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Nokia's debt rating downgraded on cashflow fears and shifting markets

By CAROLINE GABRIEL

Published: 19 December, 2008

READ MORE: Nokia

As the market tightens, wireless players have suffered a series of downgrades by the debt ratings agencies, whose assessments are highly significant for a company's financial confidence. The latest to be marked down is Nokia, whose score on the important 'long term issue default' rating has fallen from 'stable' to 'negative'. While hardly comparable to recent downgrades of Nortel, Sprint and others, the news does highlight how even the strongest players are being squeezed by the downturn - although Fitch, like other observers, expects Nokia to emerge from the recession with its market position enhanced.

The main reasons for the change in Nokia's rating are the difficulties expected across the sector in 2009, but Fitch also picks on a changing business risk profile for handset makers as their market mature and margins fall; on the need for Nokia to put new business strategies in to place convincingly to counter that trend; and on a weakened cashflow profile, largely because of the larger scale of its capital intensive infrastructure business, since the formation of Nokia Siemens.

Just as recession strikes, Nokia is being forced to invest in expansion strategies to protect itself from the maturity of its core handset business, says Fitch, such as the $8.1bn acquisition of mapping firm Navteq, and the move to become a web services company, with a target of

€2bn in software revenues by 2011.

While the Finnish giant still has gross cash of €7.2bn and net cash of €2.9bn (as of the end of the third quarter), these figures are down from €11.7bn and €10.5bn at the end of 2007, reflecting M&A activity and relatively high shareholder distributions, and the cash position will be further impacted by the €1.7bn upfront payment to Qualcomm in Q408. The doubling in size of Nokia's infrastructure business following the formation of the NSN joint venture has also weakened its cashflow position as new networks in emerging markets "put increased strain on working capital flows across the industry" (which in other ways might be seen as a good problem to have). This is illustrated in Nokia's negative working capital of €1.5bn for the first nine months of this year, compared to a positive €1bn in the year-ago period.

One of the key factors that has been affecting Nokia's margins, market share and cash prospects is the rise of low cost Asian vendors. Although most analysts believe their increase in share will be a temporary phenomenon, and they will not be able to sustain momentum against Nokia's scale and brand, a few of the larger players, especially in China, will take a permanent position in the cellphone market. These are mainly pinning their midrange webphone hopes on Google's Android platform, which offers relatively low development costs and a wide range of open source applications. Huawei, which is seeing strong growth now it has fully committed to its devices business, plans an Android phone in mid-2009, and now Lenovo's mobile unit is also jumping on the bandwagon, eyeing China Mobile's 3G roll-out.