When Finnish handset maker Nokia (NOK) came in with better than expected quarterly results on July 17, the telecom sector was encouraged. Sales and shipments of Nokia's handsets were up. Just as important, a big part of the Finnish company's growth in the quarter came from Nokia Siemens Networks, its joint venture in telecom equipment with Siemens (SI). Sales for the network business surged 18% in the quarter, to more than $6.34 billion. The market took that as an indication demand remained strong for mobile handsets, despite economic uncertainty, and telcos would still put money into building and upgrading wireless networks.

But that optimism evaporated on July 22, when Vodafone (VOD), the world's largest mobile-phone company, reduced its sales forecast. The company said organic growth was lower than the previous quarter, primarily due to a decline in customer spending in Spain, which it characterized as a difficult "macroeconomic and competitive environment."

Vodafone's news was seen as an ominous sign that telecom operators, which have thus far been shielded from the economic slowdown, are starting to feel the pinch. The fear is the slowdown in Spain will spread elsewhere in Europe and that telco operators will respond by cutting back orders of mobile handsets and networking equipment.

Hammering the Stocks

European telecom stocks tumbled in response. Vodafone's share price plunged 16%, the most in 20 years, dragging down Swedish telecom equipment vendor Ericsson (ERIC), the world's largest wireless equipment maker, and three of Europe's biggest telcom operators. Ericsson slid 10% in Stockholm, Spain's Telefónica (TEF) posted its biggest drop in six years, and Germany's Deutsche Telekom (DT) fell 6.9%. "Until today, we took the view that telecom operators, relative to many sectors, had a good position in terms of resilience, but this report has called that into question," says John Davies, a financial analyst at Dresdner Kleinwort. "The question is to what extent the problem in Spain will be mirrored in other countries and in other companies next quarter."

If the Continent slips into recession, analysts know what to expect from mobile-phone customers. "People will still make phone calls, but it is possible that the uptake of sexy new stuff, like video and data, will take a little longer, even though operators are starting to introduce all-you-can-eat flat [pricing]," says Sylvain Fabre, research director for carrier network infrastructure at tech consultancy Gartner (IT).

The weird thing about Vodafone's plunge is that the news from the company was not uniformly bleak. Chief Executive Arun Sarin, who steps down at the end of the month, said growth in data revenues and emerging markets helped the company offset the weakness in the Spanish market. In the June quarter, Vodafone's group sales jumped 19.1%, to $19.55 billion, over the same period in 2007. And sales in the emerging-markets division rose 30.5%, to $5.2 billion, helped by revenue growth of 50% in India.

Emphasizing the Negative

The news from Ericsson about the second quarter wasn't all bad, either. But when investors are jittery, they focus on what's disturbing. Ericsson's revenue ticked up 10% for the quarter, to $9.55 billion. That was in line with the consensus. But net income fell to $374 million, from $1.26 billion a year earlier, due in part to drooping sales at Sony Ericsson, its joint venture with Sony (SNE). Ericsson's shares were hit particularly hard because Vodafone, which buys handsets from Sony Ericsson and networking equipment from Ericsson, lowered its 2008 revenue outlook. That could be pointing to slower traffic growth and hence lower infrastructure spending, said Richard Windsor, an analyst in the London office of brokerage Nomura, in a research note. "Ericsson confounded its critics by reporting better than expected profitability, but still the shares fell heavily," Windsor said. "We think Vodafone's cautious comments and an Olympics-related pause in spending in China are to blame for the fall."

Even before Vodafone's warning note, analysts were projecting modest growth for mobile infrastructure in 2008. Ericsson has reported four straight quarters of falling profit, as spending on networks remains flat. For Ericsson to return to real revenue growth and healthy margins, operators in developed markets need to run out of data capacity and start spending on more hardware, said Windsor. And, emerging markets need to start upgrading to third-generation networks en masse. "Unfortunately," noted Windsor, "there is no real sign of any of this, and we continue to expect that it will be 2009 before there is any real movement in either of these areas."

Ericsson has also been hurt by weak earnings at Sony Ericsson (BusinessWeek.com, 6/30/08). To some extent, Sony Ericsson's woes are shared by the industry as a whole. Mobile-phone sales fell 16% in Western Europe in the first quarter—the first such decline since 2001, according to Gartner. Sony Ericsson is far more dependent on European sales than such rivals as Nokia, making it more vulnerable to flagging demand on the Continent. Nokia's news last week, it seems, was positive for the Finnish phone maker, but not for the rest of the European telecom industry.

Source:businessweek