Once a top-selling brand and market leader, Nokia has had its long-term debt rating cut to highly-speculative, for the first time, by a leading ratings agency, following previous cuts that dropped it below investment grade to the so-called junk level.
Standard & Poor's dropped Nokia's rating to the level below junk and is now characterising it as "highly-speculative", while Moody's has Nokia at the last notch before "highly-speculative", but warns it could be further downgraded, and Fitch is at the same rating.
Standard & Poor's move comes on the back of Nokia's announcement that it will buy out half of Nokia Siemens Networks (NSN) for EUR1.7 billion, taking its stake to 100%, but causing the rating agency to have concerns over Nokia's free cash flow.
However, Nokia - once one of the pioneers of smartphones and a key driver of sales in the cellular handset world - has hit back, saying its financial position is strong. Lower ratings typically make it more difficult for companies to raise debt without paying hefty premiums.
Nokia says NSN has a leading position in long-term evolution, which provides it with growth opportunities.
Worrying factors
Standard & Poor's lowered its long-term corporate credit rating on the Finnish mobile to "B+" from "BB-", affirmed its "B" short-term corporate credit rating, and said the outlook is stable. It also dropped its issue rating on Nokia's senior unsecured debt to "B+" from "BB-", but noted the recovery rating remains at "3" based on its expectation of meaningful - 50% to 70% - recovery in the event of a payment default.
"Nokia's strong balance sheet, which we view as an offsetting factor to Nokia's cash burn and supportive to the rating, will weaken following the acquisition. We also factor in the company's estimate cash burn of EUR300 million to EUR800 million during the second quarter of 2013."
Standard & Poor's says the deal, which will not have a positive impact on Nokia's profitability or cash flow because it was already accounting for the stake, will weaken its net cash position. The acquisition could close in the third quarter of 2013.
"We have lowered our estimate of Nokia's net cash to EUR1.3 billion or above at end-2013, from EUR3 billion or above previously." In addition, says Standard & Poor's, it thinks Nokia's free operating cash flow will be negative in the second half of 2013 and for the full year.
Standard & Poor's thinks Nokia may struggle to return to positive free cash generation in 2014, although it does expect it to maintain a strong net cash position over the next 12 months, despite its anticipation of negative free operating cash flow.
Smartphone need
The rating agency says it could increase its rating, if free operating cash flow sustainably became positive. However, this would require Nokia's share of the smartphone market, and its earnings before interest, tax, depreciation and amortisation, to return durably to positive territory.
It warns the rating could drop if Nokia failed to gain smartphone market share, leading to continuing negative free operating cash flow prospects in 2014 and beyond. "This would further reduce Nokia's net cash position."
According to IDC, Nokia was the second-largest overall mobile vendor in the first quarter of the year, shipping 61.9 million units for a share of 14.8% of the total market. This was a year-on-year decline of 25.1%.
The top overall vendor is Samsung, which shipped a total of 115 million units and has a 27.5% share of the market, a position that increased 22.9% year-on-year.
However, in terms of smartphones - where Samsung is again the market leader with 32.7% ? Nokia is not ranked in the top five, with Apple, LG, Huawei and ZTE all outselling it, based on IDC figures.
At the end of the first quarter, CEO Stephen Elop said "people are responding positively to the Lumia portfolio, and our volumes are increasing quarter-over-quarter". However, he noted its mobile phones business faces a difficult competitive environment, and it is taking tactical actions and bringing new innovation to market to address its challenges.
On the defensive
In reaction to the downgrade, Timo Ihamuotila, executive VP and CFO, says: "With a strong positive gross and net cash position, Nokia was able to take advantage of an opportunity to fully own Nokia Siemens Networks and, we believe, create meaningful value for Nokia shareholders. We will continue to prudently manage our cash resources post-transaction."
The company argues its financial position remains strong and it estimates its net cash, at the end of the second quarter, would be between EUR3.7 billion and EUR4.2 billion. Had the deal closed in the second quarter, the company would still have been net cash positive, it says.
Nokia will pay EUR1.2 billion in cash, which it has secured through bank financing, and EUR500 000 through a secured loan from Siemens, which is due one year from closing.
Elop said in April that Nokia had achieved underlying operating profitability for the third quarter in a row. It ended the first quarter with net cash and other liquid assets of EUR4.48 billion, a 3% quarter-on-quarter gain, but an 8% decline from last year.
"While operating in a highly competitive environment, Nokia is executing our strategy with urgency and managing our costs very well." In addition, Elop said Nokia Siemens Networks delivered another strong quarter and contributed to an overall improvement in its cash position.
Tough times
However, Sasha Naryshkine, Vestact analyst, says cash flow has been a problem for Nokia for a while and it does not offer new products that appeal to the market. He says while Nokia is not a write-off, it is likely to be bought out.
Naryshkine points out that Nokia's market capitalisation is the equivalent of 4% of that of Apple's. "That's really sad."
Generally, lower ratings make it more difficult for companies to raise debt, adds Naryshkine. He says the market has fallen out of love with what used to be one of the best businesses around as it is no longer compelling. "We'll just have to wait and see."
However, Nokia notes it has access to additional liquidity through a revolving credit facility of EUR1.5 billion, which is entirely undrawn and available to the company through to March 2016. Nokia Siemens Networks also has a EUR750 million revolving credit facility that is entirely undrawn and available through to June 2015.
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