Nokia Debt Ratings Downgraded to Negative Outlook

Debt ratings agency, Fitch Ratings has downgraded Nokia Long-term Issuer Default rating (IDR) to Negative from Stable. The IDR and senior unsecured ratings are affirmed at 'A+.' A Short-term IDR of 'F1' has been assigned.

The change in the Outlook reflects the prospect of difficult industry conditions in 2009, a changing business risk profile as the handset industry matures, weakened cash flow profile and reduced financial flexibility given sizeable cash payments in 2008.

In addition, it takes into account Fitch's view of weaker growth prospects for handsets - Nokia's more dominant business - than network equipment.

While Nokia remains by far the most successful vendor in the mass market handset segment, margins are likely to come under pressure in 2009 as the global economic slowdown takes hold. After several years of strong top-line growth and robust cash flow generation, maturity in Nokia's traditional handset business is now driving investment in more expansive strategies, including the US$8.1bn acquisition of NAVTEQ and a target of achieving service and software revenues of €2bn by 2011.

While the company retains good liquidity in the form of gross cash of €7.2bn and net cash of €2.9bn (at end-Q308), these values have reduced from €11.7bn and €10.5bn respectively at FYE07, reflecting M&A activity and relatively high shareholder distributions. A €1.7bn payment to Qualcomm (a down-payment relating to royalties covering the next 15 years) will impact the cash position in Q408, although this will be offset to some extent by underlying operating cash flow.

Fitch acknowledges that new business strategies are needed in order for Nokia to ultimately regain top-line growth and potentially recover the high operating margins of the past.

A weakened free cash flow (FCF) profile in 2008 is primarily being driven by the increased scale of the company's networks business, through Nokia-Siemens Networks (NSN), its JV with Siemens. Networks is a more capital-intensive business, with the amount of new network-build taking place in emerging markets, in Fitch's view, putting increased strain on working capital flows across the industry. This is illustrated in Nokia's negative working capital of €1.5bn for the 9M08 period compared with a positive €1bn in the year-ago period. NSN is roughly twice the size of Nokia's former networks business, and is weakening Nokia's cash flow profile (traditionally one of the company's core strengths). While emphasis on improving cash management in the past two quarters has eased these pressures, FCF trends have weakened.

Fitch believes that Nokia remains in much better shape than its mass market handset competitors, some of whom are already loss-making. With a 38% market share, its scale and cost structure should protect margin and cash flow performance through the downturn.

Operating margin guidance for 2009 of "in the teens" in its Devices & Services division (compared with a previous target of around 20%), and low single-digit margins expected at NSN (versus a previous target of 10% by YE09), suggest that Nokia is, however, preparing for a difficult period for the industry. It is possible that Nokia will exit the downturn with a stronger competitive position, given that the weak operating environment is likely to affect competitors, with smaller scale, far more significantly. In the meantime the need to invest in evolving business strategies, combined with lower - albeit still strong - financial flexibility and ongoing cash flow pressures, reduces the amount of headroom in the current 'A+' rating.

Operating performance in line with stated targets, an ongoing recovery in cash flow trends and progress in rebuilding the cash position, will all be important in the context of stabilising the rating. The suspension of share buybacks (€3.1bn spent in 9M08) through 2009 is expected to ease some of these pressures.

Posted to the site on 18th December 2008