More Bad News for Nokia

Nokia Corp. (NYSE: NOK) is getting kicked while it's down. The latest blow from corporate ratings firm Moody's Investors Service deepens investor concerns about the company and may force it to begin considering strategic alliances to boost its cash position and shore up critical operations.

Moody's on Friday slashed Nokia's debt rating to "junk" status and confirmed it would maintain a "negative" outlook on the company until its operating conditions improved. The downgrade impacted about $4.5 billion (€3.6 billion) of Nokia debts, Moody's said. The company reported total debt of approximately €4.9 billion at the end of the March quarter, which means Moody's action would affect substantially more than half all of its outstanding financial obligations.

Moody's did note in its research report (available only to subscribers) that it "regards Nokia's commitment to decisive restructuring as positive and necessary to return the group to profitability."

The path to profitability remains stormy for Nokia, though, and it may be quite a while before it starts to benefit from the restructuring actions, all of which will drain it of much needed cash as it compensates employees being laid off. Nokia is facing tough competitive pressures, and despite the recent cost-cutting actions and the introduction of its newest phone (the Lumia), the company hasn't posted the kind of positive improvements analysts have said it needs to improve its profile. In fact, Nokia's stock price weakened even further after the 10,000 job cuts it announced last week on concerns sales were dropping faster than expected. (See: Nokia to Cut 10,000 Jobs, Divest Assets and Nokia Job Cuts Don't & Won't Impress Anyone.)

Wolfgang Draack, a Moody's senior vice president and lead analyst for Nokia, said in the report:

Today's rating action reflects our view that Nokia's far-reaching restructuring plan -- which involves drastically downsizing its infrastructure by focusing its direct marketing on fewer markets, streamlining support functions and reducing investments in certain R&D projects in order to realize additional fixed cost savings of up to EUR1.3 billion by the end of 2013 -- delineates a scale of earnings pressure and cash consumption that is larger than we had previously assumed.

Moody's reasons for downgrading Nokia's debt rating and its general outlook for the company are worth restating here. They point to some of the challenges facing the company and the viability of its long-term competitive position. While Moody's analysts believe the company is on the right track with the reorganization actions and efforts to spark sales of its devices, they were also concerned about the lack of visibility into demand for its products and the declining "future net cash flows." Here are further comments from the Moody's report, including the ratings firm's conditions for, in the future, changing Nokia's ratings up or down:

Given that the rating outlook is negative, there is currently limited potential for an upgrade of Nokia's ratings. However, Moody's could upgrade the rating to investment grade if (i) Windows devices make meaningful gains in the smartphone market; (ii) Nokia's revenues start to grow again and it achieves an operating margin (-4.0% for the last 12 months to March 2012, as adjusted by Moody's) in the mid-single digits in percentage terms; and (iii) the group maintains an adjusted net cash position (approximately EUR2.4 billion as per the end of March 2011, as adjusted by Moody's).

Moody's would stabilise Nokia's outlook if (i) the Lumia family of devices gains meaningful market share and the Smart Devices segment returns to non-IFRS operating profit; (ii) the sales volumes of Mobile Phones segment at least stabilises and its margin contribution returns to the double digits in percentage terms; and (iii) the group's cash consumption falls to marginal levels.

Moody's would consider downgrading Nokia's rating further if (i) there is evidence that the Lumia product family is failing to gain momentum, due, for instance, to a slowdown in customer take-up; (ii) the non-IFRS operating margin of the group's Devices & Services segment declines further below -5% and fails to improve in the second half of 2012; or (iii) Nokia's cash consumption remains high, and is not materially reduced over the coming quarters such that the group's reported level of net cash does not trend below EUR3.0 billion (EUR4.9 billion at end of March 2012).