Ericsson: staying grounded

The slick features on your smartphone are useless without the infrastructure that shoots data through the air. Network equipment is the circulatory system of the digital economy. Yet its makers are struggling to grow: most global markets have already upgraded to the latest wireless technology, 4G. Sweden's Ericsson recognises the problem and has begun shifting towards higher-margin internet protocol equipment.

IP equipment lets network operators carry lots of data on both mobile and fixed-line networks. Ericsson has mostly grown its IP business organically. Nokia meanwhile has made a big bet on the area by offering to buy Alcatel-Lucent, not only a wireless equipment supplier but also one the three largest players in IP, with a fifth of the global router market. If the deal closes Nokia will leapfrog Ericsson in IP equipment.

Ericsson's top line has not risen since 2011. Operating margins have slipped 150 basis points to 9.3 per cent over that period. Thursday's first-quarter results suggest that the trend is not changing. Weak operating margins - due to foreign exchange hedges - plus weaker gross margins, especially in its networks division, disappointed the market. The shares fell 10 per cent.

Ericsson could respond to its lack of growth, and Nokia's move, in one of two ways. It could take advantage of Nokia's distractions and try to grab market share. Nokia will spend the rest of this year completing the Alcatel purchase and then, if it succeeds, integrating it. Or Ericsson could play tit-for-tat by doing a deal of its own. One obvious candidate is Juniper Networks, the US IP equipment specialist. Valued at $9bn, it trades on a price to forward earnings multiple of 15 times. That is cheaper than Ericsson and might ease the decision, as would Ericsson's $5bn of net cash.

The first option is better. Deals are hard enough to get right when done from a stable position. Today's results suggest that Ericsson is not there yet.

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