S&P Downgrades Nokia Once More

Aug.16.12 | About: Nokia Corporation (NOK)

Within a matter of months, S&P has downgraded debt of Nokia (NYSE:NOK) for the second time. Prior to the downgrade, Nokia's debt was already in the junk status, and now it sits deeper in the junk status. The company's debt rating was moved down 2 notches from BB+ to BB- with a negative outlook, meaning that the company's debt can be downgraded even further.

In its statement, S&P announced that Nokia's second quarter results were worse than expected, and the company's cash burning needed to come under control. Obviously S&P didn't check the company's cash flow which indicated that the company's cash flow was almost flat excluding the dividend payments it made during the second quarter. Also, Nokia's earnings in the quarter was mostly in line with the expectations of the analysts covering the stock.

The downgrade will make it more difficult for Nokia to sell debt. The company will have to pay a higher percentage of interest in order to sell its debt, and this could worsen the situation for the company in the short term. Ironically, when a company performs badly, it gets downgraded, and when it gets downgraded, it becomes even harder for that company to perform better, as its debt servicing becomes more expensive.

Currently Nokia is aggressively attempting to slow down its cash burn by cutting costs. The company terminated employment of thousands of employees in the last year, and thousands more will join them in the next 12 months. Many of Nokia's production plants and facilities in European countries were shut down to be replaced with production plants and facilities in cheaper countries in Asia. Also Nokia is now outsourcing most of its software and operating system needs to Microsoft (NASDAQ:MSFT). Only time will tell how well these cost cutting measures will work. Typically, cost cutting measurements increase costs in the short term as there are a lot of one-time costs associated with lay-offs, property closures and asset reallocation; however, the costs should come down in the long term.

Nokia's CFO, Timo Ihamuotila, brushed off S&P's downgrade and said: "As we continue our transition, we are applying a strong focus on cash conservation while simultaneously reducing our operating costs and making our operating model stronger and more agile." The company is obviously committed to return to profitability as soon as possible. S&P went on to warn that if the company doesn't improve its margins in a timely manner, another downgrade may follow in the next couple of quarters.

At this point, it would be very helpful for Nokia if Microsoft could step in to buy some debt of Nokia. Microsoft currently has so much cash laying around (as of last month, Microsoft had nearly $8 of cash per share) that it could use some of the cash to save one of its biggest partners. Of course Microsoft has no obligation to help Nokia; however, Nokia plays a very major role in Microsoft's self-declared war on Apple (NASDAQ:AAPL). If the company truly doesn't want to leave any stones unturned, helping Nokia is the way to go for Microsoft.

According to S&P's report, Nokia's current cash of $5.2 billion will drop to $3.7 billion by the end of this year. Also the amount of the company's current debt is $6.4 billion. Of course this debt will isn't due all at once, as parts of it will mature between 1 and 30 years.

Nokia closed the day up by 6% at $2.64 per share. It looks like the company's investors have ignored the downgrade but this may be mostly due to Steve Elop's announcement today that Nokia's phones running on Windows 8 would hit the markets soon.

On a side note, income investors may consider Nokia's bonds, as they enjoy very high yields at the moment. Currently Nokia's bonds sell at a deep discount, and the annual yields range from 6.82% to 9.09%, depending on maturity date. Plus, if the company goes bankrupt, the bondholders will have a higher priority over the stockholders in getting their money.

Disclosure: I am long NOK, MSFT, AAPL.