Ericsson – The bugbear is back.

After 20 years, corporate governance is once again a problem.

• 18 years ago, Ericsson’s corporate governance went from awful to not great but now with its latest blunder, the pressure is on to fix what it should have fixed back in 2004.
• Activist investor Cevian Capital has accumulated a large position in Ericsson and, smelling blood in the water, is calling for further improvements in corporate governance.
• Ericsson’s problems with corporate governance go back many years and mostly involve two of its biggest shareholders, the Wallenberg family and Swedish holding company Industriavarden.
• Ericsson has two classes of shares (A and B) each of which carry different numbers of votes.
• Prior to 2004, the A shares had 1 vote each and the B shares 1/1000^th of a vote each.
• The A-shares have always been very tightly held by the two investors and this meant that prior to 2004, these two investors controlled over 90% of the votes despite having around 3% economic interest in the company.
• I have long believed that this was part of the reason why Ericsson fiddled while its business was on fire after the internet bubble popped which resulted in an emergency and highly dilutive rights issue.
• This led to a round of intense pressure being placed on Ericsson which agreed to adjust the voting structure of the B votes from 1/1000^th to 1/10^th in 2004.
• This reduced the voting of the two investors from over 90% to the mid-30s which meant they ceded control but still had a blocking minority.
• This was an imperfect solution but critically it was a compromise that Ericsson’s controlling shareholders agreed to.
• However, Ericsson has had another slip up which has once again cost shareholders dearly and opened the door to further changes to its corporate governance which in my view is long overdue.
• This time it was the disclosure that payments it had made in Iraq may have found their way into the hands of ISIS, that has hit its reputation once again and caused the share price to collapse by 14%.
• Furthermore, the US Department of Justice now considers that Ericsson has again breached its deferred prosecution agreement meaning that punitive measures may now be taken.
• This has left Ericsson scrambling to salvage its reputation and aligning the voting structure of the A and the B shares may be a good way of achieving some of that.
• This is easily achieved by converting the A shares into B shares which is something that I have long wanted to see at Ericsson.
• The commentators are increasingly of the opinion that Ericsson is uninvestable while these issues persist, which to me means that we could be in for a serious bout of underperformance.
• However, when anyone says uninvestable, I am immediately interested as heavy and indiscriminate selling will create a value opportunity.
• The buy case for Nokia is built on both the turnaround that it is clearly underway, and its relative undervaluation compared to Ericsson, its chief peer and rival.
• However, if Ericsson continues to crater and attracts universal antipathy, then the situation may begin to reverse itself.
• Market conditions have also caused a heavy correction in Nokia, meaning that selling it now to buy Ericsson makes no sense but this is something to keep an eye on.
• If Nokia recovers to €6 and Ericsson continues to flounder, then serious consideration should be given to this switch but I am not close to pulling the trigger on it yet as Nokia has further to run and Ericsson may have further to fall.