Nokia Bond Risks Endure After Dividends Cut: Corporate Finance

Nokia Oyj’s tendency to burn through cash faster than any of its rivals is putting bondholders at risk even after the smartphone maker bolstered its balance sheet by skipping a dividend for the first time in 143 years.

Societe Generale SA recommends investors sell Nokia’s 500 million euros ($673 million) of 6.75 percent bonds due in 2019 and buy five-year credit-default swaps that insure against the Finnish company missing debt payments. While Nokia posted its first profit since early 2011 last week after Chief Executive Officer Stephen Elop cut jobs and closed factories, it also had a seventh straight drop in quarterly revenue.

“Although recent results show that its turnaround plan is heading in the right direction, we remain cautious with regard to the company’s ability to achieve its longer-term financial objectives, including a return to sustainable profitability and free cash flow generation,” said Robert Jaeger, an analyst at SocGen in London.

Nokia is the only global maker of cell phones with negative free cash flow for 2012, data compiled by Bloomberg show, as its flagship Lumia brand fails to match sales of competitors such as Apple Inc. and Samsung Electronics Co. Nokia has 3.6 billion euros of bonds outstanding, including 1.25 billion euros coming due next year, according to Bloomberg data. Samsung has about $2.5 billion of notes, while Apple has no public debt.

Cash Burn

Nokia decided not to pay its dividend to save about 750 million euros, after cutting 20,000 jobs and closing production and research facilities. Even with the bondholder-friendly steps, analysts and ratings firms are concerned the Espoo, Finland-based company is burning cash too quickly and that its smartphone sales are lagging too far behind competitors.

The rising popularity of Samsung’s Galaxy and Apple’s iPhone has pushed Nokia into third place in the smartphone market, after it held the record for sales in 2010, according to Strategy Analytics. Nokia’s share has declined to 5 percent from 15.8 percent, the analysis firm said.

“The market share is still a long way from where the leaders are, and a long way from where they were,” said Dave Novosel, a senior analyst at Chicago-based bond research firm Gimme Credit. “We’re still a sell here.”

Negative Flow

Nokia’s free cash flow declined to minus 812 million euros in the 12 months to Dec. 31, from a positive 2.3 billion euros as of September 2011, Bloomberg data show. Apple gained $44.7 billion and Samsung added $7.5 billion.

“We have gross cash of 9.9 billion euros and net cash of 4.4 billion euros, both higher than what we had a quarter earlier,” James Etheridge, a spokesman for Nokia, said in an e-mailed statement. “2012 was clearly a transition year for us. A major part of our costs and cash outflows were restructuring related. We go into 2013 a more nimble and agile company.”

Etheridge said the company has additional liquidity available via an untapped debt facility and that it has improved the “time-to-market” for its products. Network operators and consumers want a “third eco-system to succeed” and Nokia is “especially focused on returning our phones business to sustainable positive operating cash flow as soon as possible,” he said.

Risk Demand

The Finnish manufacturer’s bonds rallied over the past three months, benefitting from rising demand for higher-yield, higher-risk assets amid record-low central bank interest rates.

Nokia’s notes in euros due 2019 returned 12.2 percent since Oct. 25, according to data compiled by Bloomberg. That beats the 5.6 percent total return, including reinvested interest, of Bank of America Merrill Lynch’s Euro High Yield Index.

The extra yield over benchmark government debt that investors demand to hold the Nokia notes shrank to 466 basis points from 681 basis points on Oct. 25, according to Bloomberg generic prices. A basis point is 0.01 percentage point.

Spreads are still wider than the 140 basis points for Ericsson AB’s 500 million euros of 5.375 percent bonds due 2017, which returned 1.25 percent in the past three months.

The spread on Samsung’s $1 billion of 1.75 percent securities maturing in 2017 is 67 basis points, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Junk Bonds

The three major ratings companies grade Nokia three steps below investment grade. Moody’s Investors Service lowered Nokia by two levels to Ba3, with a “negative” outlook, on July 23. Standard & Poor’s and Fitch Ratings downgraded the phone company by two steps to an equivalent BB-, also with a “negative” outlook, within about a month of that decision.

Moody’s said the Finnish company’s “transition in the smartphone business will cause deeper operating losses and consequently cash consumption in the coming quarters than we had previously assumed.” Nokia’s cash pile “will gradually erode,” the ratings firm said.

Nokia had positive cash flow before dividends in the second quarter of last year, though that was boosted by 400 million euros of pre-payments on intellectual property and a 120 million-euro contribution from Nokia Siemens Networks, according to Moody’s.

S&P cut Nokia’s rating as it revised lower its revenue and profitability estimates for the company’s smartphone operations in 2012 and 2013. The firm said it may downgrade Nokia again if it failed to stabilize margins and “significantly cut its cash losses.” The New York-based ratings firm had Nokia at investment grade as recently as April.

Higher Ratings

Ericsson is rated six levels higher than Nokia at A3 by Moody’s and five levels higher at BBB+ by S&P and Fitch. Samsung is eight levels above its Finnish rival at Moody’s with an A1 rating, and seven steps higher with an A grade at S&P.

Credit-default swaps insuring Nokia’s debt have halved to 567 basis points after reaching a record-high in July, prices compiled by Bloomberg show.

There were 110 trades of the swaps insuring a gross $462.7 million of the phone maker’s debt and a total 4,038 contracts covering a net $1.4 billion outstanding in the week through Jan. 18, according to the Depository Trust & Clearing Corp.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a contract protecting 10 million euros of debt for five years is equivalent to 1,000 euros a year.

NSN Benefit

Nokia benefited from its Nokia Siemens Networks joint venture to return to profit. Nokia’s cash flow from operating activities was 563 million euros in the fourth quarter of 2012, down from 634 million euros a year before, and including a 740 million-euro contribution from the joint venture.

“Excluding NSN, Nokia continued to burn cash in the fourth quarter, at a rate which is likely to increase in Q1,” SocGen’s Jaeger said.

Net cash rose to 4.4 billion euros at the end of the fourth quarter, and the missed dividend will “ensure strategic flexibility,” Nokia said.

The company’s shares fell to 3.1 euros from a nine-month high of 3.49 euros before the dividend announcement, and have lost more than half their value since February 2011, when Nokia said its phones would run Microsoft Corp.’s Windows.

Nokia is burning cash after abandoning its own system, Symbian, which couldn’t keep up with Google Inc.’s Android platform and the system Apple uses in its iPhones. Nokia said it sold about 700,000 Lumia smartphones in North America in the holiday quarter, compared with the tens of millions of iPhones and Android handsets sold.

“Cutting the dividend helps Nokia’s liquidity and they should have done it a year ago,” said Ping Zhao, an analyst at CreditSights Inc. in New York. “They need to cut costs further. Even though they made progress, the smartphone is nowhere near turnaround. It’s going to be a long and hard slog for them to get back.”

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