Nokia Debt Ratings Downgraded to Junk Status by Moody's Ratings

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The debt ratings agency Moody's has downgraded Nokia's long term senior unsecured debt ratings to Ba1 and its short term senior unsecured ratings to Not Prime from Prime 3 which is essentially downgrading the company to junk status albeit at the very highest end of that rating range.

"Today's rating action reflects our view that Nokia's far-reaching restructuring plan -- which involves drastically downsizing its infrastructure by focusing its direct marketing on fewer markets, streamlining support functions and reducing investments in certain R&D projects in order to realize additional fixed cost savings of up to EUR1.3 billion by the end of 2013 -- delineates a scale of earnings pressure and cash consumption that is larger than we had previously assumed," says Wolfgang Draack, a Moody's Senior Vice President and lead analyst for Nokia.

Despite today's downgrade, Moody's regards Nokia's commitment to decisive restructuring as positive and necessary to return the group to profitability. A return to profitability also depends on Nokia successfully transitioning its range of smartphones to the new Windows operating system and stabilising its feature phone business.

On Thursday 14 June, Nokia announced its intention to continue investing in its priority businesses, but also to downsize ancillary activities to better align its fixed cost in Devices & Services (D&S) to lower revenues. Management is seeking to reduce operating expenses by approximately 44% by the end of 2013 from the 2010 level. This compares with revenues in the segment that fell to EUR21.1 billion for the last twelve months from EUR29.1 billion which represents a 28% decline, with revenue growth not yet in sight. Nokia estimates that its two restructuring plans announced to date have a cumulative cash cost of EUR1.7 billion of which EUR450 million has already been paid out by the end of Q1/2012. However, Moody's cautions that, if Nokia's revenues do not stabilise soon, it may need to carry out additional restructuring.

For Nokia to return to growth in this segment, it will primarily require the Lumia smartphones, which are selling in several versions and many markets, to gain traction in the smartphone market. Indeed, in Moody's view, the attractiveness of the Lumia range should be boosted by the introduction of the Windows 8 operating system for mobile devices, to be launched in the second half of 2012. The recently launched Asha full touch-screen model should support demand for feature phones and raise average selling prices, although Nokia may sell fewer units of mobile phones as the distribution networks are being scaled down and the overall feature phone market continues to decline as customers migrate to smartphones with lower price points.

Moody's now expects Nokia's non-International Financial Reporting Standards (IFRS) operating margins in its Devices & Services segment to fall to the negative mid-single digits in percentage terms (from -3% assumed so far) in the next one or two quarters, with material improvement starting in the second half of 2012 driven by rising sales of the group's new Lumia smartphone range and realised cost savings. Nokia's high gross and net cash balances should remain strong during its product transition to Windows-based devices, with the group's net reported cash likely to remain above EUR3.0 billion.

Moody's notes that Nokia has maintained a strong liquidity position and capital structure. At the end of March 2012, Nokia, including 100% of the Nokia Siemens Networks (NSN) communications equipment partnership with Siemens, had approximately EUR9.8 billion of cash and marketable securities, around twice its reported financial debt. Nokia ended the first quarter of 2012 with EUR4.9 billion of net cash. For its liquidity needs, Nokia also has a reliable EUR1.5 billion revolving credit facility due in 2016, which does not contain financial covenants.

In addition to the pressure on its own operations, Moody's notes that Nokia may have to contribute additional capital or funding to NSN if the company's restructuring costs start to exceed its cash flow from operations.

Structural Considerations

In its Loss Given Default (LGD) approach, Moody's decided not to rate the structurally preferred operating liabilities of subsidiaries above Nokia's debt instruments. The senior unsecured debt of Nokia was rated at the level of the CFR, instead of a notch below, because of (i) the investment-grade nature of Nokia's financing structure, with virtually all financial debt raised by the parent company on a pari-passu, senior unsecured basis; (ii) Moody's assumption that more than half of the group's liquidity, balances of cash and equivalents are unencumbered and directly accessible by Nokia Oyj without delay; and (iii) the fact that the majority of intellectual property rights are held, and more than 40% of group revenues are recorded, by the parent company, which itself has only small amounts of external assets, however. If cash held at, and directly accessible by, the parent company declines materially below Nokia's financial debt, Moody's may differentiate its rating of Nokia's senior debt instruments from the CFR.

The negative outlook on Nokia's Ba1 ratings reflect the low visibility with regard to (i) the trend for Nokia's market share in smartphones and whether there is customer acceptance of the Lumia range of devices; (ii) demand and margin potential for the group's feature phones in emerging markets; and (iii) Nokia's future net cash flows, which are adversely affected by pricing pressure, marketing incentives and restructuring expenditures, although this is partially mitigated by royalty collections, platform payments from Microsoft and potential disposal proceeds.

Future Ratings Changes

Given that the rating outlook is negative, there is currently limited potential for an upgrade of Nokia's ratings. However, Moody's could upgrade the rating to investment grade if (i) Windows devices make meaningful gains in the smartphone market; (ii) Nokia's revenues start to grow again and it achieves an operating margin (-4.0% for the last 12 months to March 2012, as adjusted by Moody's) in the mid-single digits in percentage terms; and (iii) the group maintains an adjusted net cash position (approximately EUR2.4 billion as per the end of March 2011, as adjusted by Moody's).

Moody's would stabilise Nokia's outlook if (i) the Lumia family of devices gains meaningful market share and the Smart Devices segment returns to non-IFRS operating profit; (ii) the sales volumes of Mobile Phones segment at least stabilises and its margin contribution returns to the double digits in percentage terms; and (iii) the group's cash consumption falls to marginal levels.

Moody's would consider downgrading Nokia's rating further if (i) there is evidence that the Lumia product family is failing to gain momentum, due, for instance, to a slowdown in customer take-up; (ii) the non-IFRS operating margin of the group's Devices & Services segment declines further below -5% and fails to improve in the second half of 2012; or (iii) Nokia's cash consumption remains high, and is not materially reduced over the coming quarters such that the group's reported level of net cash does not trend below EUR3.0 billion (EUR4.9 billion at end of March 2012). The bulk of this cash consumption will be accounted for by EUR740 million of dividends paid in the second quarter of 2012 and restructuring cash costs at both Nokia and NSN.

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