Case 2: Nokias Foreign Exchange Exposure

In its 4th quarter 2004 earnings announcement, Nokia, the Finnish cell phone giant, reported a three percent increase in sales to 9.06 billion due to strong demand for new phone models and sales of network gear. However, Nokia management noted that sales would have been higher if it hadnt been for the adverse impact of currency exchange rates.

Nokia is the worlds largest manufacturer of mobile devices and a leader in mobile networks. Its business is divided into four business groups and two horizontal groups that support the business groups. The four business groups are mobile phones, multimedia, enterprise solutions, and networks. The two horizontal groups are customer and market operations and technology platforms. Nokia was founded in 1967 through the merger of three Finnish companies. In the early 1980s, Nokia began a big push into telecommunications and consumer electronics markets through the acquisition of three Swedish companies. After some other acquisitions, it became the largest Scandinavian information technology company and then expanded its cable business into Continental Europe. However, it decided to divest its information technology and basic industry operations in the beginning of the 1990s so that it could focus on telecommunications.

Even though the sale of handsets increased 16 percent in 2004, competition and low prices actually pushed revenues down by 3 percent and global market share fell 20 percent. The stock price was pushed down 52 percent by investors between March and August 2004. Nokias management was able to turn around the company by the end of the year, but sales were still flat.

In order to move the company forward, CEO Jorma Ollila is putting a lot of money into R&D. Nokia generates 63 percent of its revenues and 87 percent of its operating profits from basic cell phones, a market that isnt expected to expand significantly in the developed markets. As a result, Nokia is putting more emphasis into the developing markets of China, India, Brazil, and Russia and moving into even higher technology areas.

Nokia is the biggest mobile phone manufacturer in the world, and only one percent of its sales comes from Finland. It makes twice as many handsets as its closest rival, Motorola. Nokia employs 22,000 workers in Finland and has relationships with some 6,000 Finnish suppliers and subcontractors. In addition, it has about 51,000 employees worldwide. It had 15 manufacturing facilities in nine different countries as of December 31, 2004. Only a small percentage of its cell phone manufacturing takes place in Finland. Manufacturing facilities in the U.S., Mexico, and Brazil supply the North and South American markets. Plants located in Finland, Germany, the United Kingdom, and Hungary supply the European market and non-European markets that have adopted the GSM technology standard. Plants in China and South Korea service Asia. In 2005, Nokia announced that it was going to set up a manufacturing facility in India.

In 2004, Nokia generated 55 percent of its sales in Europe, the Middle East, and Africa; 25 percent in China and the rest of Asia; and 20 percent in North and South America. However, the largest market for Nokia in 2004 was the United States, followed by China, the United Kingdom, Germany, India, and Brazil.

Nokia reports in euros and keeps its financial statements according to IFRS. Its shares are traded on stock exchanges in Helsinki, Stockholm, Frankfurt, Paris, and New York. Because it lists in New York it must disclose form 20-F reconciling the financial statement from Finnish Accounting legislation and IFRS to U.S. GAAP.

In discussing its risk factors, Nokia management noted the following:

We operate globally and are therefore exposed to foreign exchange risks in the form of both transaction risks and translation risks. Our policy is to monitor and hedge exchange rate exposure, and we manage our operations to mitigate, but not eliminate, the impacts of exchange rate fluctuations. Our sales and results may be materially affected by exchange rate fluctuations. Similarly, exchange rate fluctuations may also materially affect the U.S. dollar value of any dividends or other distributions that are paid in euro.

Talking about the risk in more detail, management noted,

Nokias business and results of operations are from time to time affected by changes in exchange rates, particularly between the euro and other currencies such as the U.S. dollar, the Japanese yen, and the U.K. pound sterling Foreign currency-denominated assets and liabilities, together with highly probable purchase and sale commitments, give rise to foreign exchange exposure.

In most countries where it does business, Nokia has more sales than purchases, with the exception of Japan where it has more purchases than sales. During 2004, 2003, and 2002, both the U.S. dollar and the Japanese yen depreciated against the euro. In 2004, the British pound appreciated against the euro, but in 2003 and 2002, the pound fell against the euro. The importance of the dollar is significant, because in 2004, more than 50 percent of Nokias net sales were generated in dollars or currencies that closely followed the dollar. In addition, about 50 percent of the components that Nokia uses are sourced in U.S. dollars.

The company is highly centralized in establishing its hedging strategy. In its discussion on risk, Nokia notes that foreign currency-denominated assets and liabilities as well as expected cash flows from highly probable purchases and sales give rise to foreign exchange exposures. Due to a high degree of production and sales outside of the Eurozone, transaction exposures are managed against the different national currencies. Material transaction hedges are hedged, and most of the derivatives it uses mature in less than one year.

Questions

1.Identify the different types of foreign exchange exposure Nokia faces.

2.Given the discussion of the movements of the U.S. dollar, Japanese yen, and British pound against the euro in 2002-2004, what is your guess on how the exchange rates should have affected the different types of exposure of Nokia?

3.What types of hedging devices do you think Nokia might have used against its different exposures?

4.Discuss whether or not Nokias manufacturing strategy was an effective hedging strategy.