London, 03 May 2017 -- Moody's Investors Service, ("Moody's") has
downgraded to Ba1 from Baa3 the senior unsecured long-term rating
and to (P)Ba1 from (P)Baa3 the senior unsecured medium term note (MTN)
program rating of Telefonaktiebolaget LM Ericsson (Ericsson), a
leading global provider of telecommunications equipment and related services
to mobile and fixed network operators.
Concurrently, Moody's has assigned Ericsson a Ba1 corporate
family rating (CFR) and a Ba1-PD probability of default rating
(PDR), in line with the rating agency's practice for corporates
with non-investment-grade ratings. The outlook on
all ratings is stable.
"The downgrade of Ericsson's ratings reflects the anticipated negative
impact on the company's operating earnings and cash flow in 2017
and 2018 due to rising restructuring charges and provisions, as
recently announced by the company, leading to credit metrics that
will no longer be commensurate with investment-grade ratings,"
says Alejandro Núñez, a Moody's Vice President --
Senior Analyst and lead analyst for Ericsson.
RATINGS RATIONALE
The ratings downgrade primarily reflects the negative near- and
medium-term financial implications that Moody's anticipates
will arise in 2017 and 2018 from the company's strategic review
announcement of 28 March 2017 and detailed further in the company's
Q1 2017 results.
For Q1 2017, Ericsson reported a 11% year-on-year
revenue decline and a drop in its gross margin to 13.9%
(30.5% adjusted to exclude restructuring charges,
write-down of assets and provisions related to the strategic review)
from 26.1% (29.4% adjusted) in Q4 2016.
In March 2017, the company announced an acceleration of its existing
restructuring program by outlining estimated restructuring charges of
SEK 6 -- SEK 8 billion for FY2017 (contrasted with SEK3 billion of
restructuring charges for FY2017 announced in January 2017) as well as
provisions of SEK8.3 billion related to a revaluation of customers
discounts, a reassessment of the value of trade receivables and
certain transformation projects in the IT & Cloud division.
While Moody's recognizes the strategic review's intention
to increase investment in certain core portfolio areas and that the company's
cost savings initiatives should deliver longer term operating expense
savings (after associated restructuring charges), the rating agency
also highlights that a strategy premised primarily on cost-cutting
is not sustainable over the long run and could also hamper the company's
competitiveness including its ability to innovate and maintain its historical
technological leadership position.
Moody's notes that the company's declining operating cash
flow and restructuring charges are likely to continue to erode Ericsson's
key credit metrics over the coming year. Ericsson's materially
reduced EBITDA generation alongside elevated levels of debt led to a significant
increase in the company's (Moody's-adjusted) gross
debt/EBITDA ratio to 4.6x for FY2016 compared with 1.9x
at the end of FY2015. Based on the company's revenue guidance of
-2% to -6% in 2017 for its core networking
equipment market and including the effects of the recently announced restructuring
and provisions charges as well as its dividend cut for 2017, Moody's
anticipates that Ericsson's gross debt/EBITDA ratio (Moody's-adjusted)
will trend above 7x for FY2017.
Despite the company's publicly stated financial policies,
its relatively high exposure to the competitive wireless networking equipment
market without sufficiently offsetting earnings contribution from other
market segments, coupled with its revenue headwinds and uncompetitive
cost structure, will continue to hamper Ericsson's ability
to exhibit credit characteristics consistent with an investment-grade
profile over the next two years.
The Ba1 ratings continue to reflect: (1) Moody's expectation
of a continued negative revenue and earnings growth outlook in 2017 and
2018 driven by softening market demand during a cyclical trough as well
as intense competition amidst gradual structural shifts in the sector's
competitive and technological landscape; (2) the lack of sufficient
growth or earnings contribution from the company's IT & Cloud
or Media divisions to offset weakness in the Networks division; (3)
the structural challenge that Ericsson faces because of its heavy exposure
to the wireless networking equipment market which is unlikely to see material
growth before 2020 as the next technology investment cycle (5G) is expected
to ramp up more significantly from around 2020; and (4) a weakened
financial profile, driven by a relatively high cost base and declining
revenues, leading to significantly reduced operating earnings and
continued negative free cash flow generation. Furthermore,
the unpredictable development of pending questions from US authorities,
regarding Ericsson's anti-corruption program and specific
cases, represents an event risk which further constrains the ratings
in the short to medium term.
These negative considerations are balanced against: (1) Moody's
expectation that the company's cost savings activities begin to
evidence a stabilization of the company's operating earnings trajectory
by the second half of 2018; (2) a maintenance of the company's
good liquidity position; (3) financial policies within the limits
of the company's free cash flow generation and liquidity resources;
and (4) a track record of shareholder support. Moody's considers
Ericsson's solid liquidity and main shareholders' support
to be the company's two principal supportive credit factors in this
period of structural challenges.
RATIONALE FOR STABLE OUTLOOK
The stable outlook reflects Moody's expectation that: (1)
Ericsson's total revenue decline in FY2017 will not be materially
higher than the -2% to -6% range guided by
the company for its core networking equipment market with a subsequent
material improvement in its revenue trajectory in FY2018; (2) the
company will not implement restructuring charges and/or provisions,
beyond those announced to date, that would require further material
cash outflows over the next two years; (3) a modest improvement in
the gross leverage level in FY2018 from the deterioration in gross leverage
Moody's projects for FY2017; (4) modest progress in FY2018
operating margins from levels that Moody's anticipates will be near
0% in FY2017; (5) there will be no material worsening of the
company's free cash flow trend compared with that of FY2016;
(6) Ericsson will continue to maintain a good liquidity profile to buffer
its expected negative free cash flow over at least the next year;
and (7) the company maintains financial policies which balance the interests
of creditors and shareholders. The outlook also reflects Moody's
expectation that Ericsson's adjusted gross debt/EBITDA (Moody's-adjusted,
excluding restructuring charges and provisions) will be around 7x in FY2017.
WHAT COULD CHANGE THE RATING UP/DOWN
Given today's rating action, a rating upgrade over the short term
is unlikely. However, over time, Moody's could upgrade
the rating if: (1) the announced restructuring program starts bearing
fruit leading to a sustainable recovery of the company's operating performance
such that its operating margins returned consistently into a high single-digit
percentage range; (2) the company were to better diversify its earnings
base which is currently highly exposed to the cyclical and highly competitive
wireless networking equipment market; (3) Ericsson demonstrates a
sustainably robust competitive position and technological leadership;
(4) end-market demand were to rebound quicker than currently anticipated
into positive revenue growth territory over a 12-month horizon;
(5) free cash flow were to be materially and sustainably positive;
and (6) Ericsson's own liquidity sources were to improve materially from
currently projected FY2017-FY2018 levels such that it achieved
a net cash position (including the company's pension deficit) and
reduces gross leverage from currently excessive levels.
Negative pressure could be exerted on Ericsson's ratings in the case of:
(1) negative operating margins in FY2017 with no expectation of a material
margin recovery in FY2018; (2) a further deterioration of free cash
flow (post-dividends) and/or gross leverage in FY2017, relative
to FY2016, without the prospect of a material recovery in FY2018;
(3) a diminished competitive position, particularly in the core
Networking division as the 5G investment cycle approaches; (4) a
further material decline in the company's own liquidity sources;
and/or (5) the imposition of a material fine resulting from the pending
questions from US authorities.
LIST OF AFFECTED RATINGS
Assignments:
..Issuer: Telefonaktiebolaget LM Ericsson
.LT Corporate Family Rating, Assigned Ba1
.Probability of Default Rating, Assigned Ba1-PD
Downgrades:
..Issuer: Telefonaktiebolaget LM Ericsson
....Senior Unsecured Regular Bond/Debenture,
Downgraded to Ba1 from Baa3
....Senior Unsecured Medium-Term Note
Program, Downgraded to (P)Ba1 from (P)Baa3
Outlook Actions:
..Issuer: Telefonaktiebolaget LM Ericsson
....Outlook, Changed To Stable from
Negative
PRINCIPAL METHODOLOGY
The principal methodology used in these ratings was Diversified Technology
Rating Methodology published in December 2015. Please see the Rating
Methodologies page on www.moodys.com for a copy of this
methodology.
With revenues of SEK222.6 billion in FY2016, Telefonaktiebolaget
LM Ericsson ("Ericsson") is a leading provider of telecommunications
equipment and related services to mobile and fixed network operators globally.
Its equipment is used by over 1,000 networks in more than 180 countries
and around 40% of the global mobile traffic passes through its
systems. In FY2016, Ericsson's Networks division contributed
49%, Global Services 46%, and Support Solutions
5% of group revenues, respectively. Geographically,
revenues are well diversified across all major regions in North America,
Europe, Asia and Rest of the World. The company's largest
shareholders are Investor AB (Aa3 stable) and AB Industrivärden (unrated),
with voting rights of 21.7% and 15.2%,
respectively.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the credit rating action on the support provider and in relation to
each particular credit rating action for securities that derive their
credit ratings from the support provider's credit rating.
For provisional ratings, this announcement provides certain regulatory
disclosures in relation to the provisional rating assigned, and
in relation to a definitive rating that may be assigned subsequent to
the final issuance of the debt, in each case where the transaction
structure and terms have not changed prior to the assignment of the definitive
rating in a manner that would have affected the rating. For further
information please see the ratings tab on the issuer/entity page for the
respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit
support from the primary entity(ies) of this credit rating action,
and whose ratings may change as a result of this credit rating action,
the associated regulatory disclosures will be those of the guarantor entity.
Exceptions to this approach exist for the following disclosures,
if applicable to jurisdiction: Ancillary Services, Disclosure
to rated entity, Disclosure from rated entity.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
Alejandro Nunez
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Ivan Palacios
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454