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Nokia Default Swaps Trading Like Junk: Corporate Finance

Nokia Swaps Trade Like Junk as Cash Dwindles
The phone maker’s free cash flow, which produces money available to pay down debt, reward shareholders with buybacks and dividends, or reinvest in the business, plummeted 87 percent to 541 million euros last year, Bloomberg data show. Photographer: Chris Ratcliffe/Bloomberg

Nokia Oyj, once the world’s biggest smartphone maker, risks a downgrade to junk-bond status after cutting its profit forecast and reporting a decline in its cash.

Nokia’s credit-default swaps soared for the eighth day today, rising 55 basis points to a record 490 basis points, according to data provider CMA. Espoo, Finland-based Nokia’s swaps imply a Ba3 bond rating, according to Moody’s Analytics. That’s the third-highest junk grade and four levels below the company’s Baa2 at Moody’s Investors Service.

The firm is burning cash 14 months after linking up with Microsoft Corp. to make phones based on the U.S. company’s Windows Phone software. Nokia abandoned its own system, Symbian, which couldn’t keep up with Google Inc.’s Android platform and Apple Inc.’s iPhones. The Finnish company reported a first-quarter operating loss for its mobile phone unit and forecast earnings wouldn’t recover this quarter.

“We’re going to see the crisis perhaps reach a terminal phase if the cash begins to dwindle to levels where we’re looking at a couple of quarters left,” Horace Dediu, a Helsinki-based analyst at industry-research website, said in a telephone interview. “That will cause a liquidity crisis. It’s already causing a confidence crisis with respect to their debt. The cost of financial distress would bring the company down.”

Nokia declined 7.2 percent to 3.04 euros at the close of trading in Helsinki.

Bonds Fall

The company’s $1 billion of 5.375 notes due in May 2019 dropped 7.1 cents on the dollar since the earnings announcement to 91.1 cents for a yield of 7 percent at 12:19 p.m. in New York, according to Trace, the bond-price reporting service of the Financial Industry Regulatory Authority. That’s the lowest price ever for the debt, which was issued in April 2009. Nokia has $4.75 billion of bonds and term loans outstanding, according to data compiled by Bloomberg.

Default swaps insuring the phone maker’s obligations soared to a record 490,000 euros ($645,700) to protect 10 million euros of debt, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The swaps traded at 115,000 euros a year ago.

Nokia’s net cash and other liquid assets shrank to 4.9 billion euros at the end of the first quarter, from 5.6 billion euros at the close of 2011 and 6.4 billion euros at the end of March 2011, the company said yesterday in a statement. The firm that took in almost half the global revenue from smartphones in 2007 now claims only 10 percent of the $219 billion per year market, Bloomberg data show. Fitch said today that revenue and profit are “likely to be even lower” than current forecasts.

‘Needs a Winner’

“With its market share plunging, Nokia definitely needs a winner,” Dave Novosel, an analyst at Chicago-based bond researcher Gimme Credit LLC, wrote in a March 28 research note that recommended selling the company’s bonds.

While Nokia’s net cash and other liquid asset holdings account for about 1.4 times the value of its bonds and term loans, the company’s ratio of total debt to earnings before taxes, depreciation and amortization, at 3.4, ranks higher than 80 percent of its peers with market values bigger than $1 billion, Bloomberg data show.

Nokia’s current “burn rate” would also exhaust its cash holdings by the end of 2013,’s Dediu said. The company said yesterday the reduction in cash during the quarter was caused by operating losses and “non-recurring” changes in net working capital. Its devices and services unit also probably had a first-quarter operating loss of about 3 percent of sales. Second-quarter figures will be “similar to or below” those for the first quarter, it said today.

Free Cash Flow

The phone maker’s free cash flow, which produces money available to pay down debt, reward shareholders with buybacks and dividends, or reinvest in the business, plummeted 87 percent to 541 million euros last year, Bloomberg data show.

Chief Executive Officer Stephen Elop said yesterday during a conference call to discuss the latest earnings that he’s reviewing options including asset sales, vowing to take “significant structural actions if and when necessary.”

“We have to make decisions about, are we concentrating on certain markets, are we emphasizing certain product opportunities over others, do we sell off certain non-core assets along the way,” Elop, whose company yesterday lost about $3 billion of market value to $15.9 billion, said. “What I’m really heavily focused on is making sure that we have the right levels of investment to break through in the areas where we need to break through.”

Symbian, MeeGo

Elop shifted Nokia to Microsoft’s Windows Phone platform more than a year ago after determining his company’s Symbian and MeeGo systems couldn’t keep up with competition from Apple, now the biggest smartphone maker by value, and Google.

Nokia already trades at BBB-, the bottom rung of investment grade at Standard & Poor’s. S&P cut Nokia’s long-term debt rating on March 2 from BBB and maintained a “negative” outlook, reflecting concerns that sinking operating margins and eroding sales from smartphones based on the Symbian system. S&P analysts led by Thierry Guermann in Stockholm said the debt could be downgraded in the next two years if margins at its devices and services division remained in the “low-to-mid single digits” or if net cash dropped below 2 billion euros. Nokia had an A- rating at S&P and an equivalent A3 at Moody’s until June of last year.

Nokia’s handset margins, adjusted for some items, dropped from more than 20 percent in 2007, when Apple introduced the iPhone, to 4.9 percent in the final quarter of 2011. Net cash, now about 5 billion euros, will fall to 4.6 billion euros this year, according to analyst estimates compiled by Bloomberg.

“You’re going to see revenue decline, and you’re going to see margin decline, and you’re going to see cash flow decline,” Ping Zhao, an analyst at CreditSights Inc. in New York, said in a telephone interview. “It’s very likely in the next 12 months it will get to junk.”

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