Ericsson last week reported a higher than expected 38.5% YoY increase in its Q3 gross profit on revenues of SEK 57.5 ($6.5 billion), driven by a sharp increase in Asia sales. This also helped boost its overall gross margins to 43.1%, up from 37.7% in Q3 2019. Ericsson now has 113 commercial 5G agreements with 65 live networks.

The key driver behind the improved financial performance was increased sales in North East Asia, primarily mainland China. Total revenues in the region were up 39% YoY and 13% compared to the previous quarter. The only other region to report positive YoY revenue growth was the SE Asia, Oceania and India region with 5% growth, mainly due to gains in Australia and Indonesia. Together, sales in the two Asia regions grew 20.3% YoY and 15.3% compared to the previous quarter.

Revenues in all other regions were down on a YoY basis (Exhibit 1), although flat or marginally higher compared to the previous quarter (Exhibit 2).

Exhibit 1: Ericsson Q3 2019/2020 YoY Revenues by Region

In terms of business units, revenues from Ericsson’s network business dwarfed all other units, accounting for 73.7% of total revenues for the quarter. YoY revenues at the Digital Services and Managed Services business units fell while the Emerging Business unit reported flat revenues.

The increased revenue growth due to mainland China is a vindication of Ericsson’s strategy to compete aggressively for 5G contracts. Unlike rival Nokia, Ericsson has won contracts with all three major MNOs in China. The company believes that the increase in margins this quarter is largely attributable to its increase in scale coupled with lower production costs due to R&D investments.

Exhibit 2: Ericsson Q2/Q3 2020 Revenues by Region

However, in the same week, Sweden’s regulator announced that it was banning Chinese vendors Huawei and ZTE from supplying 5G equipment. MNOs currently using Huawei or ZTE equipment will have until 2025 to remove it from existing networks. Of the four MNOs, Telia uses mostly Ericsson equipment and recently signed a new contract with the company. However, rivals Tele2 and Hi3G Access both use Chinese equipment. Tele2 uses Huawei products and Hi3G Access uses a mix of Huawei and ZTE equipment.

In addition, the regulator has banned the use of Huawei and ZTE equipment in the forthcoming 3.5 GHz spectrum auctions and the later 2.3 GHz auctions. Although this ban will benefit Ericsson (and Nokia), there is a high risk that the Chinese government will retaliate in its domestic market. In fact, the Chinese regulator has already issued a notice calling for “a strengthening of supervision of foreign-invested telecom companies in China.” This could hit Ericsson hard in future quarters. Nokia is also potentially at risk as the company has several non-RAN contracts in China.

Overall, Ericsson continues to benefit from the early availability of its 5G portfolio, and in particular, its ability to offer Dynamic Spectrum Sharing (DSS) before most of its rivals. In fact, DSS software revenues accounted for a large part of the revenue mix in the quarter and also contributed to Ericsson’s margins boost. Political risks aside, Ericsson expects continued growth in China in 2021 with strong demand in North America on the back of spectrum auctions in the US as well as continued contract wins in Europe in Huawei’s absence.

After focusing on the Networks business unit since 2017, Counterpoint Research believes CEO Ekholm now needs to focus urgently on increasing revenues and delivering profitability in the company’s other business units. The company announced that it plans to increase R&D investment in cloud-native software development as well as continue investing in enterprise networks beyond the recent $1.1 billion acquisition of wireless LAN company Cradlepoint.