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Moody's changes outlook for Nokia' A1 rating to negative

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Moody's has changed its outlook on Nokia's ratings to negative, from stable although it affirmed the A1 ratings for Nokia's senior debt and the Prime 1 for short term debt. The outlook change was triggered by Nokia's results for the first quarter 2009, which confirmed a double digit rate of decline for the mobile phone market in units and a one third year over year revenue reduction for Nokia in this segment and it disclosed increasing earnings pressure in the Nokia Siemens Networks business.

Moody's says that it is concerned that the currently depressed mobile phone market may not only be a result of transitory, cyclical factors, but may also reflect a degree of market saturation in most regions, so that the fast revenue growth of the past years in which Nokia had benefited from superior scale and efficiency might not be restored and a slow growth environment may not allow Nokia to return to credit metrics sustainable at a level that meets Moody's expectations for a A1 rating with regard to profitability and free cash flow generation in 2009 and beyond.

Although Nokia maintained its gross profit margin in devices, the company's group results fell below Moody's operating profit-margin expectation of above 10% in Q1, 2009 by reporting a 0.6% margin or 5.5% after Nokia's adjustments for purchase price accounting effects and restructuring charges. Similarly, Nokia fell short of expectations in cash generation with a EUR1.0 billion free cash flow (as adjusted by Moody's) for the last twelve months compared to above EUR2.0 billion guidance for the A1 rating.

While Moody's tends to be tolerant with regard to temporary undershooting of metric guidance as a result of market-related factors, in this case the rating agency notes that this cyclical downturn hits the company at a time when it had reduced considerably its leeway in the category following large financial transactions completed in 2008. During 2008 management has spent around EUR5.3 billion for the strategic acquisition of NAVTEQ (Q1, 2009 adjusted operating profit: EUR5 million) and EUR3.1 billion on share buybacks in addition to the EUR2.0 billion dividend. These expenditures exceeded free cash flow by almost EUR7.0 billion and caused Nokia to move into a slight net debt position (as adjusted by Moody's) by Q1, 2009 from EUR8.5 billion net cash at the end of 2007 so that the financial cushion factored into the A1 rating was largely exhausted. To preserve its financial flexibility, management decided in mid-2008 to suspend its share buyback program and in early 2009, to propose a one quarter cut to its dividend payment.

Nokia has remained the industry leader in mobile phones with a market share of about 39%. Currently, the depressed markets weigh on Nokia's profitability by diluting its scale advantages, by exposing an unfavourable product-mix (e.g. converged devices) and by reducing the average selling price of Nokia. As a result, its operating margin in Devices and Services has halved compared to the year ago quarter, but stayed above 10%, yet not sufficient to bolster the other operations to a group margin above 10%. Nokia expects mobile device market volumes to decline by approximately 10% in 2009, which implies an even greater percentage reduction in revenues for the year, given continued price erosion, unless the company's targeted gains in market share are realized extensively. Given these challenges in all of Nokia's businesses, management's fixed cost reduction programme targeting savings of more than EUR700 million per annum by the end of 2010 in the device business, may well prove insufficient to return earnings performance of the group to double--digit margins, if the mobile market does not resume its fast growth path in volumes and price competition in networks abates. Given the profitability targets set by the company for Devices & Services, lower than expected revenues would require additional cost saving measures.

Moody's considers a return to double-digit margins for the group to be challenging, as mobile phone penetration rates have reached a relatively high level, estimated by Nokia at 58% globally, as replacement cycles in the mature markets are lengthening and price competition in networks is accelerating due to market share strategies of certain competitors.

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