being higher for services related to mobile infrastructure than for the gear itself. Ericsson said it sees the services market growing 10% in 2005.
Siemens AG (SI) no longer discloses figures for the mobile networks unit and Nortel Networks Ltd (NT) has yet to disclose its full year 2004 earnings due to accounting problems.