Ericsson 5G business expects negative gross margins in China

Ericsson said it expects to take a second-quarter writedown of about 1 billion crowns or $109 million on product inventory in China.
Ericsson Radio basestation antennasThe telecom equipment maker, which has won 5G network contracts from China Telecom, China Unicom and China Mobile, said it expected negative gross margins in China in the quarter reflecting the high initial costs for new products.

Ericsson had warned in its first-quarter report that an increasing share of strategic contracts would hurt profitability in the second quarter, primarily due to negative gross margins in China.

China’s three largest telecom operators – China Mobile, China Telecom and China Unicom – have awarded 5G contracts worth billions of dollars this year, mostly to Huawei and ZTE, according to media reports.

Ericsson’s writedown was likely associated with free products given to the Chinese telecom companies and is not a real one-off and needs to be taken into the gross margin estimates, JP Morgan analysts wrote in a client note.

“This has always been an issue with China contracts in our opinion that they cause gross margin issues so though this announcement is not a surprise, investors will want further clarity on the extent of the impact,” the investment bank said.

Ericsson, which maintained its financial targets for 2020 and 2022, said while the deployment of 5G in China will hurt in the short term, it is expected to have healthy profitability over the life of the contracts.

European rival Nokia won a share of China Unicom’s 5G core network, but has been on the sidelines for larger China radio orders which often mean taking losses in the early years of a contract.