We understand that restructuring of Devices and Services division and the Telecom Network Equipment division (NSN), targeting a combined cost reduction of at least EUR2 billion by the end of 2013, could accelerate and deepen in the Devices and Services division. However, we do not believe that this will offset declining revenues and we expect non-IFRS operating margins for the Devices and Services division to be slightly negative in 2012, compared with 7% in 2011. We have also revised our free operating cash flow (FOCF) expectations to incorporate our weaker margin assumptions; we now expect consolidated FOCF of minus EUR1 billion in 2012. We continue to view Nokia's cash position as a positive factor but now expect net cash to fall much faster than we had previously anticipated to EUR3.5 billion-EUR4.0 billion at Dec. 31, 2012, from EUR4.9 billion at March 31, 2012. This anticipated sharp decline also includes a dividend payment of EUR750 million in the second quarter of 2012.
The short-term rating is 'B'. We assess the group's liquidity as "strong" according to our criteria. In our opinion, the group's strong liquidity can more than cover its needs over the near term, even if EBITDA were to decline sharply for a limited period or if NSN were unable to draw on a EUR2.0 billion multicurrency revolving credit facility (RCF). The group has good relationships with its banks, in our view.
Nokia's main liquidity sources are as follows:
-- Assumed consolidated surplus cash of about EUR5 billion over the next two years. As of March 31, 2012, the group's liquid assets totaled EUR9.8 billion. This figure includes cash on hand of EUR1.8 billion and short-term marketable securities of EUR8 billion.
-- An undrawn committed RCF of EUR1.5 billion maturing in March 2016 with no financial covenants.
-- NSN's EUR2.0 billion RCF, maturing in June 2012. We understand that NSN has already entered agreements to refinance this RCF with a EUR1.5 billion facility in two equal tranches maturing in June 2013 and June 2015. NSN's existing and new facilities contain maintenance financial covenants. Following a recent EUR1 billion capital injection from Siemens AG (A+/Positive/A-1+) and Nokia, we believe that headroom under NSN's covenants should be adequate over the next few quarters.
Against these sources, we anticipate the following liquidity uses:
-- Negative group FOCF of EUR1 billion in 2012, including cash restructuring outlays relating to NSN and the Devices and Services division.
-- Debt amortization of EUR1 billion in the next 12 months, which primarily relates to already refinanced debt maturities at NSN, and a lack of other debt maturities before 2014.
-- Dividends of EUR740 million in 2012.
The senior unsecured notes issued by Nokia are rated 'BB+,' in line with the corporate credit rating. The recovery rating on these instruments is '3' indicating our expectation of meaningful (50%-70%) recovery prospects for debtholders in an event of payment default. In line with our recovery criteria, the recovery ratings on unsecured debt issued by corporate entities with a corporate credit rating of 'BB-' or higher are generally capped at '3' to account for the possibility that their recovery prospects are at greater risk of being impaired by the issuance of additional priority or pari passu debt prior to default.
The recovery ratings and issue ratings are underpinned by our valuation of the group as a going concern and its base in Finland, which we view as having a relatively creditor friendly insolvency regime. However, they factor in the unsecured status of the notes, whose documentation contains typical investment grade protection. All of the group's debt ranks pari passu and is issued on an unsecured basis with limited documentary protection. Noteholders benefit from a negative pledge clause, with notable carve-outs to exclude NSN.
To determine recoveries we simulate a hypothetical default scenario, in which a payment default occurs in 2019, triggered by an inability to refinance notes maturing in that year. In our view, this would most likely be due to a continued decline in revenues and market share and an inability to reduce costs coupled with continuous significant use of cash balances to invest in new technologies that do not improve operating performance. At this point, we envisage annual EBITDA to have declined to about EUR690 million.
Our stressed enterprise valuation at our hypothetical point of default in 2019 is EUR2.76 billion, equivalent to a stressed EBITDA multiple of 4.0x. After deducting priority liabilities of EUR250 million, which mainly comprise enforcement costs and 50% of the group's pension liabilities. We see about EUR2.5 billion remaining for unsecured debtholders. We envisage about EUR5 billion of debt outstanding at default (including six months pre-petition interest), assuming that debt maturing in 2014 is refinanced, and the EUR1.5 billion RCF remains in place and is fully drawn at default.
In calculating Nokia's stressed enterprise value, we exclude NSN, which we view as a stand-alone entity with its own financing arrangements with no guarantees from Nokia. We also exclude debt relating to NSN in our post-default waterfall. If value were to be obtained from NSN at our hypothetical point of default, it might enhance recovery prospects but would be unlikely to have an impact on the recovery rating which is capped at '3' due to the unsecured nature of the notes.
The negative outlook reflects the possibility of a downgrade in the next 12 months if we see that the non-IFRS operating margin in the Devices and Services division remains at or below break even, or if consolidated FOCF remains negative, as this would further reduce Nokia's net cash position. This could be the case for instance if revenues from Lumia smartphones do not increase significantly toward the end of 2012 as we currently expect, or if margins deteriorate further due to competitive pressure.
We could revise the outlook to stable if revenues in the Devices and Services division stabilize, cash burn declines significantly, and non-IFRS operating margins return to at least mid-single digit percentage levels.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal.
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- Key Credit Factors: Methodology And Assumptions On Risks In The Global High Technology Industry, Oct. 15, 2009
Corporate Credit Rating BB+/Negative/B BBB-/Negative/A-3
Senior Unsecured BB+ BBB-
Recovery Rating 3