Fitch Maintains Nokia on Rating Watch Positive
Published on: 4th Mar 2014
By: Ian Mansfield
Fitch Ratings says that it has maintained Nokia's debt ratings on Rating Watch Positive (RWP) pending the closing of the disposal of Nokia's Devices Services (D S) activities to Microsoft.
Fitch placed Nokia on RWP at the time of the disposal announcement in September 2013. Nokia continues to guide to a transaction close in 1Q14 and that it intends to announce the results of its strategic evaluation shortly afterwards. Resolution of the RWP will include a formal review of the underlying continuing operations as well as an understanding of management's intentions with respect to the disposal proceeds and objectives for the long-term capitalisation of the business.
Removing Handsets Weakness
The sale of the D&S business will bring to a close a period of extreme stress in the credit profile of the handset industry's former leading manufacturer, which at one time accounted for close to 40% handset unit volumes on a consistent basis. The pace of industry change, the accelerated advent of the smartphone and dominance of Apple's iOS and Google's Android as the industry's leading operating systems have seen Nokia's handsets business increasingly marginalised. The business has recorded significant losses and driven material weakness in the company's cash flows. Non-IFRS losses from discounted operations were EUR667m in 2013 (EUR1.1bn in 2012) while net cash flow was negative EUR1.2bn (2012: negative EUR2.4bn).
NSN, Advanced Technologies Underpin Profile
Following the disposal, Nokia Solutions & Networks (NSN) and the newly created Advanced Technologies (the division housing Nokia's technology licensing activities) will form the most significant underlying business drivers of the group. NSN, which accounted for 89% of 2013 ongoing revenues, has reported increasingly solid results, although top-line performance continues to reflect decisions to exit low margin or unprofitable markets and customer relationships. Non-IFRS operating income of EUR1.1bn and a margin of 9.7% at NSN in 2013 underlines the increasing resilience of this business. Advanced Technologies is expected to increase its annualised net revenue run-rate to EUR600m following the D&S disposal, while the division reported a non-IFRS operating profit of EUR329m and margin of 62.2% in FY13. Nokia's location/mapping division (HERE) provides a smaller (FY13 sales of EUR914m/non-IFRS margin 5.2%) but nonetheless important revenue stream.
Improved Earnings Visibility
Revenue pressures at NSN (both market driven and a function of ongoing strategic contract exits) continue to be expected in 2014. Fitch assumes high single/low double digit declines in our rating case. Revenue and margin visibility at NSN and Advanced Technologies is nonetheless expected to be far better than under a reporting perimeter that previously included the volatility and weakness in the D&S division. The sustainability of revenues and margins at NSN will be an important driver in determining any potential ratings upside for Nokia, while a separately reported division housing the company's licensing activity increases visibility of this high margin revenue stream.
Fitch continues to guide that closing of the transaction is likely to result at a minimum in the affirmation of the current rating and assignment of a Stable Outlook, but that potential exists for a one-notch upgrade.
The D&S disposal will remove the weakest and most challenging part of the business, a business that was burning cash at a run-rate of around EUR300m per quarter in 2013.
Continuing operations generate healthy underlying cash flow and Nokia is expected to continue to manage the balance sheet conservatively, ie on a net cash basis. Fitch's confidence in the sustainability of cash flows in the underlying business, although this was materially down on the previous year, is the key driver to ratings upside from the current level.
The agency added that it similarly views a commitment to conservative financial policies and a net cash position as important for the rating.