Ericsson Debt Is Close To Junk Downgrade
By DAVID PRINGLE
Staff Reporter of THE WALL STREET JOURNAL
Telefon AB L.M. Ericsson, one of Europe's largest technology companies, faces the prospect of having its debt downgraded to junk status.
The world's leading supplier of mobile-network equipment said Friday that its planned 30 billion kronor ($3.25 billion or €3.22 billion) share offering will be fully underwritten. However, Ericsson is offering the shares at a heavy discount after its second-quarter results showed how desperately it needs the money. Ericsson said its market is deteriorating faster than it expected, which helped sent its shares down 18% to 11.90 kronor in Stockholm trading Friday and may trigger further downgrades by the credit agencies Moody's and Standard & Poor's.
Roger Appleyard, a credit analyst with ABN Amro, said he believes it will now be nearly impossible for the Swedish company to become profitable in early 2003, as Moody's envisioned when it downgraded Ericsson's long-term debt rating to one notch above junk status in June. Mr. Appleyard believes both Moody's and S&P will now downgrade Ericsson's long-term debt to junk, which implies a reasonable chance the company will default. Such a rating typically makes its more difficult to raise cash and can scare off conservative investors.
While Ericsson doesn't have any immediate liquidity problems, Mr. Appleyard says continuing operating losses combined with restructuring costs will soon take their toll. "In nine to 12 months their cash flow could start to look very stretched," he said. "In a year's time they could be at crisis level."
A downgrade to junk status would add Ericsson to the list of European blue-chip technology stocks reduced to high-risk propositions by the collapse in telecommunications industry spending. Analysts now advise mainstream investors to steer clear of the heavily indebted telecom-equipment maker Marconi PLC, which just two years ago had one of the largest market capitalizations in the United Kingdom, and earlier this month both Moody's and S&P downgraded to junk the debt of France's Alcatel SA, one of the strongest players in the global telecom-equipment industry.
Some analysts believe that in financial flexibility, Ericsson is in worse shape than Alcatel. "I much prefer Alcatel's position to Ericsson's," says Jean-Yves Guibert, a credit analyst with BNP Paribas in London.
Moody's has Ericsson's rating on a negative outlook, but its analysts weren't available for comment Friday. A spokeswoman for S&P, which rates Ericsson's debt two notches above junk, declined to comment Friday.
Sten Fornell, chief financial officer of Ericsson, said Friday the company could manage the impact of further downgrades, though it would increase the interest costs on the company's debt. Ericsson is aiming to become profitable at some point in 2003 by cutting its cost base so that it can break even on annual revenue of 120 billion kronor, far less than its 2001 revenue of 232 billion kronor. An Ericsson spokesman said the cost-cutting program should give the company plenty of financial leeway.
Indeed, the news that Ericsson's share offering will be fully underwritten boosted the company's euro-denominated bonds expiring in 2006 by about three points Friday; they now trade at 87% of their face value. Also, Ericsson's second-quarter operating loss of 2.7 billion kronor, reported Friday, wasn't as bad as many analysts had feared.
But a 17% fall from the first quarter to the second in the value of orders booked Ericsson's flagship infrastructure division worries credit analysts. Moreover, Ericsson warned that it now expects the mobile network equipment market to decline more than 15% this year; it had previously forecast a decline of more than 10%. Many mobile-phone operators -- Ericsson's customers -- have been cutting capital spending to ease their debt burdens. Ericsson expects the market to be flat next year.
While the company's net debt is a relatively modest 21 billion kronor, it plans to spend a further 17 billion kronor restructuring its operations between now and the end of 2003. In the first six months of 2002, the company burned through about 21 billion kronor, reducing its cash to 47.5 billion kronor at the end of June.
In addition to the 30 billion kronor it raises from the share offering, Ericsson could bolster its reserves by selling some noncore assets such as its cable division or its defense operations. If things got really bad, it might also be able to sell its stake in its handset joint venture with Sony Corp.
But the key to Ericsson's future is the health of the mobile network infrastructure market, and it isn't clear when mobile phone operators will be able to start spending heavily on equipment again.
Even though several large Swedish institutional investors committed themselves to backing the rights issue Friday, some analysts recommend steering well clear. Richard Windsor, an analyst with investment bank Nomura in London, says: "Ericsson is a long way from being an investment that should be held by institutions as its markets, finances and management are in disarray."
Write to David Pringle at david.pringle@wsj.com |
