Ericsson's share price drags after $6.2bn Vonage deal failure

The markets have given a thumbs down to Swedish telecoms group Ericsson [ERIC] after shelling out $6.2bn in its biggest ever deal to buy Vonage’s [VG] cloud communications portfolio.

Following the announcement on 22 November, Ericsson’s shares dropped about 6% and have failed to recover since. Application programming interface-maker Vonage’s share price soared 25% higher, but in the last week has remained flat at about $20.

What is the deal? 

Ericsson said the acquisition of Vonage – which provides cloud-based communications to over 120,000 customers and over 1 million message, voice and video application developers - would expand its presence in wireless enterprise and broaden its global offerings. 

Borje Ekholm, president and CEO of Ericsson, said: “The core of our strategy is to build leading mobile networks through technology leadership. This provides the foundation to build an enterprise business. Imagine putting the power and capabilities of 5G at the fingertips of developers.” 

Rory Read, CEO of Vonage, added: “The convergence of the internet, mobility, the cloud and powerful 5G networks are forming the digital transformation and intelligent communications wave.” 

Indeed, Ericsson, according to IOT World Today, expects the deal to benefit a range of sectors, from telemedicine to virtual education. This, it is hoped, will stem from the ability of Vonage’s developers to embed messaging or video technology into Ericsson products, combined with the Swedish company’s networking infrastructure, R&D capabilities and the power of 5G.

It follows Ericsson’s $1.1bn purchase of 4G and 5G solutions provider Cradlepoint last November. 

The Vonage acquisition, funded by Ericsson’s existing cash resources and a 28% premium to Vonage’s closing price on 19 November, would be ‘accretive’ to the Swedish firm’s EPS and free cashflow before M&A from 2024 onwards. The deal is expected to close in the first half of next year. 

“We see this as strengthening Ericsson’s vertical integration and product offering within the cloud space, but we also deem the price tag quite steep” - Danske Bank Credit Research analyst Mads Rosendal on the Vonage deal

Analyst views 

Analysts saw the merits of the Vonage deal, but were concerned about the cost.

“We see this as strengthening Ericsson’s vertical integration and product offering within the cloud space, but we also deem the price tag quite steep,” said Danske Bank Credit Research analyst Mads Rosendal.

Zeus Kerravala, founder and principal analyst at ZK Research, was also mostly positive. “Cradlepoint gave them some of the network APIs, and Vonage will bring them the communication APIs, and that makes some sense. The important thing to understand is that 5G is cloud native. That creates an excellent opportunity for a developer platform on top, and then roll out a whole bunch of other applications that run on top of that network that are integrated in the network. [But] on paper it looks like square peg, round hole.” 

Mirabaud Equity Research analysts were scathing: “We think this is a low-margin, low-end cloud tech with little differentiation,” they said. “Ericsson doesn’t appear to be buying a leader here, but a company that has underinvested in R&D and struggled to move upmarket.”

Ericsson, however, defended the rationale and price. Chief financial officer Carl Mellander told Bloomberg: “I think we’re paying the right price. It’s a value that we justify, otherwise we wouldn’t do it."

China and 5G 

Industry watchers also suspect that Ericsson’s desire to move further into the cloud was a result of lost business in China and a shortage of components caused by the global supply chain squeeze.  

Ericsson has also lost market share in China following the latest round of telecom tenders. This was in retaliation to Sweden’s ban on Chinese telecoms group Huawei selling 5G equipment in the country amid security concerns.

Mellander said the proportion of revenue the group gets from China has dropped to 3% from around 11%.

But Ericsson has made gains elsewhere as countries that have also banned Huawei have turned to it to fill the gap. It has secured 5G contracts with Verizon [VZ], AT&T [T] and T-Mobile [TMUS].

Ericsson is bullish about its 5G growth, recently hiking its forecasts to 660 million subscriptions by the end of this year, up from 580 million. It expects 4.4 billion 5G subscriptions by the end of 2027.

The company also believes that three-quarters of the world’s population will have access to 5G coverage by 2027.  

This is almost certainly why analysts, according to Market Screener, have an outperform rating on the stock. The 5G potential is huge and deals such as Vonage will only strengthen Ericsson’s case. 

Expect its shares to get the message soon.