For Ericsson, more pain before any gain

By Adam Cox and Helena Soderpalm

STOCKHOLM (Reuters) - You're an Ericsson investor: in little more than a month, you've been stunned by two downbeat projections in a row and the shares you hold have lost almost half their value.

So when executives say the long-term picture remains bright, should you believe? Analysts say yes, but be prepared for further pain first if you plan to stick it out.

What undid Ericsson in the first place was what it called an "unexpected shift in the business mix", with fewer high-margin network upgrades and more sales of new networks.

According to chief executive Carl-Henric Svanberg, the first quarter of next year could well be the low point for the company, and analysts believe soaring data usage means the company will once again bask in solid demand -- eventually.

"We can basically forget about Q4, Q1 and probably about Q2 too," said Thomas Langer, analyst at WestLB.

"We think Ericsson is being punished, and this has to do with investors not wanting stocks in their portfolios that send disappointing signals. If investors have a view of four to six quarters ahead, they will be rewarded."

In October, when it warned third-quarter profits would fall short, Ericsson sought to reassure investors with a fourth-quarter "planning assumption" for sales of 53 billion to 60 billion crowns ($8.4 billion to $9.6 billion).

Last week, it said fourth-quarter sales would be at the low end of that range, sending the stock down 11 percent. The shares have shed 43 percent since just before the profit warning.

DATA DEMAND

The company says the long-term picture for the industry has not changed, despite a move by the consolidating universe of telecoms operators to postpone network upgrades.

Richard Windsor, analyst at Nomura Securities, said these upgrades can only stay on hold so long. Operators, he said, will eventually be "bursting at the seams" and will need growth.

"Basically, what's going on is the operators are trying to massage their capex," he said.

Windsor and Langer say trends herald surging data demand. Langer cited a Cisco Systems study that suggested mobile data traffic on IP networks is set to grow 70 percent a year between 2005 and 2011.

All that traffic will need direction -- through the stations, switches and routers made by Ericsson and its rivals. And since it is the industry's dominant player, Ericsson, in theory, is in a strong position to get a lot of that business.

The WestLB analyst notes that for this scenario to play out, operators will need to cut data tariffs to ensure demand does balloon, while Ericsson will need to cut prices to make a business case for cost-sensitive operators.

Investors, taken aback by the third-quarter warning, fret about Ericsson's ability to track its own operations.

To improve its results tracking, the company named a new chief financial officer -- Hans Vestberg -- right after the third-quarter warning.

Cheuvreux analyst David Hallden made waves in Swedish financial markets last week by saying he thought Svanberg's days were numbered as well.

"If you ask me whether Carl-Henric Svanberg will be there in 2009, the answer is definitely no," he said.

Ericsson board chairman Michael Treschow countered by saying Svanberg had the total support of the board.

That the fourth-quarter forecast, however bleak, came right on the heels of the third offered reassurance to some analysts.

"There is a silver lining to this, being that they saw it coming," said Windsor.

On the road back to health, shareholders have plenty to contend with. The stock, now at its lowest point in nearly four years, trades at about 10 times forecast 2008 earnings per share. That, according to Reuters data, is less than half the average multiple for major telecoms equipment providers.

Nomura says Ericsson stock is worth just over 23 crowns, well above Monday's 15.20 crowns. Others are less bullish. Goldman Sachs last Thursday cut its target to 17 crowns from 22.

For those who are prepared to play the waiting game, there is the nagging question of how long.

"When the product mix and the margin for networks are going to be better is only speculation," Mats Nystrom of SEB Enskildahe said.

Industry data show Ericsson's share of the network market excluding the CDMA standard fell to 41 percent in the third quarter from 48 percent in the second.

But it is still ahead of Nokia Siemens with 36 percent, Alcatel-Lucent with 9 percent and Chinese rival Huawei [HWT.UL] with 5 percent.