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Moody's Lifts Outlook on Nokia (NOK) to Positive; Credit Metrics Could Improve Following Q3 Results

October 27, 2014 1:50 PM EDT

Moody's Investors Service has changed to positive from stable the outlook on the Ba2 corporate family rating (CFR) of Nokia Oyj (Nokia)(NYSE: NOK), following the company's stronger-than-expected results for the first nine months of 2014, as well as the upward revision to slightly above 11% from 5%-10% of its guidance for 2014 operating margins.

At the same time, Moody's has changed to positive from stable the outlook on the respective Ba2 and provisional (P)Ba2 ratings of Nokia's senior unsecured notes and medium-term note (MTN) programme. Concurrently, Moody's has affirmed Nokia's Ba2 CFR, Ba2-PD probability of default rating (PDR) the Ba2 and provisional (P)Ba2 ratings of Nokia's senior unsecured notes and medium-term note (MTN) programme. The NP/(P)NP short-term senior unsecured ratings of Nokia and Nokia Finance International B.V. have also been affirmed.

"The positive outlook reflects our view that Nokia's credit metrics could improve following the company's stronger-than-expected results in the third quarter and in the last nine months," says Roberto Pozzi, a Moody's Vice President -- Senior Credit Officer and lead analyst for Nokia. "Moreover, if Nokia is able to sustain the ongoing positive performance in revenues, operating margins and cash flow generation, we could consider upgrading its ratings over the next 12 months."

RATINGS RATIONALE

Today's outlook change to positive follows Nokia's announcement of stronger-than-anticipated third quarter results, with revenues up 13% to EUR3.3 billion compared to the same period in 2013, which represents the first year-on-year increase since 2011. At the same time, Nokia's (company's adjusted) operating profit rose 33% year on year to EUR457 million, prompting the company to revise its margin guidance for the year upward to slightly above 11% from 5%-10%.

The improved results reflect recent contract wins in the Long-Term Evolution (LTE) market in North America and China, as well the positive effects of previous cost reduction measures and more focused but also, in Moody's view, riskier strategy. Around half of the company's revenue came from mobile broadband sales, which generate higher margins than services or network modernisation programmes, but also tend to be more volatile. Revenues at HERE, the company's mapping business, also increased by 12% year on year to EUR236 million, although only breaking even compared to an operating profit of EUR21 million in the same period last year. The company's Nokia Technologies' business generated revenues of EUR152 million, up 9% year on year, with an operating margin of 65%, up from 60% last year. Other highlights of the quarter were a EUR1.2 billion charge to write down the value of goodwill at HERE, which was offset by a one-time gain of EUR2.0 billion on deferred tax assets in Finland and Germany.

Although the results bode well for the future, the company acknowledges that its wireless infrastructure business is somewhat seasonal. In the fourth quarter, Nokia already expects that a higher share of revenues will come from lower gross margin services than in the previous quarter. While Global Services business typically has lower gross margin that Mobile Broadband, it has generated six consecutive quarters of non-IFRS operating margin above 10%. In Moody's opinion, a degree of uncertainty over the sustainability of Nokia's recent results remain, however, we recognise the strongly positive trend of the company's results in the last nine months.

Nokia's Ba2 CFR reflects the company's good competitive position in the mobile networks industry, in which Moody's expects moderate growth to be supported by the ongoing growth of data and video traffic over communications networks. The rating also considers Nokia's (1) solid liquidity profile, increasing free cash flow generation and moderate financial leverage on a gross, Moody's adjusted basis; (2) Nokia Technologies' business (particularly its intellectual property licensing); and (3) HERE location business, which provides further cash flow and business diversification for the company.

That said, the rating is constrained by (1) the company's smaller scale and narrower market focus relative to industry leaders Telefonaktiebolaget LM Ericsson (Baa1 stable) and Huawei (unrated); (2) the intensity of competition, volatility and cyclicality of the mobile network equipment industry; and (3) the need for the company to establish a track record in terms of performance and, particularly, free cash flow generation.

At the current rating level, Moody's expects that Nokia's revenues will increase in the mid-single digits and that operating margins will stabilise in the low double-digits over the next 12-18 months, driven by (1) modestly improving demand and market share gains in 4G/LTE and other industry segments; and (2) the company's high margin intellectual property licensing business, which continues to be part of the Nokia Group. The rating agency anticipates that Nokia will maintain a solid credit profile over the same period, with debt/EBITDA of approximately 2x, free cash flow (FCF)/ debt exceeding 10% and an EBIT interest coverage above 6x (all ratios are Moody's adjusted and based on gross debt), as the company executes its capital structure optimisation programme. In May 2014 Nokia announced plans to return EUR3 billion to shareholders through dividends and share repurchases, both of which commenced in the third quarter of 2014, and to reduce gross debt by EUR2 billion over the next two years.

Moody's expects that Nokia will maintain a strong liquidity profile even after considering the company's plan to complete the distribution of EUR3 billion to shareholders by Q2 2016 (via dividends and share repurchases). During the first nine months of 2014, Nokia reported operating cash flow of approximately EUR1.1 billion before capital expenditure and acquisitions of EUR0.2 billion each; as well as returns to shareholders. At the current rating level, Moody's expects that the company will generate breakeven FCF in 2014, despite cash outflows related to restructuring of EUR450 million, and over EUR300 million of FCF in 2015. The company's recent performance, however, suggests that FCF generation could significantly exceed Moody's expectations over the next 12-18 months.

During the third quarter, Nokia paid a special dividend of around EUR1.0 billion and an ordinary dividend of EUR0.4 billion whilst also commencing share repurchases totalling EUR220 million under its capital structure optimisation programme. At the end of the third quarter, the company reported gross cash of EUR7.6 billion and net cash of EUR5.0 billion compared to EUR9.0 billion and EUR6.5 billion, respectively, at the end of the second quarter of 2014. The company redeemed in June 2014 the NSN EUR450 million 6.75% bonds due April 2018 and the NSN EUR350 million 7.125% bonds due April 2020, as well as approximately EUR150 million other debt, in line with the plan to reduce gross debt by EUR2 billion over two years starting from Q2 / 2014. Nokia also returned approximately EUR1.6 billion to shareholders through dividends and share repurchases during the third quarter of 2014.Over the next 12 months, we expect the company to distribute an additional EUR1.2-1.4 billion to shareholders. The group has no major debt maturities until a EUR750 million convertible bond matures in 2017 and a EUR500 million and $1,000 million bonds in 2019.

RATIONALE FOR POSITIVE OUTLOOK

The positive rating outlook reflects Moody's expectations that Nokia will continue to maintain a good competitive position against larger competitors, such as Ericsson and Huawei, while maintaining a robust liquidity profile and modest financial leverage, which will allow the company to sustain investments in product development.

WHAT COULD CHANGE THE RATING -- UP/DOWN

Nokia's ratings could be upgraded if the company sustainably increases its market share, as evidenced by revenue growth exceeding that of its main competitors, while maintaining good profitability, moderate leverage and sustainable positive FCF generation.

A loss of market share or a decline in profitability could create negative rating pressure. Also, negative rating pressure could develop if the company leverage deteriorated as a result of a more aggressive financial policy, as evidenced by debt/EBITDA sustained above 3x. The current rating also factors in the maintenance of a solid liquidity position.

Following the sale of its handset operations to Microsoft Corporation (Aaa stable) completed in late April 2014, Nokia operates three businesses (Nokia Networks, HERE and Nokia Technologies), with revenues of about EUR12.7 billion in 2013. Nokia Networks (87% of revenues) is a leading provider of radio access/mobile broadband wireless equipment and services to carriers. It provides mobile, fixed and converged network technologies as well as services, mainly to telecom carriers. HERE (7% of revenues) provides digital map data and location-based content and services for automotive navigation systems but also for other applications. Nokia Technologies (6% of group revenues) is a licensing, brand and technology development business with around 30,000 patents.



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