The world’s largest mobile-phone maker’s bonds are trading as if Nokia’s rating has been cut, with spreads over government debt widening as the company strives to develop devices with the same mass appeal as the iPhone, Research In Motion Ltd.’s BlackBerry and devices based on Google Inc.’s Android software.
There’s a “significant amount of risk overall with Nokia’s business model,” said Scott Shiffman, who directs bond research at Chapdelaine Credit Partners in New York. “Credit spreads should move wider over time and ratings will continue to move lower. We think the ratings agencies will play catch-up to the business deterioration.”
A downgrade would add to the Espoo, Finland-based company’s woes, with market share falling and margins eroded by competition in smartphones, the fastest-growing part of the industry. Nokia shares have tumbled 23 percent this year, wiping out 9.4 billion euros ($11.9 billion) in market value.
The yield demanded to hold Nokia’s 5.5 percent euro- denominated bonds due 2014 climbed to 136 basis points over comparable German government debt from a low of 80 in April. That’s wider than the average 108 basis-point spread for similarly graded bonds, according to the Merrill Lynch EMU Corporates, Non-Finance A rated Index.
Nokia’s bonds are rated A with a negative outlook at Standard & Poor’s and A2 with a stable outlook at Moody’s Investors Service, the sixth investment-grade level at the ratings companies. It is ranked A- with a stable outlook at Fitch Ratings.
Fitch cut its Nokia rating twice last year, while Moody’s did so once, the first downgrade since 2000. S&P, which has never lowered it, said on June 22 it may do so in 2011 if the operating margin doesn’t recover after the third quarter.
“Nokia is a company that two years ago was in such a dominant position that the thought of them falling from their pedestal wasn’t really present,” said Hunter Martin, a credit analyst at BNP Paribas SA in London. “Now it seems Nokia can’t necessarily keep it going forever and it’s trading like a lower- rated company.”
Ericsson AB, the world’s largest maker of wireless networks, has fared better with a lower rating.
The yield over comparable government debt sought for the Stockholm-based company’s 5 percent bond maturing 2013 has widened just 30 basis points from April to 157. The bonds have a BBB+ rating from Standard & Poor’s and Fitch Ratings, and a Baa1 from Moody’s, two steps below Nokia.
“Nokia has definitely underperformed Ericsson by two percentage points on a total return basis, which is a lot,” said Juliano Torii, a credit analyst at Societe Generale SA in London. “The company has been re-rated down from being the undisputed leader to a company that’s increasingly seen as kind of a dinosaur being eaten by the other players.”
Nokia lowered its margin outlook two quarters in a row as iPhones, BlackBerrys and Android devices eroded its high-end smartphones market share. Nokia’s latest response, its new N8 model, has been delayed and is due to be shipped this quarter.
Nokia said device margins in the three months ending September may be as low as 7 percent, rebounding to 10 to 11 percent for the year after new products are introduced. The margin was 12.5 percent last year and 18.2 percent in 2008. In July, Nokia posted a 40 percent drop in second-quarter profit.
Its market share has also shrunk. Nokia had 34.2 percent of the overall mobile-phone market, compared with 36.8 percent a year ago, according to Gartner Inc. Its smartphone share fell to 37.4 percent from 45 percent in the second quarter of 2009.
“We believe Nokia will be coming more and more under pressure from competitors and we haven’t seen a clear strategy for the company,” said Patrik Janovjak, a portfolio manager at Bank Sarasin & Cie AG in Basel, who says he sold his Nokia bonds and shares more than six months ago.
Nokia’s smartphones chief, Anssi Vanjoki, dismissed skeptics during a talk at Aalto University’s business school in Helsinki this week, saying “we are by a very wide margin the largest supplier of smartphones and small computers in the world.” He said Nokia plans to make the new operating system it is developing with Intel Corp., called MeeGo, ubiquitous.
Nokia issued the bonds in early 2009 with a spread over German government bonds of 300 basis points, reflecting the credit crunch that roiled financial markets.
The company raised about $3.8 billion in sales of euro-and- dollar denominated bonds in January and April last year as it tapped credit markets for the first time in five years. Nokia had almost no long-term debt and had been the world’s biggest handset vendor for more than 10 years. Rivals Apple, Google and RIM have no bonds outstanding, according to Bloomberg data.
Nokia’s margin for error is “getting thinner,” Fitch analyst Stuart Reid said in an interview. “They’re going through a transitional period and there’s a good chance they’ll come through it and recover some of the luster they had before. They still know how to make mass market mobile handsets and the balance sheet is strong.”
Nokia’s cash hoard is helping to protect its creditworthiness. The company had 9.5 billion euros in cash and short-term investments at the end of the second quarter after paying a dividend of 40 cents a share.
“The strong point in the Nokia credit story is they do have significant cash and relatively low leverage,” said Chapdelaine’s Shiffman.
Credit Default Swaps
Still, Nokia’s five-year credit default swaps have widened to about 110 basis points from 40 basis points a year ago, while Ericsson’s CDS contracted to 95 basis points from 120 basis points.
Credit default swaps pay the buyers face value in exchange for the underlying securities or cash equivalent should a company fail to adhere to its underlying credit agreements. A narrowing signals improvement in perceptions of credit quality.
“If the CDSs were to get beyond 150, which is the historic high in 2008, then people may get very unsettled,” said Brian Barry, a credit analyst at Evolution Securities Ltd. in London. “The new smartphone they’re launching soon may be a key turning point for the company.”