Ericsson's Management Hosts Strategic Way Forward For ST-Ericsson Conference (Transcript)

Mar.18.13 | About: LM Ericsson (ERIC)

LM Ericsson Telephone Company (NASDAQ:ERIC)

Strategic Way Forward For ST-Ericsson Conference

March 18, 2013 9:00 am ET

Executives

Helena Norrman - Head of Group Function Communications and Senior Vice President

Jan Frykhammar - Chief Financial Officer, Executive Vice President and Head of Group Function Finance

Douglas L. Gilstrap - Head of Group Function Strategy and Senior Vice President

Analysts

Simon F. Schafer - Goldman Sachs Group Inc., Research Division

Andrew Humphrey - Morgan Stanley, Research Division

Matthew Hoffman - Cowen and Company, LLC, Research Division

Stuart Jeffrey - Nomura Securities Co. Ltd., Research Division

Chetan Udeshi - JP Morgan Chase & Co, Research Division

Achal Sultania - Crédit Suisse AG, Research Division

Youssef Essaegh - Barclays Capital, Research Division

Per Anders Pontus Lindberg - ABG Sundal Collier Holding ASA, Research Division

Operator

Welcome to the Ericsson and STMicroelectronics agree on strategic way forward for ST-Ericsson conference call. To view visual aids for this call, please log onto www.ericsson.com/press or www.ericsson.com/investors. [Operator Instructions] As a reminder, replay will be available 1 hour after today's conference. Helena Norrman will now open the call.

Helena Norrman

Hello, everyone, and welcome to this conference call. I'm here today together with our CFO, Jan Frykhammar; and our Chief Strategist, Doug Gilstrap, to talk about today's announcement regarding the future of ST-Ericsson.

Before digging into the presentation that will be followed by Q&A, I have to make the usual reminders that we will, during the call today, will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions which are subject to risks and uncertainties. The actual results may differ materially due to factors mentioned in today's press release and discussed in this conference call. We encourage you to read about these risks and uncertainties in our earnings report as well as in our annual report.

With that said, I would like to hand over the call to start to Jan Frykhammar.

Jan Frykhammar

Okay, thank you, Helena. And good afternoon, good morning, good evening, to all of you.

So we are here today to go through with you the main context of today's announcement, and we start with just a recap of the different -- of the timelines here that we have been working on.

If we start with the different strategic options that we have, then. In April of 2012, last year, ST-Ericsson announced its strategic plan. And in October of 2012, Ericsson and ST together announced that we are, as parents, conducting a strategic review of the business plan and the future ownership structure of the joint venture. In -- on December 10 of the last year, 2012, ST then makes an announcement that they intend to exit as a shareholder in ST-Ericsson. And then following that announcement, Ericsson, on December 20, announces to all of you that we have taken a decision to not acquire the full majority of ST-Ericsson. Now during a few months here in the beginning of the year, we have been exploring various strategic options for the ST-Ericsson assets, and that's obviously the context of today's call.

If we take the next slide that may appear at some point, okay, so then the key points of this announcement today, then. First and foremost, ST and -- Ericsson and STMicroelectronics have agreed on a separation of the company into 3 parts, we'll come back to that. Ericsson, we will then take on the thin modem LTE multimode modem operations. The aim that we have with this takeover is obviously to maximize the value. And also, we believe that the modems here have a good fit into the strategies of our company. ST-Ericsson, then, unfortunately will have to carry out the restructuring activity in the remaining -- remainder of the joint venture, we'll come back to that. We expect that this transaction that we announced today will be -- will close during the third quarter of 2013. Of course, that's subject to ordinary regulatory approvals but also subject to negotiations with respective unions. The cost for implementation of the options that we present here today or the chosen path is included in the estimate that we gave you on December 20. So it's covered for the -- in the provision that we set aside of SEK 3.3 billion, so that's important.

If we take the next split -- the next slide, then. So how will this work? So if we look at the split-up of the joint venture, and we again start with Ericsson on the right-hand side of this slide: We take on the design, the development and the sales of the LTE multimode thin modems, and that includes, then, 2G, 3G and 4G multimode. This will be approximately 1,800 employees and contractors. The main sites will be Sweden, Germany, India and China. And we will then be financially responsible for this part of the JV from March 1, 2013.

On the ST side, they will take over the existing products in the JV other than the LTE modems, then, and then also all other related business as well as certain assembly and test facilities. This will be approximately 950 employees and with the main sites being France and Italy. And they will also then be financially responsible for that from 1st of March this year.

In the JV, then, they will -- it will be then restructuring activity that have commenced today. And the remainder of the joint venture will then be, over time here, reduced and run down. And then also, we will look at selling the connectivity business. All in all, this is approximately 1,600 employees and contractors, and you'll have around 200 of those being employees and contractors in the connectivity business. So this is the split-up of the JV.

With that, I would like to hand over to Doug for a few remarks on the modem and as well as on the market. Please, Doug?

Douglas L. Gilstrap

Thanks, Jan.

First of all, we've said in the past that we believe that the modem assets have a strategic value to the wireless industry, so this is consistent with what we're trying to explain here. We are taking over the thin modem business, and the target market is the smartphones and the tablets. We've invested significant amounts of money to establish this position from a product perspective, from a testing perspective and where we are with the thin modems today within the joint venture. This also leverages our heritage and the investment in our R&D standardization and in, of course, our leading infrastructure solutions.

In terms of the thin modem architecture and what it covers, we believe we have advantages on low power. It's highly integrated multimode, multi-baseband, with a variety of GSM, GPRS, EDGE, TD, HSPA, LTE TDD/FDD and then LTE Advanced. So it's very comprehensive. And of course, some of the other features that will -- sets this apart: It's a Single RF Chip Carrier Aggregation. It includes VoLTE and IMS.

And if we go to the next slide, in terms of the market itself that we're targeting. Again, focus on the thin modems, and we see over 400 million units on the thin modems in 2013. That's the green area, and that's growing at 10%. We see the average sales price of approximately $13 to $18. And it's -- our aspiration is to be in the top 3 in this market.

In addition, there are other markets to connected devices: machine-to-machine, modules, data-centric devices. And then of course, there's an opportunity to move toward a license business model with the ModAp in the ModAp market. But we're very clear: the thin modem is a -- going to be our focus, it's going to be a focused organization. And again, it's a 400 million unit in 2013, moving to greater than 600 million, from a market perspective, in 2017.

With that, Hans -- Jan, you want to discuss the financial implications?

Jan Frykhammar

All right, thank you, Doug.

So then, just briefly on the financial implications. So as I've said before, when we made the announcement in -- on December 20, we looked at several sets of strategic options. The one chosen here is the one that we have presented today. The restructuring charges that we've set aside in that -- in the December announcements will be sufficient for implementation of these strategic options. Then once the thin modem business that Doug presented here is fully integrated into Ericsson, and if we assume that that's the case for the full part of the fourth quarter of 2013, our estimate that we would -- this will then be run as a separate business, we will report it as a separate segment. And the best estimate that we have is that this unit then will have an operating loss of approximately SEK 500 million in the fourth quarter of 2013. This will primarily be driven by the research and development expenses. We also estimate that this new modem company will have sufficient resources to deliver on the product roadmap ambitions as well as the sales ambition.

If we then look at the next steps. So we will now obviously finalize the formal break-up of the JV. ST-Ericsson will carry out the necessary restructuring of what this will remain -- will -- what will remain in the JV, and then we will move on with the necessary approvals. We think that the break-up will be completed by the third quarter 2013.

If we look at the product portfolio, then. The modem 7450 will have a volume ramp-up in the first half of 2014. And then it will be -- the follow-up product will be the M7500. That work -- will have a volume ramp-up in the first half of 2015. When we look at these -- we are excited about the modem company, obviously, and the thin modem products. We will look at success in an 18- to 24-month time frame. Again, as Doug mentioned, the -- our ambition is to be top 3 in the thin modem market and, of course, that this segment should add to Ericsson overall profitability.

With that said, I think we are ready for some question-and-answers.

Helena Norrman

Exactly. So operator, if you'd take us through the instructions for how to poll the question, please.

Question-and-Answer Session

Operator

[Operator Instructions] Detailed information is provided in the report, and Ericsson's investor relations and media relations teams will be happy to take additional questions and discuss further details with you after the call. We now have the first question from Mr. Simon Schafer from Goldman Sachs.

Simon F. Schafer - Goldman Sachs Group Inc., Research Division

Just wanted to go back to the accounting method. I understand that, the initial loss, you guys estimated about SEK 0.5 billion effect for the fourth quarter. But for the SEK 2 billion annualized, is that a reasonable level that you -- we would expect for 2014? I would presume it'll take some time before you can actually generate some sales for future generations of the modem family. So just any color on that would be helpful. Just trying to get an understanding as to this overlap between how much costs you're carrying initially and when that may eventually translate into product sales.

Jan Frykhammar

I think that -- so Simon, you know our philosophy, and that is that we want to give some planning parameters for you to be able to make your own assessment of the earnings potential here. I think what I said was that -- I said a couple of things, right? The first thing I said was that, in the fourth quarter, the operating loss that we estimate to be around SEK 500 million is primarily driven by R&D expenses. That's an indicator on -- and it will be limited, or if any, sales in the fourth quarter. If we then look forward, we said also that we believe that we have sufficient resources in this modem company to fulfill the portfolio ambition and sales ambition. We also have an ambition to be top 3 in the market. That will obviously take some time because it takes time between a design-in and an actual product realization, probably between -- at least between 2 and, in some cases, up to 4 quarters. Anything else you would like to add there, Doug?

Douglas L. Gilstrap

No, I think you said it best, including the chart on the volume ramp-up in the -- in year 2014, next steps and ambitions. I think we gave some guidance in terms of what do we expect the products to be.

Simon F. Schafer - Goldman Sachs Group Inc., Research Division

That' helpful. And my second question would be just on the IPR position. You guys have been helpful in, as have ST this morning, just explaining how the people side of the equation and the sales portion of the business is being separated. And some of that is obviously going to you, some is going to ST, but there's very little as it relates to how much of the licensing portion is going to which parent. I guess the way to ask it: Does this meaningfully change the way that you think about your IPR position in terms of annualized sales or profit potential for that segment? Or is that broadly unchanged?

Jan Frykhammar

No. I mean, I think, first and foremost, this doesn't at all change our view on the IPR business. We continue with those ambitions that we have talked to you about before, and so that doesn't change. Secondly, I think also it's important to be clear to everyone that this is, this is now a -- that we take over the thin modems multimode LTE, with all the great features that Doug has been through here. And that's a business that has been obviously we have invested, together with STMicro, significant amount of dollars in. And we are really happy with the progress and the customer traction we have. However, it will still take some time before we will see revenue on -- in this business.

Operator

Our next question comes from Mr. Andrew Humphrey from Morgan Stanley.

Andrew Humphrey - Morgan Stanley, Research Division

Just in terms of a bit of clarity on what's -- what come to term -- what constitutes success in your desire to get to -- become a top 3 player in this market? Do you expect that 18- to 24-months time frame to be realized from the start of the M7450? I mean, is that what we should assume you're targeting? Or is that a kind of per-product target? And what market share do you think a top 3 player has today in that market?

Jan Frykhammar

So I think, Doug, if you take the second part of that question, I'll take the first one. I think it's fair to -- I mean, the 7450 is really the first mass-market product on the platform, so I think that's a fair assumption. Doug, do you want to talk about the market shares on the thin modems? I don't think there are still many alternatives in the market. But back to you.

Douglas L. Gilstrap

Exactly. I think the main point is just that there aren't that many alternatives. There is one dominant player, we believe. And the asset is -- it is important to the industry. That's why we're taking it over and being very focused to try to achieve the top 3 position. From a market share perspective, we've -- we talk about being a top 3, and I think that's about as far as we want to state.

Operator

Our next question comes from Mr. Matthew Hoffman from Cowen and Company.

Matthew Hoffman - Cowen and Company, LLC, Research Division

I'm interested in the structure of the business and how it'll operate over the next 6 months, first of all, well until the formal break-up occurs. First of all, will there be a leader appointed? Or is there a leadership change outside of the appointment of Mr. Ferro to run ST-Ericsson as a whole? Is there somebody now in charge of the thin modem part of the business that was not there before?

Jan Frykhammar

Doug, do you want to answer it, please?

Douglas L. Gilstrap

Sure. We have very competent existing managers within the ST-Ericsson modem division. Those people will continue the work that they're doing. There will certainly be more interaction between the 2 parents, both ST and Ericsson, with their respective areas, and that's how we'll manage this going forward.

Matthew Hoffman - Cowen and Company, LLC, Research Division

Okay. So getting back to the revenue question. It sounds like there is no revenue associated with the Ericsson side of the equation until 2014, if I'm not mistaken. Basically, even the thin modem products you have in the market today, they're all over in the ST side of the ledger. Is that correct?

Jan Frykhammar

No. So I think -- it's Jan here. So what we've been trying to tell you is that we take over the thin modem products, which is, today, it's 7400 which the mass-market product will be 7450. The legacy modem products will all be with ST, so this is the thin modem business. And all the assumptions around the ramp-up and so forth is in this slide: We have -- the first half of 2014 will be the volume ramp-up of 7450, first half of 2015 will be the ramp-up of M7500. So that's the business that Ericsson is taking over. And it's correct to assume that, this year, in 2013, we don't think there will be a lot of revenue on these modems.

Operator

Our next question comes from Mr. Stuart Jeffrey from Nomura.

Stuart Jeffrey - Nomura Securities Co. Ltd., Research Division

I guess I'm a bit confused as to why you want to continue with this business. Historically, if we look in the last 5, 6 years, it's not obvious that the EMP or ST-Ericsson business has helped the infrastructure business. And I guess I would have thought that, if your position in thin modem multimode LTE was that exciting and an established semis company might have been better positioned to leverage that. And so I'm trying to understand why you believe that you can make a big success of this. I'm just trying to understand the strategic rationale a little bit more.

Jan Frykhammar

Okay. So I think, first and foremost, then, if we start with what we have said all the time to you during this review of different strategic options, and that is that we are excited about the development on the thin modem side and we are -- we also think that the modem, thin modem, business has a strategic value for the industry. We think it's important, with more alternatives. That is -- obviously goes hand-in-hand with our company overall mission around the network society, 50 billion connected devices, and so forth. So from that point of view, I think the strategic intent is quite clear. I also think that we have been reviewing a lot of different strategic options. This, what we present today, is the best solution out of all the different options that we have looked at. And we are here today to really welcome the modem company into Ericsson. And we are also convinced the we will be able to add value to the industry, which we have been stating for, for quite some time now.

Stuart Jeffrey - Nomura Securities Co. Ltd., Research Division

I mean, I -- it just seems to me that you're taking on a significant cost of SEK 2 billion in R&D. Is it potentially roll-out risks once the product gets up and running? I mean, I've heard quite a lot of excitement about this product in the past, and I'm struggling why Ericsson would be the best time for this product.

Jan Frykhammar

No. So I think that -- first and foremost, I think that we have -- first and foremost, we have a product, okay? That product is in the market. It's been trialed, so the development effort has been worthwhile. We also have customers. I also think that, Ericsson working with the modem company and other partners in the industry, we have a very important role to play when it comes to connecting the access points with the networks. And I think we have -- I think we have a very good role to play in this, and also very skilled engineers. That kind of work together end to end.

Operator

Our next question comes from Mr. Chetan Udeshi from JPMorgan.

Chetan Udeshi - JP Morgan Chase & Co, Research Division

Few questions. Firstly, Jan, you've said your ambition is to be a top 3 player in this market. So would this mean that you may have to raise your investments in this business going forward? And secondly, you mentioned good customer traction with your existing thin modems, but I believe 7400 was being sampled, too, last year. But you are essentially indicating that there will be no revenue for -- from 7400 this year. So I mean, how does this change with 7450? Are you already seeing some customers signing up on the product?

Jan Frykhammar

So I ask the -- I answer the first part of the question. And Doug, if you can answer the second part, around the differences between 7400 and 7450 and all the great things around carrier aggregation and so forth. But if we start with the first question, then: We have -- first and foremost, what we will take over once this -- we have gotten all of the regulatory approvals is a thin modem operation with around 1,800 employees and contractors. We think that -- given the portfolio ambition and the sales ambition we have, that the resources we have in that unit will be sufficient to deliver on the ambitions. So that's what we have said and that's what we will repeat again. Doug, will you take the differentiation on the 7450 and 7500 (sic) Please?

Douglas L. Gilstrap

Sure. Just to start with the -- as you say, the 7400, that has been in customer testing. It's been in field operator testing in the past, first global field operator testing. The 7450 has always been our expected mass product. 7450 has a smaller footprint, carrier aggregation and a variety of different other attributes, but it's based on the 7400 software that has gone through this testing. So we've had very positive feedback and interest on the 7400, in terms of the architecture, and certainly on the 7450 and our current plans and timelines that we have with the 7450.

Operator

Our next question comes from Mr. Achal Sultania from Crédit Suisse.

Achal Sultania - Crédit Suisse AG, Research Division

So basically, if I look at the market, most of your competition is moving towards an integrated model where you have baseband and apps processor, but it seems that you are trying to focus more on the modem technology. And I'm just trying to understand what do you -- why do you think this strategy is going to be more successful than what your competition is doing. And also, basically, your ambition is to be a top 3 player in this market long term. Once we get there, what do you think would be the long-term profitability in this business?

Jan Frykhammar

So Doug, do you -- I'm not sure I agree to your view there on where our competitors are going. But then...

Douglas L. Gilstrap

I'm happy to take the first one.

Jan Frykhammar

Doug, do you want to comment on that part, please?

Douglas L. Gilstrap

Sure, sure. What we're doing is we have been a very focused team, just as Jan said. As we've made this split, it's going to be a very focused, competent team that's just focused on the thin modems. As we presented earlier, we believe there's a big-enough market in the thin modem area. And certainly, our expertise is more on the modem side than the application processor side, and that's where we want to put our focus and our strength.

Jan Frykhammar

Then I -- then on the profitability, I think that what we will -- the way we will measure success here in this business will be -- will obviously be around achieving a top 3 position in the thin modem market. We have talked about the size of that market in terms of 400 million units, approximately, for 2013; also with the ASP there of between $13 and $18. We also will measure success in getting high volumes of the 7450 modem. And then we will also measure success when this LTE thin multimode modem business adds to the Ericsson group profitability. So those are the first, I would say, midterm objectives. And as we have said before, we will measure this in an 18- to 24-months perspective, so that's kind of the time frame. We are -- we also, then, have given you an indication on the resources in the unit that we take over, and we have also said that we think that this will be sufficient for the product portfolio ambition and so forth. So I think we have given you quite a lot for you to model a possible break-even point and so forth of this business.

Achal Sultania - Crédit Suisse AG, Research Division

And just a follow-up, if I may. When you talk about the SEK 500 million of operating losses in Q4, does that include or exclude restructuring? And if it does include, what kind of restructuring is it in that number?

Jan Frykhammar

No, I think that this number is for the organization that we take over, which will be the -- again, the LTE thin modem organization that consists of about 1,800 employees and contractors. And that organization's main focus is to deliver on the ambitions in terms of roadmaps and portfolio that we have explained today. We can -- so our intent is to build there. Unfortunately, as we have also discussed earlier in the call, within ST-Ericsson, there is a need to reduce operations further. That's unfortunate, but that's necessary. What we have in mind here is, of course, a business that is going to be part of Ericsson and it is going to be a sustainable business, a price that needs to be some restructuring happening in -- within ST-Ericsson.

Operator

Our next question comes from Youssef Essaegh from Barclays Capital.

Youssef Essaegh - Barclays Capital, Research Division

I would like to start quickly on the -- well, what you're planning to do actually with the ModAp business. So STMicro told us this morning that they are planning to discontinue basically working on that. And you are now clearly focusing on making your same -- standalone modem. But do you have the ambition to eventually license your IP so that other companies that don't have the existing modem capabilities are able to do ModAp processors?

Jan Frykhammar

Doug, do you want to take that, please?

Douglas L. Gilstrap

Yes. So our primary focus is going to be the thin modem product itself. We certainly will look at machine-to-machine connected devices and potential for licensing the thin modem to customers that have the application processor. And that's probably where we are right now in terms of our business plan and our revenue models.

Youssef Essaegh - Barclays Capital, Research Division

Is it something that you started already to discuss with your potential customers? Or is it something that will come later?

Douglas L. Gilstrap

Again, the focus is on the thin modem product at this point.

Youssef Essaegh - Barclays Capital, Research Division

Of course. So just a quick follow-up, if I may. It's on the competitive intensity because there've been a flurry of companies focusing on the baseline business and obviously there have been some winners and losers on the recent end-generation [ph] of products. And now you believe that you're going to be top 3. And as you fairly mentioned, there's only one company shipping such products today, but there is also a lot of roadmaps that we've seen from some other of your -- some of your other new competitors now are planning to release this kind of products as well at the end of this year and early next year. So how do you expect that to play over the long term? Do you think you have something that already gives you a head start of 6 month or 1 year on this front?

Douglas L. Gilstrap

Yes...

Jan Frykhammar

Doug, it's best if you take that because you know that by heart.

Douglas L. Gilstrap

Sure. Thanks, Jan. I am jumping in. I mean, we feel very committed to this thin modem because we have been monitoring the progress of not only ours but our competition in terms of the attributes and the characters of the unique selling points. We've invested a lot in this thin modem. We've seen the test results and where we see going forward with the 7450. So we're confident, but we also know it's going to be a tough market. But as we said in the past 6 months, we believe this is an asset that's important to the industry.

Operator

Our last question comes from Mr. Per Lindberg from ABG Sundal Collier.

Per Anders Pontus Lindberg - ABG Sundal Collier Holding ASA, Research Division

I just want to get more clarity, if I could or we could, by the way, regarding how you will report the forthcoming licensing revenues. Will this be part and parcel of what Ericsson classifies as intellectual property rights, i.e. net royalty fees? Or will be that -- will that be treated separately, i.e. will the -- will this be added to your total, yes?

Jan Frykhammar

[indiscernible] understanding [ph] what you are saying. Now this will be a separate, external segment. And so you will -- what you will see in that segment is -- will be the success of the modem business in accordance with the midterm objectives that we have discussed here. So we will introduce the new external segment that -- and you will then see the complete P&L of this business in that segment.

Per Anders Pontus Lindberg - ABG Sundal Collier Holding ASA, Research Division

But in the aggregate, will be it -- will it be treated as licensing revenues?

Jan Frykhammar

No.

Per Anders Pontus Lindberg - ABG Sundal Collier Holding ASA, Research Division

No. I see. Okay.

Helena Norrman

Okay. Thank you, all. We have reached the end of this presentation and Q&A session, and we want to say thank you for joining. And if you have any follow-up questions, please don't hesitate to contact our IR or media relations team. With that, until the next time. Goodbye.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

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