AT&T 3G delays weigh on Ericsson

Ericsson today warned that its third-quarter sales and operating profit would be lower than expected due to lessened spending on infrastructure and software, a shortfall analysts pinned directly on AT&T’s slow deployment of its UMTS network.

In a statement, CEO Carl-Henric Svanberg said that most of Ericsson’s sales last quarter were in developing markets where competition is fierce and profit margins low. Those deployments are usually offset by high-margin upgrade and expansion contracts with existing customers in developed markets, but last quarter the orders just weren’t there. As a result, Svanberg said, the vendor’s deployment mix was lopsided toward new network builds, thus reducing its overall revenues and profitability.

“All other businesses performed as expected,” Svanberg said in the statement. “The effect of market dynamics is always a matter of judgment. This quarter we have underestimated the effects."

In North America, Ericsson said its revenues actually increased slightly, but the company was expecting a much bigger bump due to network expansion contracts that failed to materialize. Though Ericsson didn’t name any names, the most likely culprit is AT&T. Ericsson is believed to have taken a larger share of the AT&T UMTS/high-speed downlink packet access (HSDPA) contract at the expense of Alcatel-Lucent, but according to RBC Capital Markets, AT&T is building out the 3G network very slowly. Along with other operators in Western Europe, AT&T’s slow pace is impacting high-margin expansion and upgrade orders, squeezing Ericsson’s margins by more than 7 percentage points.

Ovum analysts said they believe Ericsson was genuinely caught off-guard by the slowdown of expansion orders in the last quarter. In a research note, Ovum said Ericsson believes the orders are merely delayed, not canceled or lost to another vendor. Still Ovum said it was cautious about whether those orders will materialize this quarter, bumping up its fourth-quarter results.

Regardless of the last quarter’s sales mix, Svanberg said it was crucial that Ericsson focus on the lower-margin deals in developing markets. Those markets are where future growth lies, and Ericsson has to be competitive to ensure it maintains its global market share, he said.

“In infrastructure, scale is critical for success,” Svanberg said in the statement. “Our strategy to regain scale advantage through increased mobile systems market shares has been effective. The present market dynamics are, however, working to our disadvantage from a short-term financial perspective. Now that we have reestablished our scale advantage from the pre-industry consolidation, we will shift our focus slightly and capitalize on our market share gains.”