Ericsson’s and STMicroelectronics’s Commitment to Their Joint Venture Is Credit Negative

Ericsson’s and STMicroelectronics’s Commitment to Their Joint Venture Is Credit Negative

Last Monday, ST-Ericsson (unrated), a wireless semiconductor joint venture owned 50-50 by Telefonaktiebolaget LM Ericsson (Ericsson, A3 stable) and STMicroelectronics (ST, Baa1 stable), reported that it incurred about half of its 2011 sales of €1.65 billion as a net loss, and consumed about €700 million cash during the year. In addition, ST-Ericsson’s cash burn did not meaningfully fall during a seasonally robust fourth quarter. Its owners, which funded the resulting cash requirements, do not expect the operation to be profitable before 2013. They have increased their credit line to the joint venture by an undisclosed amount from €800 million and have reiterated their commitment to the business. Continued cash transfers to ST-Ericsson are credit negative as they erode the currently cash-rich shareholders’ credit profiles.

ST Ericsson arose from the 2009 merger of ST’s wireless semiconductor business (which included the previously acquired wireless operations of NXP) with Ericsson’s mobile platform operations. ST-Ericsson is currently transitioning its technology from feature phone chipsets primarily for Nokia’s Symbian-based9 phones to smartphone platforms. Its new Thor design has already been selected by leading suppliers such as Nokia, Motorola and Sharp for advanced mobile phones.

However, ST-Ericsson’s legacy business is declining relatively quickly, hurt by, among other things, the strategic shift at its key customer, Nokia. Revenues stabilised to around €400 million per quarter in the second half of 2011, but that level is insufficient for sustained profitability or cash generation, particularly given that cash consumption remained high at almost €200 million per quarter. ST-Ericsson’s cash needs have been funded pro-rata by credit facilities from its parent companies.

Despite ST-Ericsson’s struggles, both ST and Ericsson last week reiterated their commitment to support ST-Ericsson through its transition, arguing that substantial value resides in the joint venture’s technology portfolio, which could make it to one of the leading semiconductor suppliers for smartphones. More than 100 million smartphones are sold quarterly and the number is rising quickly. US company Qualcomm and Britain’s ARM Holdings currently design most of the chipsets for smart devices and ST-Ericsson may be able to challenge their position. However, that will require more manufacturer endorsements and more time to complete its product range. Ericsson and ST are willing to fund that path, but they are also looking for options to reduce cash burn and accelerate the transition. In December 2011, they appointed Didier Lamouche, ST’s chief operating officer, as ST-Ericsson’s new CEO, and his mandate is to review the joint venture’s strategic plan and financial prospects and execute the necessary improvements to technology roadmap and break-even cost level. ST-Ericsson’s shareholders say they are confident that the operation can achieve a turnaround.
With cash balances of SEK81 billion (€9.2 billion) for Ericsson and $2.3 billion (€1.8 billion) for ST, both have healthy cash reserves. Still, if the companies cannot find a viable and long-term solution for their joint venture, a continuation of these substantial funding transfers could erode their financial flexibility in an industry where liquidity requirements are typically high.