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Ericsson Scrambling for Cash

Ericsson AB (Nasdaq: ERICY) president and CEO Kurt Hellström will be glad it’s the weekend. While his company managed to plumb new depths of gloomy outlooks with its second-quarter results, that was not totally unexpected (see Ericsson Posts $380M 2Q Loss). The real shocker, which caused a severe jolt to the trading systems, was the pricing of the vendor's rights issue -- and the rocky situation that suggests (see Ericsson Prices Offering).

Looking to raise SEK30 billion (US$3.25 billion), Ericsson priced the issue at SEK3.8 per share, a whopping discount on yesterday's price of SEK14.50. The rights issue is also a massive dilution of existing stock, as there is a one-to-one new for old issuance.

That news did not go down well with financial folk. Ericsson's shares fell by 25 percent at one point in morning trading in Stockholm.

Richard Windsor, an equity analyst at Nomura Holdings Inc., believes the "only logical conclusion" for the level set was that Ericsson needs "money at any price".

Matthew Little, a bond analyst at Bear Stearns & Co. Inc., thinks the pricing was "almost at desperation levels." He says the bargain-basement deal inspires worry that the Ericsson board remains uncertain about the immediate direction of the telecom market.

So, why so cheap? Well, passing the hat 'round existing investors is a cost-effective way (in terms of fees) to raise money. Pricing the offer so low almost guarantees those investors will take it up, thereby saving Ericsson the expense of raising the cash elsewhere. The only fees of any significance are those to be paid to the banks underwriting SEK20 billion of the SEK30 billion being raised, but that only amounts to about 4 percent to 5 percent of the amount being underwritten.

What, then, is driving the company's desperate need for cash? Basically, it needs this financial fillip to help it through the continuing telecom chill. As things stand, Ericsson has debts of around SEK69 billion ($7.47 billion), and cash and cash equivalents of around SEK47.5 billion ($5.1 billion), which doesn't leave much breathing space.

Following the rights issue, Ericsson should have around SEK80 billion ($8.66 billion) in cash, as well as some bank credit lines. A lot then depends on the company's cash burn rate. According to Bear Stearns's Little, Ericsson absorbed around SEK6 billion ($640 million) in cash in the first half of 2002, a figure he believes could rise, particularly if market conditions do not improve.

On this basis, the SEK11 billion ($1.19 billion) that Ericsson will have to the good after the rights issue is only a slim lifeline. If it takes the telecom market two years to stabilize, Ericsson could find itself in a tight financial squeeze, with little prospect of an injection of cheap cash from the banks or shareholders.

Further deep cost cutting seems doubtful, as that would likely cut deep into the muscle of the company. Little points out that Ericsson's main asset is its technical base and that it spends about SEK50 billion ($5.41 billion) a year on R&D, with lead times of three to ten years on new developments, so there is little fat that Ericsson can trim there.

As for the results announced today, though bad, they are not as terrible as anticipated, and the loss was lower than the SEK5.2 billion posted in Q1. In terms of near-term market outlook, Ericsson now expects that total global mobile handset sales for all manufacturers in 2002 could be "slightly down" on last year's total of 390 million, against a previous outlook for sales of 400 million to 420 million. Nokia Corp. (NYSE: NOK), though it also revised its outlook downwards on Thursday, is still hoping for 400 million. Both companies have their hopes pinned firmly on the second half of the year, with Ericsson estimating that around 170 million phones were sold in the first half.

Ericsson's prediction on global net mobile subscriber growth is 175 million, well short of the 215 million at the top of its initial range. Given this slower-than-expected growth in users, the systems market is now expected to shrink by at least 15 percent, rather than the 10 percent Ericsson indicated in the first quarter.

However, Nomura's Windsor believes the systems market could shrink by as much as 20 percent during this year. Hardly the kind of forecast to brighten Mr. Hellström's weekend plans.

— Ouida Taaffe, special to Unstrung
http://www.unstrung.com
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