Nokia Suffers Setback

Recently, Standard & Poor’s Rating Services (S&P) has downgraded the credit rating of Nokia Corp. (NOK - Analyst Report), citing the reason that the rating agency expects weak operating margin for the company. S&P also expects Nokia to further suffer loss in market share in the mobile handset segment until it comes out with Windows Mobile 7-based smartphones. In order to revamp its sagging smartphone business, Nokia has decided to adopt Microsoft Corp. (MSFT - Analyst Report) developed Windows Mobile 7 software as its new platform leaving aside the company’s proprietary Symbian operating system.

The lucrative smartphone market is the weakest spot for Nokia. None of its upgraded Symbian 3-based smartphones contain any feature, which is unique in the market. The Symbian software has gradually lost charm among mobile phone users and is recognized as an out-of-date technology. In 2010, Nokia’s global market share of mobile devices went down to just 28.9% from 36.4% in 2009.

The key growth area of Nokia is the emerging markets. However, price elasticity of demand is very high in these markets due to low per capita income and the existence of several low-cost Asian phone manufacturers like Samsung, LG Electronics, HTC to name a few. The price for Nokia’s new smartphones is too expensive and ranges between $338-$645. Therefore, these newly launched smartphones may not find the required momentum in these regions.

S&P expects Nokia to generate flat revenue in the near term and encounter significant price pressure for its Symbian-based products. S&P currently provides a “A-“rating for Nokia. Although downgraded, Nokia still enjoys a stable outlook from the rating agency. The new rating is also well above S&P’s junk territory.

Nokia provided a weak financial outlook for the ensuing first quarter of 2011. The company estimated an adjusted operating margin of 7%-10% in its core Devices & Services segment, significantly below 12.5% in the prior-year quarter. Though we remain cautiously optimistic regarding Nokia’s strategic decision to adopt Windows 7 software as its smartphone operating system, we believe the first Windows Mobile 7 based Nokia smartphone may not come to the market before 2012. In the meantime, Nokia’s nightmare is expected to continue.

We maintain our long-term Neutral recommendation on Nokia. Currently, it holds a short-term Zacks #3 Rank (Hold) on the stock.

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