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Coverage Initiation: Motorola Mobility and Motorola Solutions
Value Line recently initiated coverage of Motorola Mobility (MMI) and Motorola Solutions (MSI) after the 82-year old combined entity, Motorola Inc., was broken up on January 4, 2011. The split was the culmination of numerous management missteps and the market share declines that ensued. Motorola first announced its intention to deconsolidate three years ago amid mounting pressure from investors and deep losses. Significant restructuring activity has taken place since then, allowing the creation of two companies with more focused managements, appropriate capital structures, and targeted investment stories.
Once the second-largest mobile device maker by volume with a 23% global market share in the fourth quarter of 2006, Motorola came in seventh place in 2010 with a 2.4% share (Gartner). The primary reason for this epic decline was the company’s inability to follow up its RAZR V3 (the third best selling cellphone of all time) with other compelling devices.
Some insights into why this may have happened are revealed in a former employee’s letter to Motorola management. The author, Numair Faraz, was the personal advisor to the late Geoffrey Frost, Motorola’s Chief Marketing Officer responsible for the catchy RAZR name and creating the buzz that drove the phone’s widespread adoption. After the RAZR became a certified hit, Mr. Faraz shrewdly advised former CEO Edward Zander, to enhance Motorola’s software expertise and focus on creating socially networked devices. His counsel fell on deaf ears, however, as Mr. Zander instead chose to partner with Steve Jobs to develop a music phone called the ROKR that worked with Apple’s iTunes store. The device ultimately flopped because it only carried 100 songs and was essentially competing against its partner’s own iPod devices. Mr. Faraz also claimed Mr. Zander relied totally on Mr. Frost to develop the company’s handset strategy, and after Mr. Frost’s untimely death in 2005, the Mobile Devices unit was left with little direction.
Mr. Zander ended up slashing prices on the RAZR line and glutting the market with the popular devices in an attempt to gain market share. Although this did help keep volumes high throughout part of the first decade of this century, product margins suffered and the phone eventually lost its popularity as competitors were rolling out feature-rich smartphones. Relatively inefficient manufacturing and supply chain practices coupled with the steep volume declines caused the company to report a $270 million operating loss in the first quarter of 2007.
Instead of beefing up research and development and expanding operating system expertise, Mr. Zander decided to accelerate share repurchases and release a more powerful version of the RAZR, the RAZR 2, which received little fanfare.
Eventually, the board needed to do something to convince shareholders things would turn around, so they ousted Mr. Zander and replaced him with Greg Brown, the chief operating officer and former head of the government and public safety, networks, and enterprise businesses.
This was not enough for activist investor and Motorola shareholder Carl Icahn, a major supporter of breaking up the company. Paying little credence to Mr. Brown’s ability to turn around the cellphone business, Mr. Icahn encouraged the board to take further action, saying this in a statement he issued in response to the CEO shakeup: “I believe that the best opportunity for the mobile devices business to attract top flight management and to prosper and grow is to establish it as a standalone business." Mr. Icahn’s belief that Motorola should split in order to more easily attract a cellphone savvy CEO would later be given by management as a reason for the breakup (although it never admitted that the corporate raider influenced its decision). While Mr. Brown had done well in the business of police radios and barcode scanners, cultivating a successful smartphone strategy was not his area of expertise. In fact, esteemed tech blog engandget would go as far as to report that Mr. Brown was so technologically out of touch that “he refuses to use a computer for communications, and has all his email correspondences printed by his secretary and replied to by dictation.”
On August 4, 2008, a little over four months after the CEO search commenced, it was announced that Sanjay Jha was chosen to head up the troubled handset unit and Mr. Brown would lead the other businesses. The move was applauded by the investment community as they considered him to be very qualified for the job. Mr. Jha had served as the chief operating officer of Qualcomm (QCOM) where he was responsible for overseeing R&D. He also served as president of that company’s chipset division.
Mr. Jha was one of the first to believe that Google’s (GOOG) open-source Android operating system was the key to competing with Apple’s (AAPL) iPhones and the wildly popular iOS operating system they ran on. Mr. Jha’s judgment proved sound as evidenced by Android phones rising from 3.9% of worldwide smartphone sales in 2009 to 22.7% in 2010, second only to Nokia’s (NOK) Symbian OS with 37.7% and ahead of Research in Motion’s (RIMM) BlackBerry OS with 16% and iOS’ 15.7% (Gartner). Mobility’s Android based smartphones like the Droid, Droid X, and Droid 2, helped the Mobile Devices unit go from an $840 million loss in the September 2008 quarter to a $56 million profit in the December 2010 period. A 25% headcount reduction helped also.
Despite the fact that Motorola was once again producing hit phones, the board did not waiver on its intent to split for a number of reasons. Historically, the prospects of the handset unit had greater influence over the stock’s performance than the profitable, albeit less sexy two-way radio, set-top box, barcode scanner and broadband access businesses. We attribute this to the explosive earnings growth hit phones can create and the significant market share and profit losses that can result from their absence. The fact that the media regularly covered the handset unit’s meteoric rise and eventual downfall while virtually ignoring the other businesses did not augur well for the appropriate valuation of the combined entity either.
Breaking up the company made it easier to put a proper price on the shares and it gave people the ability to invest in fewer product categories at one time. In 2010, Motorola Mobility as a standalone entity derived 68% of its revenues from Mobile Devices. The Home unit stayed with Mobile Devices due to potential entertainment center synergies. Its leading position in set-top boxes, as well as network equipment that transports video, data, and voice services to end users’ homes, was responsible for 32% of Mobility's revenues. Cellphones only made up 41% of Motorola Inc.'s 2010 revenues.
Investors that always wanted to invest in Motorola’s other businesses without the overhang of the handset unit can now do so via Motorola Solutions. This company has more stable, yet less impressive potential growth rates (3%-4% expected in the 2011 first quarter) due to dependable long-term contracts with governments and enterprises as opposed to Mobility’s finicky consumers.
Solutions’ bread and butter is two-way radios used by police, firemen, and EMS workers, where it holds a near monopoly. The retail, energy, utility, transportation, manufacturing and healthcare sectors also contribute a significant percentage of revenues. Other products include bar-code scanners, mobile computing devices and public safety LTE infrastructure. Too, radio-frequency identification (RFID) devices are becoming a greater percentage of revenues. This technology uses radio waves to exchange data between a reader and an electronic tag attached to an object, helping retailers reduce labor costs and shrinkage and improve the inventory replenishment process, which ultimately increases sales.
Although Solutions took on all of the $2.7 billion in debt Motorola Inc. accumulated, it plans on paying $600 million of that off in 2011 with some of its $5.7 billion in cash as well as a portion of the $1.2 billion in proceeds it is set to receive from the sale of its cellular infrastructure business to Nokia Siemens Networks (pending Chinese regulatory approval).
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.