By Sven Nordenstam and Olof Swahnberg
STOCKHOLM (Reuters) - Mobile telecoms equipment maker Ericsson (ERICb.ST) posted a surprise fall in profits on Thursday and warned of continued weak profitability as spending by U.S. network operators remains sluggish, forcing it to rely on China, where margins are lower.
Operating profit in the quarter fell to 2.1 billion Swedish crowns ($240 million) from 2.6 billion in the same period last year, below the average forecast of 3.3 billion crowns in a Reuters poll of analysts.
Profitability was particularly weak in its mainstay networks unit as sales in North America fell while lower-margin sales rose in China, the world's hottest market.
Higher expenses, currency hedging losses and lower patent licensing fees due to a legal dispute with phonemaker Apple also weighed.
Ericsson's shares were down 10 percent at 99.30 crowns by 1400 GMT, on track for their biggest one-day decline for more than three years as margin pressures show little sign of easing until the advent of new "fifth generation" mobile networks around 2020.
Until then Infonetics Research expects annual spending on mobile equipment to decline from $47 billion last year to $27 billion in 2019.
Telecom operators are looking to cut costs by turning to cheaper commodity hardware and relying more on cloud-based software to manage and make their networks more efficient.
That's led Ericsson to boost research, buy start-up companies and turn to clients outside the telecom industry to contend with sluggish growth in the core infrastructure market, where it remains world leader.
Marking the dramatic shifts taking place in an industry once defined by tightly controlled hardware, the word "software" occurs 106 times in Ericsson's 2014 annual report, up from 39 times a year ago.
"Ericsson's Q1 results are more or less a reflection of the state of the telecoms industry," said Bengt Nordstrom, head of telecoms consultancy firm Northstream.
"In spite of very strong growth in mobile data traffic all around the world, revenues for infrastructure vendors are not growing and margins are slim."
Like-for-like revenues in Ericsson's networks unit, which accounted for just over half of group sales last year, fell 9 percent in the first quarter.
Group sales rose by 13 percent to 53.5 billion crowns, in line with expectations and boosted by the stronger dollar, but like-for-like sales were down 6 percent. The gross margin was 35.4 percent, short of the average forecast of 37.1 percent.
While Ericsson said fast-rising data traffic would eventually require further upgrades of U.S. wireless networks, it gave no timing for when spending there might resume.
"We anticipate the fast pace of 4G deployments in mainland China to continue and the North American mobile broadband business to remain slow in the short term," the company said.
In the meantime Ericsson is looking for growth outside its core markets, aiming to boost sales to clients such as TV and online media companies to between 20-25 percent of total sales by 2020, up from around 10 percent last year.
"We believe that Ericsson's underlying issue is its struggle for growth," Liberum analysts said in a note to clients, adding that its efforts to expand into other areas required more investments and would not provide a short-term cure.
Responding to similar pressures, Finland's Nokia (NOK1V.HE) last week said it would buy Alcatel-Lucent (ALUA.PA).
The merger fuses Nokia's expertise in mobile networks with the French firm's strengths in fixed line broadband and Internet routing at a time when mobile and fixed line networks are converging, giving the combine a broader overall product offering and bigger R&D base than Ericsson's.
Ericsson Chief Executive Hans Vestberg told a conference call he saw the deal as unsurprising in view of the fiercely competitive nature of his industry, where the number of mobile vendors has been steadily reduced by merger deals in the past decade.
"I think it is pretty logical what we see. Everybody is trying to find their way of being competitive," Vestberg said, adding that Ericsson was happy with its own strategy which was focused on internal growth.
"If this happens it is an indication that whatever strategy they had before, it was not the right one," he said of Nokia and Alcatel-Lucent.
(With additional reporting by Eric Auchard in Frankfurt; Editing by Greg Mahlich)