October 30, 2017 / 3:10 PM / a year ago

Fitch: Cash Flow, not Market Volatility, is Key to Nokia Rating

(The following statement was released by the rating agency) LONDON, October 30 (Fitch) Nokia's weak near-term outlook for its networks business reflects a downturn in telecom sector spending already factored into Fitch's rating case for the company. The future path of its 'BB+'/Positive rating is most likely to be determined by whether it can generate sufficient free cash flow through the cycle, achieve its restructuring cost savings targets, and maintain a solid cash position while managing multiple technology transitions. Nokia's non-IFRS revenue fell 4% in the first nine months of 2017, in line with our expectation for a 4% full-year decline when we affirmed the rating in August. The company said it expects its primary addressable market to decline by 2% to 5% next year. But we expect an improving performance from its intellectual property (IP) business to partially offset this, as very high-margin, run-rate revenues in the division will reach EUR1.1 billion-1.2 billion in 2017, roughly double the 2014 level of EUR578 million. Non-IFRS revenue in 2018 is therefore likely to be slightly worse than our base case of a 2% decline if Nokia's addressable market shrinks towards the higher end of its guidance. The telecoms equipment market is volatile and performance is driven by the investment cycle of major telecom companies. Demand has weakened recently as telecom companies' spending on 4G equipment in developed markets has fallen and as they have also slowed the roll-out of fibre networks. Our base-case scenario envisages Nokia's revenue stabilising over the next two to three years as declines in its traditional business are offset by growth in new customer segments and software-based products and applications. But a return to growth will take longer, as it is likely to require at least three to five years for mobile network operators to start making significant investments in next-generation 5G technologies and for Nokia to shift its product mix so that it is less affected by its declining traditional business. Nokia expects commercial 5G rollouts to start in 2019. Nokia's recurring cash flow margin position when the contraction in its primary addressable market halts will be key to its rating. If Nokia is able to maintain positive free cash flow helped by restructuring cost savings, its market position, strong cash balance, stable IP revenues and strategy for managing changes in the network sector would all be compatible with a low investment-grade rating. We believe there is a good probability of this happening, resulting in the Positive Outlook on the rating. But the restructuring and market contraction create uncertainty and we will need to see further evidence that it is on track before considering an upgrade. The restructuring follows the acquisition of Alcatel Lucent, which expanded Nokia's mobile networks business to include fixed-line network equipment. We believe this expanded portfolio means Nokia is now much better positioned in relation to the trend of greater convergence between fixed and mobile networks and IP and cloud services. These trends also mean that telecom networks will become as reliant on software as they are on hardware to achieve optimal performance. This will open the sector up to greater competition from software companies, but we believe its hardware background will give Nokia an advantage as it makes this transition. Contact: Tajesh Tailor Senior Director Corporates +44 20 3530 1726 Fitch Ratings Ltd 30 North Colonnade London E14 5GN Simon Kennedy Senior Analyst Fitch Wire +44 20 3530 1387 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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