The year 2006 hasn't exactly been all peaches and cream for investors in the big three wireless equipment manufacturers, Nokia (NYSE:NOK), Ericsson (NASDAQ:ERIC), and Motorola (NYSE:MOT). Shares of these former stock market darlings have only managed to gain an average 7% so far this year, well below the 24% return posted by the Nasdaq Telecommunications Index, and even failing to keep pace with the 10% gain posted by the S&P 500.
Does that mean that this relative underperformance will continue, and that investors should hang up on these stocks? In my Foolish opinion, the answer would be a resounding "no." I believe that all three of these companies are well-positioned to benefit from strong demand growth in the global cellular market (especially in emerging markets), the long-awaited acceleration in the buildout of 3G networks in more mature markets, and the discount at which each of these companies trades to its projected growth rate.
While I look for all three of these companies to outperform in 2007, I especially like Ericsson's prospects, thanks to its leadership position in the wireless infrastructure space, the beneficial effects of its soon-to-be completed restructuring on the company's bottom line, and its modest valuation.
Let's take a gander, shall we?
LM Ericsson
Ericsson, formally known as LM Ericsson Telephone Company, is the global leader in providing wireless network equipment used to connect more than 80% of the world's mobile subscriber base. The company, through its 50/50 joint venture with Sony (NYSE:SNE), is also the fifth-largest supplier of handsets in the world, and last year's acquisition of 75% of Marconi (for $2.1 billion) has boosted Ericsson's profile in offering advanced next-generation IP-based networks.
On a geographical basis, for the first nine months of fiscal 2006, Ericsson derived 38% of its revenue from the mature North American and European markets, and 62% of sales from "emerging markets" in Eastern Europe, Latin America, the Middle East and Africa, and Asia/Pacific. Mobile products and systems accounted for roughly 70% of revenues, professional services (i.e. network integration, consulting, etc.) came in around 19%, and fixed-line equipment sales and "other" contributed the rest.
So much for the past. Let's look at Ericsson's future.
The mobile-infrastructure marketplace
At the end of Q3 2006, there were an estimated 2.5 billion wireless subscribers worldwide. Roughly 80% of these customers were using GSM or W-CDMA based networks -- an area where Ericsson holds roughly a 35% market share.
With the world's subscriber base expected to increase another 20 percentage points during 2007, and the average minutes of use per wireless customer growing by leaps and bounds, many wireless companies are being forced to expand their networks to cope with the increased traffic. That should provide a solid driver of revenue growth for Ericsson's infrastructure and professional-services offerings going forward.
In addition to the expansion of existing networks, Ericsson should also benefit from its pole position in the market for 3G networks, primarily through its offering of High-Speed Downlink Packet Access (HSDPA) -- a turbocharged version of W-CDMA that gives wireless users the ability to download data at a rate comparable to fixed-line broadband. As of the end of the third quarter, there were 109 W-CDMA networks operating worldwide, and Ericsson supplied 60 of them, giving it a ready-made, trusted market for HSDPA. Ericsson recently won a contract to supply Cingular, the largest U.S. wireless company, with HSDPA technology.
A further point to consider, though it remains relatively speculative, is the Chinese government's announced intentions of having 3G services available by the start of the 2008 Olympic Games in Beijing. When these licenses are finally issued (which latest reports suggest could happen within the next month), Ericsson's leadership position in this field should allow it to grab a fair amount of this business.
Now, since my esteemed colleague Anders Bylund has already commented on the potential benefits of Ericsson's restructuring in his recent article, I'll move right on to valuation.
Valuation
At a recent price of around $39 per share, Ericsson trades at approximately 16 times forward earnings estimates, pretty much in line with its projected growth rate. Given a decent yield of roughly 1.2% and the likelihood of infrastructure orders coming in ahead of expectations, I'd urge investors to consider building up a position in Ericsson.
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Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than playing golf, reading The Financial Times, rooting for the Jints or taking a nap. He welcomes your feedback at [email protected]. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.
