EUR 850.00 For Business Accounts Only

Morningstar | 5G Spending Propels Ericsson's Transformation; Long-Term Concerns Remain; Lowering FVE to SEK 62. See Updated Analyst Note from 01 Oct 2018

We are lowering our fair value estimate for Ericsson to SEK 62 per share from SEK 69 while maintaining our no moat and stable moat trend ratings. Although we believe Ericsson will benefit from 5G infrastructure spending tailwinds and its concerted turnaround efforts, our concern lies within possible market overreaction to the company's progress since late 2017.

Ericsson has made considerable progress in slashing costs while staying committed to R&D, and the second half of 2018 should showcase its improvements. Our expectation is for 5G to offer a longer buildout period and create more selling opportunities than previous wireless generations. 5G's fastest speeds will require many small cell antenna sites and we posit that "Internet of Things" device proliferation could increase demand for Ericsson solutions from a diverse set of industries. We believe Ericsson's software will be desired as software-defined networking becomes commonplace and that its services will be needed as customers navigate through increasingly complex network structures. Ericsson's strong licensing program should benefit as 5G handsets are manufactured and we expect additional licensing upside as Internet of Things devices proliferate across networks.

We posit uncertainty exists around Ericsson's long-term ability to generate excess returns on invested capital in an increasingly competitive market. CSPs typically multisource vendors while exerting pricing power over the equipment manufacturers. Ericsson's resolve to ensure contracts are always value accretive will be tested as 5G rolls out within price-sensitive economies and as 4G spending declines. Even with formidable competitors, we believe that 5G's spending wave can lift all dominant suppliers. We opine that Ericsson's focused leadership will drive adjusted operating margins toward double-digits by 2022, but we remain cautious on Ericsson's ability to post excess economic returns after the CSP 5G spending surge.

Ericsson is a leading provider of hardware, software, and services to communication service providers. 5G network infrastructure spending was pulled into 2018 as major carriers announced their generational upgrade intentions. 5G may have a longer spending period than previous wireless iterations, and we believe Ericsson's robust portfolio of hardware and software coupled with its industry leading services business has it primed to take advantage of 5G network demand.

The company has been on a turnaround mission after its 2015 apex. We believe that Ericsson is making wise strategic efforts and has readied itself to capture growth from 5G buildouts. We applaud that the firm has a more prudent outlook after cutting its cost of goods and operating expenses while committing to exit or renegotiate unfavorable contracts. We believe the management team has properly focused the company on invigorating networking innovation while honing operational efficiency.

We do not believe the CSP equipment provider industry lends itself to economic moats since CSPs multisource vendors and flex pricing power by pitting suppliers against each other. However, we expect Ericsson's restructuring and strategic efforts, combined with 5G demand, to create top-line and operating margin expansion. We believe that Ericsson's concerted efforts within software-defined networking will be fruitful as software becomes essential in a 5G world. Our expectation is for Ericsson to gain from 5G networks requiring small cell antenna sites to propagate the fastest transmission bands. Ericsson should profit from 5G networks creating more product use cases such as Internet of Things devices within cars and factories. Based on our view that network complexity will increase as firms control and monitor a rapidly growing quantity of Internet of Things devices, our expectation is for Ericsson's software and services to be in high demand. The company also creates revenue from licensing patents that are essential in the production of 5G smartphones (as well as previous generations). We believe Ericsson may find licensing opportunities in non-handset markets, and that licensing revenue will help bolster operating results.