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Ericsson revisited

Little did I know how timely my recent analysis of Ericsson would become. It just ended up on the top of my “Value list” and because of that I decided to take a closer look (Value hunting – Ericsson). My conclusion was to buy in the 50-55 SEK range, and well, it entered and went below that in one single day. I won’t say I had any idea that this would happen, but what I can say is that I did mention the nasty downside risk Ericsson has showed in the past – and once again we experience it -20.21% on the day. The rumours of aggressive accounting must more or less be true, for this type of downturn in numbers.

Probability of bid went up

Before we had a fairly valued company, now it starts to look much more interesting to me. We will probably see lower dividends, perhaps back to the levels of 2009. But even so we still have a very healthy dividend yield of about 3.5% going forward. But to me the value is the patent portfolio and I believe Cisco gets more and more interested, the lower Ericsson falls. In my previous analysis I said that I don’t believe the majority owners would be interested to sell. On my latest flight to Asia I picked up a newspaper in the airplane which I took a photo of:

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The article is saying that the pressure on the majority owners is increasing and there are more or less rumours that they consider selling the company. There is apparently a lot of discussions going on behind the scenes on what is the best way forward. The article continues that there is a clear resistance towards selling Ericsson, but all options are at this moment evaluated.

Reading todays articles in the Swedish press, the majority owners and the Wallenberg family particularly is heavily criticised for not taking action. The press more or less demands the Chairman (Leif Johansson – feature image in post headline) is also thrown out. So a lot is going on, and in these situations it is really painful to go in and buy.

How to value potential Cisco bid?

Let’s do a back of the envelope valuation, based on the Sum of the Parts valuation table I presented before.

SOTP 2017E EV (SEKm) 2017E EV/EBIT (x) Per Share (SEK)
Networks excl Patents 48 350 8 15
Global Services 46 973 10 14
SS excl Patents 10 471 1 3
Patents 83 940 10 26

The idea is that Cisco is interested in the Patents portfolio and are willing to pay a good premium for that – without any deeper analysis they can pay a 40% premium on the patents parts of the business. The rest of the business is slaughter and valued at 60% of previous valuations (due to the deteriorating numbers).

Networks = 15 * 0.6 = 9 SEK

Global Services = 14 * 0.6 = 8.4 SEK

SS excl Patents = 3 * 0.6 = 1.8

Patents = 26 SEK per share * 1.4 = 36.4 SEK

Total = 55.6 SEK

But the probability of a bid is not 100%, let’s say it is 40%. Then the Patents portfolio is valued at 26 SEK + 40% * (36.4-26) = 30.16 SEK

And Total valuation is = 49.36 SEK. Which is inline with today’s valuation. I think the probability of a Cisco bid over the coming 1-2 years is in the 30-40% probability range and I don’t think the rest of the business should be valued as low as my back of the envelope calculations. I don’t find the price of Ericsson to be the bargain of a lifetime but interesting enough.

No brass balls

So since I’m not born with brass balls, I won’t take a large position here. I hold 12% of my portfolio in cash and I feel comfortable with taking a 2% position in Ericsson, with the option to increase my position to full size in case we see further share price deterioration towards the low 40 range, this is when the stock starts to become seriously interesting.

 

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