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Nokia Faces Junk Grade on Apple Domination: Corporate Finance

Nokia Faces Junk Grade on Apple Domination
An employee displays a Nokia Oyj E7 business handset during a news conference at the company's headquarters in Espoo, Finland. Photographer: Henrik Kettunen/Bloomberg

Credit investors are betting that Nokia Oyj is poised to lose its investment-grade rating as Apple Inc.’s iPhone and Google Inc.’s Android eat into the market-leading position held by the world’s biggest seller of handsets.

The extra yield investors demand to hold the company’s 6.75 percent bonds due 2019 rather than government debt has more than doubled to 307 basis points since May 30, the day before it dumped its 2011 targets and unveiled second-quarter results below analyst forecasts. The cost of insuring Nokia debt soared to 246 basis points from 120 in the period, according to CMA prices for credit-default swaps.

Standard & Poor’s today cut the Espoo, Finland-based company’s ranking one level to BBB+, two days after Fitch Ratings downgraded it to BBB-, a step above speculative grade. Consumers are deserting Nokia’s handsets, powered by its Symbian operating system, as the company works to start shipping its first phone based on Microsoft Corp.’s Windows Phone 7 in the fourth quarter.

“Nokia has totally lost its way at the high end of the market, where it’s just not up to the standards of its competitors,” said Madeleine King, a credit analyst at Credit Suisse Group AG in London, who said she “doesn’t rule out” Nokia being cut to junk if the Windows phone flops. “At the low end, it offered very similar products while rivals came up with handsets specific to each market.”

Value Plunge

S&P said it may cut the rating again and Fitch left the outlook negative. Both cited sliding margins and sales and likely cash burn.

“S&P also noted the group’s exceptional liquidity profile and Nokia’s history of maintaining a conservative financial policy, which targets a strong balance sheet,” James Etheridge, a spokesman for the phone company, said in an e-mail. “Nokia does not expect that S&P’s rating action will have a material impact on our current financing costs. Nokia’s credit ratings are underscored by our strong market position and IPR portfolio, as well as our solid liquidity and capital structure.”

Nokia, whose 2010 sales of $61 billion are equivalent to about a quarter of Finland’s annual economic output, has seen its value plunge by more than 77 percent since Apple introduced the iPhone in June 2007. The company is racing to come up with products to meet consumer demand for smartphones, particularly in Europe and China, where competition from Google’s free Android software is “intense,” according to CreditSights Inc. analysts Ping Zhao and Jordan Chalfin.

Moody’s Grade

Moody’s Investors Service rates Nokia A3, three levels higher than Fitch, and is reviewing the company for a possible downgrade. The New York-based ratings firm said it will focus the review on how Nokia plans to stem the erosion in market share and on its ability to cut costs and limit spending.

Bonds rated A have an average spread of 91 basis points, according to Bank of America’s EMU Corporates, Industrials, A Rated index.

The company’s plan to reduce expenditures by 1 billion euros ($1.5 billion) may not be enough, according to New York-based CreditSights. It’s “very likely” the company will have to reduce or suspend its dividend as it carries out the transition to Windows software, the analysts wrote in a report.

Nokia’s 2019 bonds yield about 5.9 percent, compared with the 3.77 percent average for European industrial companies rated BBB, Bank of America Merrill Lynch’s EMU Corporates, Industrials, BBB Rated index shows. The 307 basis-point spread on the company’s bonds, a measure of investor perceptions of risk, compares with an average of 144 basis points. Those rated BB, the top junk category, have an average spread of 398 basis points, according to Bank of America.

Credit-Default Swaps

Credit-default swaps on the Markit iTraxx Crossover Index of 40 companies with mostly high-yield credit ratings are at 397, according to JPMorgan Chase & Co.

“The momentum remains sharply negative,” said Jonathan White, an analyst at Royal Bank of Scotland Group Plc in London, in a report. Fitch’s note “suggests that a downgrade to junk is possible at any time.”

Chief Executive Officer Stephen Elop, a former Microsoft executive who took over in September, turned to Windows Phone 7 after deciding Nokia’s Symbian software couldn’t compete with the iPhone and Android, the fastest-growing smartphone operating system. The Canadian is the first non-Finn to head the company.

A Microsoft bid to buy Nokia is “not totally ridiculous,” according to King at Credit Suisse. “If the share price continues to fall, it may reach a price where a takeover starts to look attractive.”

Nokia said May 31 it has “increased confidence” its Windows-powered phones will ship on schedule.

“That will be a key moment for them,” said Juliano Hiroshi Torii, an analyst at Societe Generale SA in London. “If the Windows phone doesn’t take off, they’ll have wasted nine months and got nowhere.”

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