Nokia says it will return handset business to profit as soon as possible, but this may be a mistake

imageNokia has had its credit rating downgraded once again, this time by Moody’s, to B1, four levels below "investment grade" and well into “junk” territory.

This follows a similar rating by Standard and Poor a month earlier.

Moody’s rating is based on concerns for Nokia’s cash flow.

"We have downgraded Nokia’s CFR [corporate family rating] mainly because we believe that the company continues to face challenges returning to sustainable profitability in its core smartphone and mobile phone operations, and because we believe that it is unlikely to reach break-even on a cash flow basis before well into 2014, at the earliest," said Roberto Pozzi, Moody’s vice president and lead analyst on Nokia.

"Nokia is currently experiencing strong double digit volume growth rates – it shipped 13.5 million smart devices in the first half of 2013 – but from a very low base and therefore it has yet to see a sustainable ramp that could allow it to achieve break-even. In the second quarter of 2013, the smartphone business was still losing €14 for every €100 of sales," they noted.

"The negative outlook on Nokia’s B1 reflects Moody’s view that it may take longer than 18-24 months for the company to return to sustainable profitability and cash flow generation.

"The outlook on all ratings is negative," concluded Moody’s.

Nokia responded to the the downgrade by insisting they still had plenty of cash and unused credit facilities, and that their smartphone business was growing well.

Timo Ihamuotila, Nokia’s Executive Vice President and CFO, said:

"We are pleased that the strong cash position we have maintained throughout our transition has enabled us to take advantage of an opportunity to acquire full ownership of NSN, whose financial performance has strengthened markedly in recent quarters. In Devices & Services, we are pleased with the Lumia volume growth we delivered in the first half of this year and are looking forward to driving further share gains for the ecosystem. With these efforts our target is to return our Devices & Services business to sustainable cash generation as soon as possible."

At the end of the second quarter 2013 and prior to the closing of the NSN transaction, Nokia Group had gross cash of EUR 9.5 billion and net cash of EUR 4.1 billion.

Nokia notes that it also has access to additional liquidity via a revolving credit facility of EUR 1.5 billion, which is entirely undrawn and available to the company through March 2016. Nokia Siemens Networks also has a EUR 750 million revolving credit facility that is entirely undrawn and available through June 2015.

A focus on a rapid return of profitability may however damage Nokia’s long term prospects. By increasing the focus on Nokia’s handset margins Nokia may be disincentivised  from developing and selling cheap and wildly popular handsets such as the Nokia Lumia 520, or end up turning buyers away by charging prices higher than the market is willing to bear for handsets such as the Nokia Lumia 625 and 1020.

At present undercutting the competition while growing what is turning out to be Nokia’s unique ecosystem is strategically necessary, and one wonders if this would not be a further impetus for Microsoft purchasing the company and removing the profit incentive entirely.

While Nokia has lost around $5 billion since the start of the transition, Microsoft has also lost around $4 billion over the same period in its Online division, and surely Mobile is as strategic or even more so than Online at present.

Or of course Nokia can just ignore the analysts and continue executing on their strategy.

Bloomberg notes despite the downgrades the cost of insuring Nokia’s debt using five-year credit-default swap contracts has fallen about 17 percent this year, signalling an improvement in creditworthiness and even Moody admits "… Nokia has currently adequate liquidity to meet its significant debt maturities in 2014-15 and that it has still a significant positive net cash position also excluding NSN."

Do our readers agree focussing on profit at this point would be a mistake? Let us know below.

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