telefonaktiebolaget lm ericsson huawei ... operations support systems (“oss”) and business...

CORPORATES

CREDIT OPINION6 July 2016

Update

RATINGSTelefonaktiebolaget LM Ericsson

Domicile Sweden

Long Term Rating Baa1

Type Senior Unsecured - FgnCurr

Outlook Stable

Please see the ratings section at the end of this reportfor more information.The ratings and outlook shownreflect information as of the publication date.

Contacts

Alejandro Núñez 44-20-7772-1389VP-Senior [email protected]

Mikel Zabala 44-20-7772-5620Associate [email protected]

Ivan Palacios 34-91-768-8229Associate [email protected]

Telefonaktiebolaget LM EricssonEricsson: Update to Credit Opinion and Key RatingConsiderations

Summary Rating RationaleEricsson's Baa1 long-term rating reflects the company's strong market position in wirelesscommunications equipment and its deeply entrenched position within the telecom industry.These strengths are partly offset by the competition amongst telecom equipment vendors,technology risks related to the development of future generations of mobile telecomsequipment as well as the company's large exposure to telecom operators with its attendantprice pressure and cyclical capital spending.

The rating also reflects expectations that Ericsson's operating performance will improve overtime whilst maintaining adequate debt metrics as evidenced by a gross debt to EBITDA ratio(Moody's adjusted) around 1.5x. At the current rating level, we also expect the company'soperating margin to continue to move towards 10% over the next year, and to be sustainedthereafter above that level, leading as well to positive free cash flow generation. Ericssoncontinues to be weakly positioned at its current Baa1 rating level especially with regardto profitability and free cash flow generation. The rating also factors in expectations thatEricsson will maintain shareholder returns within the limits of its free cash flow generationafter considering acquisition opportunities.

Credit Strengths

» Strong global market position and scale in wireless equipment, broad geographicdiversification

» Strategic focus on services should lead to less earnings cyclicality than networkinghardware sales

» Gradual growth from newer target market areas although these will require near-terminvestments

» Broadly stable credit protection metrics and a strong liquidity position

Credit Challenges

» Weak market outlook for global wireless capex spend in 2016-2017 leading to Networksrevenue contraction

» Subdued near-term profitability and higher investments particularly in Global Servicesdivision

» Competition and technological risks remain long term threats

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MOODY'S INVESTORS SERVICE CORPORATES

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 6 July 2016 Telefonaktiebolaget LM Ericsson: Ericsson: Update to Credit Opinion and Key Rating Considerations

Rating OutlookThe stable outlook factors in our expectations that Ericsson will maintain its strong market positions, gradually improve profitabilitythrough 2017 and maintain a moderate level of leverage. Quantitatively, the stable outlook reflects expectations that Ericsson willachieve Moody's adjusted operating margins in low double-digits by 2017, Gross Debt/EBITDA of around 1.5x and Retained Cash Flow(RCF) to gross debt of 25%, based on Moody's calculations and adjustments.

Factors that Could Lead to an UpgradeMoody's would consider an upgrade if Ericsson were able to materially strengthen its market positions, achieve and sustain operatingmargins in mid double-digits, reduce gross debt/EBITDA sustainably below 1.25x and increase RCF/debt sustainably above 30%.

Factors that Could Lead to a DowngradeWe would consider a downgrade of Ericsson's rating if we expected a sustained erosion in the company's market positions, operatingmargins remaining in single-digit territory, sustained leverage above 1.75x or RCF/gross debt below 20%. A temporary erosion in thecompany's strong liquidity position could be justified in the event of strategic acquisitions.

Key Indicators

Exhibit 1

All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.

Source: Moody's Financial Metrics

Detailed Rating Considerations

1. STRONG GLOBAL MARKET POSITION AND SCALE IN WIRELESS EQUIPMENT; BROAD GEOGRAPHIC DIVERSIFICATION

Ericsson is a market leading provider of network infrastructure and services for mobile and fixed communications including 2G, 3Gand 4G wireless radio, Internet Protocol (“IP”) and transport networks. Ericsson's clear strategic focus on key segments of the globaltelecom equipment industry has historically translated into technology leadership, strong customer relationships and economies ofscale in R&D and production. Following the combination of Nokia and Alcatel-Lucent in early 2016, we do not expect further materialshifts in global telecoms equipment market shares as the level of price-based competition between the main players appears to haveabated somewhat, compared to the 2011-2014 period.

In FY2015, the sales of networking equipment hardware generated more than half of Ericsson's revenues (SEK123.7 billion in FY2015with a reported operating margin of 10%), with the majority of this coming from the cellular wireless market in which Ericsson holdsa strong position. The company has strong market positions in mobile networks where its market share is approximately a third ofthe global market. In the networking equipment markets, it competes primarily against Nokia/Alcatel-Lucent (Ba1 Stable), Huawei(unrated) and ZTE (unrated). In IP networks, however, Ericsson's market position currently ranks behind that of Cisco (A1 stable),Juniper (Baa2 negative), Nokia/Alcatel-Lucent and also Huawei.

Geographically, revenues are well diversified across all major regions with the US, Europe, Asia and Rest of the World representingapproximately 25% of group sales each.



2. STRATEGIC FOCUS ON SERVICES SHOULD LEAD TO LESS EARNINGS CYCLICALITY THAN NETWORKING

We expect the company to continue its ongoing transformation from a supplier of hardware to a services/software company. Ericssonintends to further increase the proportion of revenues coming from services and software to 75% by 2020 from 66% currently thuspotentially leading to greater revenue, earnings and cash flow stability while potentially also translating into eventually higher growth.

We view positively the company's high share of service revenues (SEK108 billion in 2015 with a reported operating margin of 8%) dueto the recurring nature of these earnings compared to equipment sales despite having lower gross margins. Within Global Services,the Professional Services business (comprising 76% of Global Services revenues) exhibits fair growth potential, EBIT margins around12% and a high rate of recurrent business. This is, however, offset by low or even negative margins and highly cyclical Network Rolloutrevenues (c. 24% of Global Services division revenues).

The company estimates its share of the highly fragmented global telecom services market is between 10-15%, ahead of its closestcompetitors Huawei (not rated) and Nokia/ Alcatel-Lucent (Ba1 Stable). In the Professional Services segment Ericsson also competesagainst IBM (Aa3 negative), Accenture (A1 stable) and Hewlett Packard Enterprise Company (Baa2 stable).

3. GRADUAL GROWTH FROM NEWER TARGET AREAS ALTHOUGH THESE WILL REQUIRE INVESTMENTS

Ericsson intends to become a leading player in the converging telecom equipment, IT and media industries by capitalizing on itsexisting leadership positions. The company is also focusing on gaining share in IP routers by leveraging its strong core positions towardcloud-based virtualized applications and expanding into other adjacent markets.

In addition to its core business markets of Radio/Core/Transmission networks and Telecom Services, whose size Ericsson estimates tobe US$150 billion (in 2014) growing at a CAGR of 1-3% from 2014-2018, Ericsson is also targeting growth in five new market areas.These include: (1) IP Networks; (2) Cloud; (3) Operations Support Systems (“OSS”) and Business Support Systems (“BSS”); (4) TV &Media; and, (5) Industry & Society. Ericsson estimates the size of these markets collectively is around US$140 billion (as of 2014) andgrowing at a CAGR of 10% through 2018.

For example, Ericsson’s Support Solutions segment (SEK15 billion of revenues in FY2015 with a reported operating margin of 10%)focuses on software for OSS/BSS, TV & Media and m-commerce. Most of the companies active in services also compete in the supportsolutions market where Ericsson claims it is one of the market’s three largest players.

Over the past two years, the company has strengthened its position in TV & Media through small-sized acquisitions as it believes thesemarkets will converge with telecom (video is already the single largest contributor to traffic in mobile networks) and that it will be ableto leverage its own assets and telecom sector expertise to capture strong expected growth in adjacent and related markets. As a resultof this focus, Ericsson aims to transform itself into a leading Information and Communications Technology (“ICT”) solutions provider.The company’s focus on these new market areas should also serve to broaden its customer sector concentration beyond the telecomoperators (approximately 90% of Ericsson’s 2015 revenues derived from telecom operators).

Similar to other technology firms, Ericsson uses acquisitions to enhance its own R&D efforts. It has built its market leading positionsinternally whilst making use of partnerships and generally small acquisitions to fill out gaps in competencies and/or enter new growthareas. Typically, acquired companies have developed a technology that complements Ericsson's strategy. Overall, Ericsson has spentSEK26 billion on acquisitions in the last 5 years. We expect Ericsson will continue spending approximately SEK4 billion annually overthe next few years on selective acquisitions in order to build its services capabilities especially in these newer target market areas ofvideo and software.

Although we recognize these new market areas’ market size as comparable, in aggregate, and their growth potential as higher than thatof Ericsson’s core business segments, we nevertheless acknowledge that building them will require investments over the next few yearsprimarily in the form of small and mid-sized bolt-on acquisitions. Until they achieve sufficient scale relative to Ericsson’s core Networksand Global Services divisions, their contributions to Ericsson’s group revenues and operating earnings will be proportionately modest.



4. WEAK MARKET OUTLOOK FOR GLOBAL WIRELESS CAPEX IN 2016-2017

Global spending on telecoms equipment is likely to be lower in 2016-2017 than it was in the previous three years. We expect areduction in global telecoms equipment spend of approximately 6% in 2016 and a further 5% in 2017. A decline in Chinese telecomoperators’ capex, due predominantly to a slowdown in LTE rollouts, is expected to contribute to roughly half of the decline in globalwireless capex spend in 2016-2017. Telecom operators’ spending on wireless equipment in other emerging markets and in Europeis also expected to continue declining in 2016-2017 while spending is expected to be broadly stable or near flat in North America.In addition, a lull in the telecoms technology cycle until 5G ramps from 2019-2020 onward will contribute to lower spending onequipment by telecom operators. In the meantime, densification (e.g. small cells) and software upgrades to LTE-A and LTE-A Pro couldmitigate, to an extent, the anticipated drop in hardware spending.

Ericsson has provided a revenue CAGR target of 2-4% over the 2014-2020 period for its core and target markets in which it believes itcan outperform thanks to its focus on higher growth areas. The market outlook remains challenging, however, and we currently expectnegative mid single-digit revenue growth over the next year.

Against this market backdrop, competition remains a risk to vendors' margins given the oligopolistic nature of each market as well asthe increasing standardization of their product offering which results in endemic price pressure. The merger consummated betweenNokia and Alcatel-Lucent in early 2016 may lead to more disciplined industry pricing and a stable competitive dynamic although it isyet too early to be able to observe that in the marketplace.

5. SUBDUED NEAR-TERM PROFITABILITY AND HIGHER INVESTMENTS PARTICULARLY IN SERVICES

Ericsson's operating performance has been affected by a decline in gross margins in the past five years, caused by competitivepressure, higher services in the revenue mix, and the lower or even negative margins of the network rollouts for the European networkmodernization projects. In the last five years, operating margins have been in the mid to high single digit range and stood at 8.9% inthe 12 months ended 31 March 2016, based on Moody's adjusted figures (which, amongst other adjustments, includes restructuringexpenses).

Exhibit 2

Adjusted Operating Margin

Source: Moody’s Financial Metrics

Profitability patterns in Ericsson’s Global Services division continue to be rather variable with, for example, a weak EBITA margin in Q12016 of c. 5%. As is typical of this market segment, there are upfront investments and costs which dilute margins in the initial stagesof network transformation projects. However, it appears that margin improvement in this segment will be gradual as Ericsson aimsto improve profitability on its contracts over the next few years. Longer term, it remains to be seen whether the company is able tosucceed in its new targeted areas while also sustainably controlling operating expenses. We expect no meaningful change to R&D costswhich are driven primarily by rising investments in IP and ICT centers.



6. NEED TO EXECUTE ON RESTRUCTURING PLAN

Ericsson announced a new major cost reduction plan in November 2014 aimed at reducing operating costs by SEK9 billion by the endof 2017, with restructuring costs between SEK3-4 billion. In Q1 2016 Ericsson increased the plan’s estimated restructuring costs for2016 to SEK 4-5 billion without concurrently raising the targeted cost savings. The expected savings include both COGS and fixed costsas well as the closure of the Modem business effected in 2015.

Exhibit 3

Global Cost and Efficiency Program (SEK bn)

Source: Company presentation

In FY2016, Ericsson's operating margin is likely to be capped at a high single-digit level, in our view, reflecting a continuingreadjustment of costs to the slowing revenue environment in both the Networks and Global Services divisions. This should besomewhat balanced by the ongoing cost efficiency program. Although progress in Ericsson’s cost savings program has yet to manifestitself significantly in Ericsson’s operating margins to date, we highlight that the company will need to achieve the targeted savings inorder to largely offset the revenue and underlying earnings headwinds we project for the business over the next 18 months.

While we expect Ericsson's key credit metrics to remain below our expectations for the current Baa1 rating over the next 12 months, wenevertheless expect them to improve toward the latter half of FY 2017 when more of the benefits of the ongoing restructuring plansshould be more evident.

7. BROADLY STABLE CREDIT METRICS

In the 12 months to 31 March 2016, leverage (measured as Gross debt to EBITDA) was 1.9x, EBIT interest cover was 9.1x and RetainedCash Flow (RCF) / Gross debt was 22%. From SEK23.6 billion of Cash Flow from Operations, Ericsson generated SEK1.1 billion of FreeCash Flow after funding SEK 11.1 billion of capex and distributing SEK11.1 billion in dividends.



Exhibit 4

EBITDA Waterfall FY2015 (SEK bn)


Exhibit 5

Gross Debt Waterfall FY2015 (SEK bn)


Ericsson reported gross debt of SEK24.5 billion at the end of March 2016 and cash and cash equivalents of SEK61 billion at thesame date. Moody's adjustments to Ericsson FY2015 reported debt are comprised primarily of SEK22.6 billion related to pensionobligations and SEK13.3 billion related to operating leases. Moody's operating lease adjustment declined in FY2015 to reflect a changein Moody's operating lease rating methodology implemented in June 2015 which broadly lowered the adjustment factor multiple forEricsson's industry. Ericsson's pension obligations doubled during its FY2014 compared to the previous year due to changes in actuarialassumptions such as a lower discount rate.

However, the weaker debt metrics also reflect a continuation of Ericsson’s weaker than historical operating performance. We projectEricsson’s operating margins will improve again in FY2017 toward our the expectations for the current rating and in high single-digitsover the next 12 months.

Liquidity AnalysisEricsson's liquidity profile is strong and supportive of the rating although liquidity strength is necessary to accommodate the cyclicaldemand swings and intense competition common to Ericsson’s industry.

The group held SEK61 billion of cash and marketable securities at the end of March 2016. We understand that the company is generallyable to access its cash balances in these countries to meet external and internal obligations and that only a small fraction is effectivelyrestricted. In addition, Ericsson has access to an unused $2.0 billion revolving credit facility maturing in 2020 with two extensionoptions of one year each. The facility contains neither financial covenants nor material adverse change conditions for drawdowns.



We expect Ericsson to generate positive free cash flow in FY2016 and in FY2017. The company has no significant short term debtmaturities while SEK4.9 billion of notes mature in June 2017.

Corporate ProfileWith revenues of SEK246.9 billion in FY2015, Telefonaktiebolaget LM Ericsson (“Ericsson”) is a world-leading provider oftelecommunications equipment and related services to mobile and fixed network operators globally. Its equipment is used by over1,000 networks in more than 180 countries and around 40% of the global mobile traffic passes through its systems. Networksrepresented 50%, Support Solutions 6% and Global Services 44% of group revenues in FY2015. The company's largest shareholders areInvestor AB (Aa3 stable) and AB Industrivärden (unrated), with voting rights of 21.5% and 15.2%, respectively.

Rating Methodology and Scorecard FactorsThe grid-indicated outcome from Moody's Diversified Technology rating methodology (published in December 2015) is Baa2 (onenotch below the actual rating of Baa1), based on financial figures for the 12 months to 31 March 2016. Based on our 12-18 monthsforward view through the end of FY 2017 the grid-indicated rating is Baa1 (in line with the current rating). While we expect Ericsson'skey credit metrics to remain below the expectations for the current rating through mid-2017, we expect them to recover toward theend of 2017 by which time more benefits of Ericsson’s ongoing restructuring measures should materialize.

Exhibit 6

[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.[2] As of 3/31/2016(L)[3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestituresSource: Moody's Financial Metrics

Ratings

Exhibit 7Category Moody's RatingTELEFONAKTIEBOLAGET LM ERICSSON

Outlook StableSenior Unsecured Baa1

Source: Moody's Investors Service



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REPORT NUMBER 1033929

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