In January 2012, Stephen Elop reflected on his tumultuous first year and a half as president and CEO of Nokia.During that time, he had completed a review of the company’s performance and strategic direction and been forced to admit to employees that they were “standing on a burning platform,” threatened by intense competition in the mobile phone market

Burning Platform Metaphor 

“There is a pertinent story about a man who was working on an oil platform in the North Sea. He woke up onenight from a loud explosion, which suddenly set his entire oil platform on fire. In mere moments, he was surrounded by flames. Through the smoke and heat, he barely made his way out of the chaos to the platform’s edge. When he looked down over the edge, all he could see were the dark, cold, foreboding Atlantic waters. As the fire approached him, the man had mere seconds to react. He could stand on the platform, and inevitably be consumed by the burning flames. Or, he could plunge 30 meters in to the freezing waters. The man was standing upon a “burning platform,” and he needed to make a choice.

Over the past few months, I’ve shared with you what I’ve heard from our shareholders, operators, developers, suppliers and from you. Today, I’m going to share what I’ve learned and what I have come to believe. I have learned that we are standing on a burning platform. And, we have more than one explosion – we have multiple points of scorching heat that are fuelling a blazing fire around us.

Apple disrupted the market by redefining the smartphone and attracting developers to a closed, but very powerful ecosystem. Apple demonstrated that if designed well, consumers would buy a high-priced phone with a great experience and developers would build applications. They changed the game, and today, Apple owns the high-end range.

In about two years, Android came in at the high-end, they are now winning the mid-range, and quickly they are going downstream to phones under €100. Google has become a gravitational force, drawing much of the industry’s

innovation to its core.

[In] the low-end price range, manufacturers in the Shenzhen region of China produce phones at an unbelievable pace. By some accounts, this ecosystem now produces more than one third of the phones sold globally – taking share from us in emerging markets.

The battle of devices has now become a war of ecosystems. Our competitors aren’t taking our market share with devices; they are taking our market share with an entire ecosystem. This means we’re going to have to decide how we either build, catalyse, or join an ecosystem.

On Tuesday, Standard & Poor’s informed that they will put our A long term and A-1 short term ratings on negative credit watch. This is a similar rating action to the one that Moody’s took last week. Why are these credit agencies contemplating these changes? Because they are concerned about our competitiveness.

How did we get to this point? Why did we fall behind when the world around us evolved? This is what I have been trying to understand. I believe at least some of it has been due to our attitude inside Nokia. We had a series of misses. We haven’t been delivering innovation fast enough. We’re not collaborating internally.

In the preceding years, Nokia, the world’s leading producer of mobile phones, had seen its market share and profits eroded by rival products such as Apple’s iPhone and phones featuring Google’s Android operating system. At the same time, its dominance in the larger, lower-priced phone segment had been threatened by competition from Samsung, LG, and ZTE. In February 2011, Elop had made his first major decision to correct the company’s course, a broad strategic plan and partnership with Microsoft (“the plan”) in which, among other

initiatives, Windows would serve as Nokia’s primary smartphone platform. Rather than quell the concerns as he had hoped, the plan’s announcement had seemed only to raise more questions about the scope and timing of the transition involved.

Reinforcing those concerns, the company had reported a net loss of earnings in July 2011, which was followed by a downgrade of the company’s credit rating the following month. In late 2011, the first Windows smartphones appeared in Europe and Asia (under the trade name Lumia), but the biggest challenge still awaited Nokia. Beginning in 2012, the new phones would roll out in the United States, the most important market for smartphones. Only after the rollout would Elop know whether his decision to join forces with Microsoft would improve Nokia’s competitive position.

It was left to Nokia’s CFO Timo Ihamuotila to assess the firm’s financing needs over the critical next two years. He estimated that the firm might need as much as (U.S. dollars) USD5.6 billion (equivalent to [euros] EUR4.3 billion) in external financing to see it through these years. At the moment, none of the alternatives to raise that amount of funding was particularly appealing. With its newly lowered credit rating, any new issue of debt would have to consider the impact of a potential loss of investment-grade rating. On the other hand, with the firm’s stock price hovering near USD5 (EUR4) per share, an equity issue would raise concerns about share

dilution and the negative signal it might send to the market. The firm had adequate cash reserves at the moment and, depite the decline in earnings, had maintained its dividend over the past few years. Ihamuotila would have to carefully assess these alternatives and devise a plan that would allow Nokia to complete its restructuring plan and give the firm a chance to put out the flames.

Company Background

Nokia began in 1865 as a paper company situated near the river Nokianvirta in Finland after which the company was named. It grew from a little-known company to be a leading mobile phone manufacturer in the 1990s, and by 2011, it was a global leader in mobile communications. The company operated in more than 150 countries and

had more than 130,000 employees. Nokia managed its operations across three operating segments: Devices and Services (D&S), Nokia Siemens Networks (NSN), and Location and Commerce (L&C). In 2011, D&S accounted for 62%, NSN for 36%, and L&C for 3% of its net sales.

The D&S segment comprised three business groups: mobile phones, multimedia, and enterprise solutions. It developed and managed the company’s mobile devices portfolio and also designed and developed services and applications (apps) to customize mobile device users’ experience.

NSN was a joint venture formed by combining Nokia’s carrier networks business and Siemens’s carrier-

related operations for both fixed and mobile networks. It began operations on April 1, 2007, and although it was

jointly owned by Nokia and Siemens, it was governed and consolidated by Nokia. NSN provided fixed and mobile network infrastructure, communications, and network service platforms to operators and service providers.

L&C was one of the main providers of comprehensive digital map information, mapping applications, and related location-based content services (i.e., GPS). It grew out of Nokia’s $8 billion acquisition of NAVTEQ in July 2008.

As recently as October 2007, Nokia’s stock price had hit a six-year high of USD39.72

(EUR27.45) before falling to USD4.82 (EUR3.72) at the end of December 2011 (Exhibit 34.2). From that lofty performance of 2007, few could have imagined how quickly the company’s fortunes would change.

Recent Financial Performance

Nokia’s success historically had been rooted in its technical strength and reliability. Its products required a great deal of technical sophistication, and the company spent large amounts on R&D to maintain its edge. The company was credited with a number of “firsts” in the wireless industry and maintained intellectual property rights to over 10,000 patent families. In 2011, the company employed approximately 35,000 people in R&D, roughly 27% of

its total work force, and R&D expenses amounted to EUR5.6 billion, or 14.5% of net sales. Few companies could match the scale of Nokia’s R&D or the size of its distribution network—the largest in the industry, with over 850,000 points of sale globally.

Although Nokia’s stock price performance was adversely affected by the global financial crisis in 2008–09, which weakened consumer and corporate spending in the mobile device market, its problems extended beyond that (Exhibit 34.2). Analysts estimated that only about 50% of Nokia’s decline could be attributed to market conditions; the rest was said to be due to a loss of competitive position to established industry players and new

entrants. Since 2007, the firm had experienced a loss of market share in most of its core markets (Exhibit 34.3). The mobile phone market was broken into two segments: smartphones and mobile phones. Mobile phones had more basic functionality and generally sold at prices under EUR100. Smartphones had enhanced functionality and also higher average selling prices (ASPs). Traditionally, Nokia had concentrated on the mobile phone market, which helped facilitate its high market share in emerging markets. In 2007, mobile phones accounted for 86% of the firm’s total handset production. For many years, this strategy had paid off because as late as 2007, smartphones made up only 10% of the total handset market. But since 2007, the growth in smartphones had accelerated so that by 2011, their share had increased to 30% of the market and accounted for 75% of total industry revenue.

Smartphones

Although Nokia introduced the first smartphone in 1996 (the Nokia 9000), since then, the market had become highly competitive. Exhibit 34.4 details competitor offerings in the smartphone market and key features that differentiated their products. Nokia’s smartphones featured the Symbian operating system (OS), which was introduced in 1998, as an open-source OS developed by several mobile phone vendors. Symbian, though reliable, proved to be an inflexible platform that had slow upgrade cycles and lacked an appealing user interface (UI). The two most significant events for Nokia were the launch of Apple’s iPhone in July 2007 and Google’s Android system in October 2008. From a standing start, both products had made strong inroads in the marketplace and had captured significant market share from Nokia in just a few short years

Apple and Google were software companies that focused on ease of use and apps that enabled users to customize and personalize their phones. Nokia’s origins were in manufacturing and engineering, and it had vertically integrated forward into software and design. Neither Apple nor Google manufactured their handsets, and analysts speculated about which trend would dominate the future smartphone market. One analyst said, “Nokia is not a software company. Apple is a software company, and what distinguishes the iPhone and the iPod Touch is their software. I think Nokia is just on the losing side.”

The Next Billion

Entry-level devices were one of the fastest-growing segments of the mobile phone market. With far fewer infrastructure requirements than traditional land lines, rural communities in emerging-market countries, such as China and India, were essentially skipping wired communications and moving straight to wireless networks. The same trend was also being observed in developed markets as individuals increasingly chose to rely on wireless

phones and dropped land-line phones. It had taken until 2002, approximately 20 years after the first mobile phone was introduced, to achieve the first billion mobile phone subscribers but only 3 years to add the next billion subscribers, and 2 years for the next billion. As mobile phones were adopted globally, it took successively less time to add the next billion subscribers. In 2010, there were an estimated 3.2 billion people who lived within range of a mobile signal who did not own a mobile phone. Because Nokia had one of the widest product portfolios, with devices spanning from super-low-cost phones (<EUR50) to smartphones (+EUR300), and the most extensive distribution channel, it was well positioned to capture this growth. But even with a strategy in place for the next billion, Nokia faced intense competition, particularly from Samsung, LG, and ZTE, which also had targeted phones at lower price points for these markets. Also troubling, the Asia-Pacific region saw a large increase in iPhone use in 2010, the strongest take-up of Apple devices in the world.

Change at the top

Throughout 2009, Nokia introduced a number of initiatives in response to the competitive pressures it faced, such as opening Ovi stores, introducing a new Linux-based operating system (MeeGo), high-end tablets, placing an executive in charge of user-friendliness on the board, and pursuing cost-cutting and restructuring measures. Despite efforts, Nokia could not shake the perception that it was being upstaged by a “Cupertino competitor,” and as global demand picked up in late 2009 and 2010, Nokia’s performance was a notable laggard. In September 2010, Nokia’s board asked long-term president and CEO Olli-Pekka Kallasvuo to step aside and replaced him with Stephen Elop, who was the first outsider and non-Finn (he was Canadian) to head the company.

Strategic Plan with Microsoft

During his first few months with the company, Elop carefully weighed three alternatives to be the firm’s primary platform for smartphones: staying the course with Symbian/MeeGo, which meant building something new from MeeGo; adopting Android, which had volume share; or adopting Windows and becoming a key partner for Microsoft, which needed a hardware provider that would put it first. On February 11, 2011, he announced the plan with Microsoft to build a new ecosystem with Windows Phone (WP) serving as Nokia’s primary smartphone platform and a combined approach to capture the next billion in emerging growth markets. Main features of the plan included the following:

Over the next few years, the Symbian platform would be gradually phased out as the WP platform was phased in. In 2010, Symbian phones amounted to 104 million units, virtually all of Nokia’s smartphone production. The plan aimed to bolster Nokia’s presence in North America, benefiting Microsoft in emerging markets. Gross margins would be lower due to royalty payments to Microsoft, but Nokia would benefit from reduced R&D expenses and Microsoft’s support for sales and marketing. Analysts were mixed on the plan. Some saw it as improving focus and reducing the cost of maintaining multiple product lines while others were skeptical that it would halt Nokia’s decline. The market was also skeptical as Nokia’s stock price declined 14% on the announcement. In the first months following the announcement, the decline in market share and profits was more rapid than expected. In July 2011, the company reported a net loss of EUR368 million. In the summer of 2011, Moody’s downgraded the company’s debt two notches from A– to Baa2 and Fitch downgraded it to BBB–, the lowest notch before losing investment-grade. However, there were positive developments that helped stabilize the situation. In November 2011, the first million units of Lumia 710 and 800 phones rolled out in Europe and Asia. In early 2012, the Lumia 900 won the “Best Smartphone of 2012” award. By 2012, there were 60,000 Windows apps available, compared to 460,000 for Apple and 320,000 for Android. The growing consensus among procurers of mobile phones was that a third competitor would be positive for the industry.

Over the course of 2011, competitors faced difficulties. Research in Motion fell behind in product development and experienced significant losses in earnings and market share. Management turmoil at Ericsson hindered attempts to gain market share. Google announced plans to purchase struggling Motorola Mobility for $12.5 billion. The death of Steve Jobs, CEO and founder of Apple, shook the world but consumers responded favorably to the iPhone 4S. The Apple juggernaut seemed poised to continue.

Implications for Financing

Nokia CFO Timo Ihamuotila and his team considered the impact of the plan on the firm’s external financing needs for 2012 and 2013, using historical income statement and balance sheet as reference points (Exhibits 34.6 and 34.7). They set the minimum cash and short-term securities at 27% of sales, based on the average of Nokia’s cash-to-sales ratio in 2007, 2010, and 2011, and set aside cash reserves for acquisitions. Information on Nokia’s peers is available in Exhibit 34.8.

For Devices and Services (D&S), the largest division, the downside scenario recognized the significant loss of Symbian and Nokia’s overall market share while the upside scenario predicted sales stabilization and exceed 2011 levels by 2013. Gross margins were expected to decline due to competitive price pressure, royalty payments to Microsoft, and aggressive pricing of Nokia phones. Under the downside scenario, gross margins were expected to erode to 24% while under the upside scenario, gross margins were projected at 26%. Lower margins result in lower adjusted operating profits, but these were partially offset by savings from restructuring efforts and Microsoft’s support for R&D and marketing functions, with the upside scenario reflecting more and faster savings. Nokia Siemens Networks (NSN) announced a major restructuring effort in late 2011, resulting in significant near-term restructuring charges and phasing out of less-profitable operations. Profits had been slow to materialize at NSN, and the downside scenario reflected continuing struggles. Location and Commerce (L&C) had also underperformed, resulting in a significant writedown of goodwill in 2011 and the forecasts pointed to continued subpar performance. In the event of the downside scenario, Nokia estimated it would need to raise EUR4.3 billion through 2013.

In addition, the ability to issue noninvestment-grade debt relied more on the strength of the economy and favorable credit market conditions compared to investment-grade debt. The high-yield debt market grew as a source of financing for companies, making up 20.5% of total debt raised over two decades but varying from a low of 2.3% in 1991 to 29% in 2004 and 2005 before dropping to 8.8% in 2008 during the financial crisis. Investment-grade debt was usually easier to raise in economic downturns. Data source: Case writer estimates based on company writings and analyst reports.

Although Nokia’s debt-to-equity ratio rose from 2007 to 2011, the company had negative net debt with its cash position considered. The ability to pay off debt with cash appeared at odds with a deteriorating creditworthiness but credit rating agencies did not consider leverage on a net debt basis. In their view, cash was subject to management discretion, making credit ratings a combination of financial strength and business risk, which for Nokia was high due to competitive pressures. Exhibit 24.13 shows credit metrics that help assess the impact of a EUR 4.3 billion debt issue on Nokia’s credit rating.

Issue Equity: An equity issue would improve the firm’s credit rating and provide flexible financing, but management was concerned about dilution of EPS and a negative market reaction.

Eliminate Dividends: Cutting dividends was a possibility, but there was no legal requirement and management was worried about a negative investor reaction.

Reduce Cash: Using cash to fund the EUR4.3 billion was considered, but it was important to preserve financial strength and flexibility.

Decision: The team had limited visibility into future financing needs and wanted to prepare for the worst while still being able to manage more favorable outcomes. The chosen financing alternative would impact Nokia’s ability to survive the current crisis.