The outlook revision reflects our revised assumption that profitability improvement in 2013-2014 could be difficult to achieve, and uncertainty about assets of the 50%-owned equity-accounted joint venture ST-Ericsson. The corporate credit rating reflects Standard & Poor’s assessment of the company’s business risk profile as “satisfactory”, including our assessment of its management and governance as “satisfactory”, and its financial risk profile as “modest”.
In our base-case assessment, we now expect Ericsson’s revenues to grow by low-single digits in 2013 and 2014 after a small decline in 2012 (revenues fell by 1.5% in the 12 months ended Sept. 30, 2012). We have slightly revised our assumptions because we think the overall mobile equipment market could remain pressured by economic or industry-specific challenges such as a weak European economy and the monetization of mobile data traffic; according to industry research firm Dell‘Oro, the global mobile telecom equipment market fell by 11% in the third quarter of 2012 compared with the year before. Mobile operators’ cautiousness could continue to affect unfavorably Ericsson’s revenue mix, with more low-margin coverage projects and fewer high-margin capacity projects.
We now think that Ericsson’s EBITDA margin could remain stable at about 10% in 2013-2014, which is lower than our previous assumption of a gradual improvement. This is despite our expectation that Ericsson’s margins will benefit from the gradual termination of a number of low-margin European modernization projects through 2013, because we think profitability improvements could be offset given the continued price erosion and pressure on market shares. Ericsson remains the global leader in mobile network technologies but is continuously challenged by aggressive competitors: According to Dell‘Oro, Ericsson’s share of the mobile telecom equipment market fell to 34% in the third quarter of 2012 from 35.5% in the previous quarter.
Ericsson recently announced it will take a charge of Swedish krona (SEK)8 billion in the fourth quarter of 2012 relating to ST-Ericsson, including SEK3 billion for future cash outflows, primarily in 2013. Unlike its partner STMicroelectronics N.V. (BBB/Negative/A-2), which announced that it would exit ST-Ericsson in the third quarter of 2013, Ericsson is considering several options with ST-Ericsson assets. We understand that Ericsson will not acquire all the STMicroelectronics shares, but it is unclear what options will be chosen and how Ericsson’s choice will affect the group’s margins and balance sheet; ST-Ericsson has reported a significant loss over recent years and we expect it to report negative cash flow in 2012 and 2013.
The short-term rating is ‘A-2’. We assess the company’s liquidity as “strong,” as defined in our criteria, because we expect sources of liquidity to amount to at least 1.5x uses over the next two years.
We estimate Ericsson’s liquidity sources at about SEK79 billion in 2012 and SEK65 billion in 2013. These include primarily:
-- About SEK30 billion of surplus cash. We deduct SEK45 billion from the company’s reported consolidated cash and short-term investments of SEK75 billion, which we believe is needed to support the operations and seasonal working capital or held in countries with exchange control restrictions (SEK13.9 billion as of Dec. 31, 2011).
-- Funds from operations (FFO) of SEK18 billion per year.
-- An undrawn revolving credit facility of $2.0 billion maturing in July 2014, which has no financial covenants.
-- EUR1.05 billion in proceeds from the divestment of a 50% stake in Sony Ericsson Mobile Communications AB.
-- A $1 billion 10-year bond issued in May 2012.
We estimate Ericsson’s liquidity uses at about SEK42 billion in 2012 and SEK30 billion in 2013, primarily including:
-- Annual capital expenditures of SEK6 billion.
-- The acquisition of Telcordia for $1.15 billion in the first quarter of 2012.
-- Annual dividends, estimated at about SEK8 billion-SEK9 billion.
-- Debt amortization of about SEK7 billion in 2012 (including the buyback of EUR442 million in bonds in June 2012) and SEK4 billion in 2013.
-- Future additional restructuring outlays at Ericsson.
-- Potential financial support for ST-Ericsson, including a SEK3 billion cash outflow in 2013 and assuming Ericsson maintained its current ownership.
The company has good relationships with its banks and a good standing in the credit markets, in our view.
The negative outlook reflects the possibility of a one-notch downgrade in the next two years if profitability remained at current levels in 2013 or if Ericsson’s currently strong balance sheet and significant net financial cash position weakened as a result of a transaction with ST-Ericsson assets, aggressive acquisition activities, or large shareholder distributions that materially exceeded free operating cash flow.
We could revise the outlook to stable if the group’s margin gradually improved and if any cash burn at ST-Ericsson remained comfortably within Ericsson’s liquidity means. In addition, adjusted credit ratios would have to return to what we view as adequate for the current rating, notably debt to EBITDA of 2x and FFO to debt of 45%; we currently expect the ratios to remain slightly weaker than those levels in 2013.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal.
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Key Credit Factors: Methodology And Assumptions On Risks In The Global High Technology Industry, Oct. 15, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings Affirmed; CreditWatch/Outlook Action
Ericsson (Telefonaktiebolaget L.M.)
Corporate Credit Rating BBB+/Negative/A-2 BBB+/Stable/A-2
Nordic Rating Scale --/--/K-1
Senior Unsecured BBB+