Nokia's Long Term Ratings Downgraded on Weak Smartphone Performance
Standard & Poor's Ratings Services said today it had lowered Nokia's long-term corporate credit rating to 'BB-' from 'BB+' and affirmed its 'B' short-term corporate credit rating. The outlook is negative.
At the same time, they lowered our issue ratings on Nokia's unsecured debt to 'BB-' from 'BB+'. The recovery rating on this debt remains at '3', reflecting a expectation of meaningful (50%-70%) recovery prospects in the event of a payment default.
The rating actions reflect a downward revision of S&P's estimates of revenues and profitability for Nokia's smartphone operations in 2012 and 2013.
They have subsequently also revised their cash flow assumptions, including the impact from Nokia's restructuring of its Devices and Services division. In line with their ratings criteria, S&P has therefore revised its assessment of Nokia's business risk profile to "weak" from "fair" and that of the financial risk profile to "significant" from "intermediate".
S&P now assumes that Nokia's smartphone operations will post lower revenues than previously anticipated over the coming quarters. They also believe that consolidated revenues for 2012 will show a decline of 16%-19% and that the company will post a non-IFRS operating loss (that is, not under International Financial Reporting Standards) before restructuring costs.
Nokia's revenues could stabilize in 2013 if growth from Lumia smartphones is able to offset the revenue decline from smartphones using the Symbian operating system and, to a lesser extent, from mobile phones. However, S&P still foresees Nokia posting a low single-digit non-IFRS operating margin in 2013.
They have also lowered volume assumptions for Nokia's smartphones because the company's market share continues to decline. Nokia held 7.0% of the smartphone market in the second quarter of 2012, down from 12.6% in the fourth quarter of 2011, according to market research company Strategy Analytics. Because Symbian devices still represent the largest portion of Nokia's sales by volume, S&P thinks Nokia's market share could decline further. The ratings agency has also lowered its price assumptions for Nokia's smartphones following the price decline of Lumia phones to €186 in the second quarter of this year, compared with €220 in the first quarter. To defend its market share, they believe that Nokia might lower the price of Lumia phones further in the coming quarters.
S&P also incorporated the recent drop in the company's gross margin for the smartphone segment to 1.7% in the second quarter of 2012, which resulted partly from €220 million of inventory-related allowances for Lumia, Symbian, and MeeGo devices. Depending on volumes sold in the future, they think that additional charges could affect future gross margins. Nokia's restructuring of its Devices and Services division and Telecom Network Equipment division (NSN) now targets a combined cost reduction of €3.3 billion by the end of 2013. However, they expect that this will only partly offset declining revenues and we expect the group's non-IFRS operating margins to remain negative over the coming quarters.
In its updated base-case assessment, S&P now expects Nokia to generate negative consolidated free operating cash flow (FOCF) of about minus €2 billion in 2012, and slightly negative FOCF in 2013. This FOCF forecast incorporates assumption of weaker profitability and the company's plan for cash restructuring outflows of €1.75 billion over the next 18 months. S&P continues to view Nokia's cash position as a positive factor, but expects net cash to fall to less than €3 billion by the end of 2012, from €4.2 billion on June 30, 2012. The sharp decline includes cash restructuring outflows and excludes the possible benefits from divestments.
The negative outlook reflects the possibility of a downgrade over the next 12 months if the non-IFRS operating margin of Nokia's Devices and Services division or consolidated FOCF remains significantly negative, since this would reduce Nokia's net cash position further. This could be the case for instance if revenues from Lumia smartphones did not increase significantly during 2013 or if margins deteriorated further.