Ericsson looks to hibernate

Management at Ericsson is breathing a big sigh of relief after existing shareholders stumped up to support its long-delayed SKr30 billion ($3 billion) rights issue last month. Uncertainty about its business prospects, 3G write-offs and doubts about its capacity to raise new equity capital had damaged its credit ratings and its share price in preceding months. For now the company’s survival is assured, but where can it go from here?

The Swedish mobile network infrastructure supplier initially announced that it would complete a rights issue in April this year. In addition to a lengthy timetable required for rights issues by Swedish law, approval also had to be gained by the SEC as Ericsson has 15% of its share register trading in the US. This itself took two months, as the SEC had not reviewed Ericsson since 1995.

The process was further delayed when the company decided to wait until it announced its second-quarter results on July 19 to avoid doing so in the middle of the subscription period. “Management felt it prudent to have the most up to date disclosure in the market before launching the deal,” says Alasdair Warren, managing director of equity capital markets at SSSB and adviser on the deal.

Again the subscription period was postponed as the entire Nordic region goes on summer holidays in July followed by the rest of Europe. The prolonged process threw the primary equity market – which is more familiar with a rights issue process of around six weeks than six months – off balance. Stephan Michel, credit analyst at Barclays Capital, says: “We’re more used to companies announcing a rights issue, starting the process and completing it fairly quickly.”

The announcement and delay of Ericsson’s issue acted as an open invitation to hedge funds to short the stock and at one point its share price came close to dropping below the subscription price of SKr3.80. On April 21, after Ericsson had said it would do a rights issue, the share price was at SKr27 and the share price at September 27 was SKr5. The company also attracted the attention of the ratings agencies.

Moody’s has seen fit to downgrade Ericsson three times in three months. On July 17 it was reduced to borderline sub-investment grade and on July 26, one week after it announced its second-quarter results, it was dropped to junk status because of a decline in orders for second-generation wireless equipment. Moody’s also raised the possibility of a further downgrade pending the outcome of the rights issue. Suddenly this became hugely significant for Ericsson.

Despite the rating agencies’ concerns, existing shareholders were not so panic-stricken as to give up on the company, and when it was finally completed in September the rights issue was oversubscribed.

Ericsson has secured the additional $3 billion in funding it initially felt it needed to bolster its balance sheet for a potential future acquisition, which it envisaged at the beginning of the process, and to pay down debt, which quickly turned into a need for capital because of the downturn in demand from operators for 3G network infrastructure.

But many analysts are convinced the company will be forced to return to the markets within the next 18 months. Barclay’s Michel says: “It’s clear that the company is on a negative outlook and it’s very clear that the company still may not have enough capital.” However a spokesperson for Ericsson says: “Even with the depressed markets we believe we’ll reach profitability in 2003.”

Further concerns

Moody’s again downgraded the company one notch to Ba1 from Ba2 on September 12, voicing its concern that wireless operators are withdrawing or scaling back investment in 3G infrastructure, or striking deals to share networks, which will affect orders. The agency is also concerned that Ericsson may have to pour additional capital into its mobile handset joint venture with Sony, which has a questionable outlook. “Combined, these factors may result in additional cash calls on Ericsson’s enriched liquidity position and possible write-offs to its equity,” says a report by Moody’s.

The rating agencies and analysts are sceptical about Ericsson’s ability to achieve its target to cut costs by SKr20 billion by the end of the third quarter of 2003 and an additional SKr10 billion in the first quarter of 2004. Snehar Shah, telecoms equipment analyst at HSBC, says: “Ericsson may not be able to avoid tapping the markets again unless it achieves its targeted cost cuts and there is a halt to the deteriorating wireless infrastructure market.” So Ericsson remains on negative outlook by Moody’s.

Ericsson’s spokesperson asserts that it is just: “a matter of hibernating for a while.” That is, until the market sees a turnaround in the uptake of mobile communications. However, he maintains that the company holds 40% market share in both the 2G and 3G market so is well positioned for eventual market recovery.