NEC Corporation, the Japanese tech giant known for its diverse portfolio ranging from facial recognition systems to space technology, recently released its Q1 2024 earnings transcript [Reference: SeekingAlpha](https://seekingalpha.com/symbol/NIPNF). While analysts focused on the deconsolidation of JAE, a significant revenue hit, and the impact of generative AI on future earnings, a quieter, potentially more significant shift within the Social Infrastructure segment went largely unnoticed. This shift, a bold gamble on software services within the telecom sector, could either propel NEC to new heights of profitability or drag it down to the depths of financial uncertainty.

NEC's Social Infrastructure segment, which encompasses telecom services, aerospace, and national security, has been a mixed bag in terms of performance. While the aerospace and national security division enjoyed strong order growth, telecom services, particularly the global 5G business, has faced significant challenges. Though the transcript boasts a "significant improvement" in global 5G profitability, achieved through business reorganization and cost-cutting measures, a closer examination of the numbers reveals a potentially perilous reliance on one-time expense reversals.

The projected operating profit increase for FY 2025 within telecom services rests heavily on the assumption that the one-time expense of JPY 15 billion, recorded in FY 2024, will not recur. This expense, attributed to "streamlining of assets in hardware business and shifting to software business, unprofitable SI projects and increased costs in submarine systems," points to a fundamental shift in NEC's telecom strategy.

The company is moving away from its traditional strength in hardware, opting for a software-centric approach. This strategic pivot, while potentially lucrative in the long term, carries considerable risk. The acknowledged "risks in telecom services," captured in the increased JPY 87 billion adjustment, underscore the uncertainty surrounding this transition.

The Crux of the Gamble

Here's the crux of the matter: NEC is essentially betting on its ability to successfully develop and market profitable software solutions in a fiercely competitive global market. The transcript's vague language, referring to a shift towards "more profitable software services areas," offers little insight into the specifics of these solutions or their market viability.

Furthermore, the acknowledged JPY 15 billion one-time expense raises red flags about the costs associated with this transition. The mention of "unprofitable SI projects and increased costs in submarine systems" suggests that NEC is encountering significant challenges in integrating software solutions into its existing infrastructure.

A Hypothetical Scenario: The Software Gamble Fails

Let's consider a hypothetical scenario: If NEC fails to achieve its projected software revenue growth and these one-time expenses become recurring, the impact on the Social Infrastructure segment's profitability could be devastating. A sustained JPY 15 billion annual expense, coupled with a failure to generate substantial software revenue, could wipe out the anticipated profit increase, leaving the segment stagnant or worse, in the red.

This scenario is not as far-fetched as it might seem. NEC's track record with low-profit businesses, as detailed in the transcript, paints a sobering picture. The company has struggled to turn around several low-performing divisions, and while some have shown improvement, others remain a drain on resources. The firefighting and disaster prevention business, for example, has only recently turned profitable after years of losses.

Source: NEC Corporation Q1 2024 Earnings Transcript

The transcript's mention of exploring "ways to maximize business value during FY 2025 by, for instance, divestiture or partnering with other entities" for businesses facing difficulty in improving profitability hints at a potential willingness to cut its losses if the software gamble fails.

A Strategic Imperative: Riding the Software-Defined Wave

However, this pivot to software in telecom services isn't just a matter of profit and loss; it's a strategic imperative in a rapidly evolving tech landscape. The global telecom market is witnessing a seismic shift towards software-defined networking (SDN) and network function virtualization (NFV), technologies that promise greater flexibility, scalability, and cost-efficiency. NEC, by embracing a software-centric model, is attempting to position itself as a leader in this transformative wave.

A History of Bold Moves: NEC's KMD Acquisition

This is not the first time NEC has made a bold move in the telecom space. In 2018, they completed the acquisition of Denmark's KMD, a leading provider of software and IT solutions, for $1.2 billion [Reference: NEC](https://www.nec.com/en/press/201804/global_20180402_01.html), significantly expanding their international footprint.

The Verdict: A Submarine Still Submerged

The success of this gamble hinges on several factors: the quality and market appeal of NEC's software solutions, the company's ability to control transition costs, and its capacity to effectively navigate a rapidly evolving market.

The "silent submarine" of NEC's software strategy is quietly lurking beneath the surface of this earnings transcript. Whether it surfaces as a triumphant vessel of success or a sunken relic of a miscalculated risk remains to be seen. Investors and analysts alike would be wise to keep a close eye on this submerged development, for it could determine the fate of the entire company.

"Fun Fact: NEC built Japan's first submarine cable in 1964, connecting Hokkaido and Honshu. This pioneering spirit in telecom infrastructure reflects NEC's history of innovation and ambition, traits that will be crucial for its software gamble to succeed."