Ericsson: Bernstein Sees WiFi Advantage on the Road to LTE

Bernstein Research’s communications equipment analyst Pierre Ferragu this morning offered up a 35-page think piece on the future of the “myth and reality” about WiFi networks as they relate to cellular and the build-out of 4G.

The basic observation is that as data rates ramp up for handsets, wireless “cells” will need to be placed more densely to get total coverage of wireless subscribers with adequate signal and bandwidth, the so-called small cell phenomenon.

That will lead to a continued 5% to 7% growth in equipment spend, per annum, over the next five years. Some of that will go to WiFi technology “as a handy bridge towards LTE,” or “long term evolution,” the emerging global standard for 4G cellular, writes Ferragu.

WiFi won’t displace cellular, given that its smaller cells can’t provide nationwide coverage. But it will be an important tool for carriers and may give some of them advantages in the move to 4G, he thinks:

Many existing portable devices are already Wi-Fi enabled and new roaming technologies allow operators to efficiently manage combined cellular & Wi-Fi user experiences. Most carrier grade Wi-Fi equipments can easily be LTE capable as well for later evolutions. In the short-to-medium term, powerful Wi-Fi strategies could nevertheless be king makers amongst operators. Aggressive deployments of carrier grade Wi-Fi technologies can be rapidly achieved at relatively low cost and can provide a decisive competitive advantage in the short term that will then be turned into denser WCDMA and LTE networks.

Moreover, for the equipment makers, including Ericsson (ERIC), small cells of WiFi can be very high margin, he emphasizes, approaching gross margin of 75% to 80%:

We estimate small cell gross margins are almost double the average equipment gross margin the industry reported in 2011. On the basis of technology deployments described above, we expect core equipment gross margins to expand by 700 bps over the next 5 years, driven by the ramp up of small cells. Operators owning the most urban footprint (i.e. Ericsson) will benefit the most from the opportunity, as most small-cells will be rolled out in cities.

Ericsson, in fact, is Ferragu’s top pick of the group, and he rates its shares Outperform. Nokia (NOK) is rated Underperform based on its struggling Nokia-Siemens equipment unit, while Alcatel-Lucent (ALU) could see some profit improvement from higher-margin gear, but it is too tied to the aging CDMA equipment franchise. He also rates ALU shares Underperform.

Ericsson stock today is up 10 cents, or 1%, at $9.65. Nokia shares are down 3 cents, or 0.7%, at $4.03, and Alcatel stock is off 7 cents, or 3.5%, at $1.93.