Nokia Oyj (NOK1V) four years ago sold more mobile phones than all the other handset-makers combined. From a 50% market share, Nokia phones are now only being bought by one out four cellphone users, as smartphones run by Google's Android operating system and Apple's iPhones continue to gain following.

As a result, Espoo, Finland-based Nokia had its debt rating cut to the lowest investment grade at Fitch Ratings due to the declining market share of its Symbian smartphones.

Fitch Ratings said it downgraded Nokia's Long-term Issuer Default Rating (IDR) and senior unsecured rating two notches to 'BBB-' from 'BBB+' respectively. The Short-term IDR is also downgraded to 'F3'. The Outlook on the Long-term IDR is Negative.

"The downgrade and Negative Outlook reflect the serious concerns Fitch has about the accelerating pace of the market share erosion for Nokia's Symbian handset business. The pace of deterioration has picked-up since Nokia decided to switch to an alternative operating system and it appears consumers are deserting these legacy handsets for cheaper Android (Google's operating system) versions or high-end Android or Apple smart phones," says Stuart Reid, Senior Director in Fitch's TMT team in London.

Early this year Standard & Poor's and Moody's Investors Service both Nokia's rating to the fourth-lowest of their 10 investment-grade ratings, to A- for S&P and A3 for Moody's.

Android and iPhone challenge

Research firm Gartner Inc. said Nokia's smartphone market share has dropped by half, to 25.5 percent in the first quarter, from 50.8 percent in the second quarter of 2007. Nokia sold 107.6 million mobile devices in the first quarter of 2011, but this equates to a market share decline of 5.5 percentage points year-on-year, and its lowest market share since 1997.

Smartphones based on the Android operating system have been gaining ground. After a shift to higher end smartphones, such as the Galaxy line, Samsung, which has a 16.1 percent market share, second only to Nokia, sold 68.8 million units, compared to only 64.9 million units in the first quarter of 2010.

Apple, which phones are running on its own iOS system, sold 16.9 million units to end users worldwide, more than doubling its sales of iPhones year-on-year. Apple, with a 3.9% market share, is now the fourth largest brand in the mobile communication market.

Google's Android system, has grown to become the largest smartphone operating system with 36 percent of units sold in the first quarter, compared to only 27.4% for the Symbian, according to Gartner. The Android is expected to continue its dominance this year as more several manufacturers, including Sony Ericsson and Alcatel, are scheduled to release new Android-based offerings in the second quarter.

Nokia has inked a strategic alliance with Microsoft on Windows Phone 7, which will replace the retiring Symbian. "This will precipitate a competitors' rush to capture Symbian's market share in the midtier," said Roberta Cozza, principal research analyst at Gartner.

Gartner expects Nokia will aggressively lower average selling prices (ASPs) in markets where communications service providers (CSPs) control the sales channels, in order to maintain shipments of Symbian devices while waiting for its first Windows Phone 7 devices to reach the market. However, Nokia will face challenges from Android competitors and from some Japan-induced supply constraints, according to Gartner.

Rapid deterioration

On May 31, Nokia cut its forecasts for the devices and services unit on lower prices and competition. Nokia said it now expects the unit's net sales to be "substantially below" its previously expected range of EUR 6.1 billion to EUR 6.6 billion for the second quarter 2011. Following the announcement, Nokia's shares slumped to the lowest price in 13 years in Helsinki trading.

Nokia said May 31 that it is continuing to invest to bring new innovative capabilities to its Symbian line up and it also started shipping its new dual-SIM devices at the end of May. It expects that the first Nokia product with Windows Phone will ship in the fourth quarter 2011.

According to Fitch, the cash flow effect of the rapid deterioration in key performance indicators such as (average selling price and handset market share is being reflected in group margins which have fallen to 6.8% in 1Q11, down from 8.6% in the past year. It noted that company guidance released last week indicated only break-even margins for Q211 and a lack of visibility on operating margins for YE 2011. This guidance is materially worse than Fitch's previous rating case forecast. By way of some sensitivity analysis, a break even margin for the full year would spike Fitch's gross leverage measure for Nokia to 5x at YE 2011, a level inconsistent with mid -'BBB' companies with this level of volatility on cash flow.

Windows phones

Nokia Chief Executive Officer Stephen Elop is readying a line of phones based on Microsoft's Windows Phone 7 operating system to replace the Symbian line. The deal is expected to be a win-win partnership as smartphones-based on Windows OS that were launched at the end of 2010 have only seen modest sales (Windows-based smartphones have only a 3.6 percent market share).

Fitch said its longer term view on Nokia is likely to be heavily impacted by the lack of a tested new product portfolio based on the Windows operating system, which is only expected to be in place well into 2012. This places an uncomfortably long phase of pressure on the existing handset business and raises the spectre of further cash flow deterioration and increased leverage metrics beyond YE 2011.

Moreover, the execution risk around the successful launch of a new Windows-based product suite against highly competitive and established players such as Samsung, HTC and Apple has now greatly increased, added Fitch.

Bloomberg News said yesterday that credit-default swaps on Nokia rose for a ninth day, surging 43 basis points to a record 213, according to CMA. The contracts are up from 120 basis points May 30. An increase signals deterioration in perceptions of credit quality. According to Bloomberg, Nokia's stock has lost about three-quarters of its value since Apple's 2007 introduction of the iPhone.