On January 4, Motorola became two separate independent companies by effecting a separation of Motorola Mobility Holdings, Inc. (MMI) from Motorola Solutions (MSI). Motorola Mobility includes the mobile devices and home segments that were formerly part of the old Motorola.
The Mobile Devices segment designs, manufactures, sells and services wireless mobile devices, including smart phones and media tablets. In the first quarter of 2011, the Mobile Device segment contributed 70% of the company’s consolidated net revenues. The Home segment designs, manufactures, sells, installs and services television set-top boxes and associated products and services. For the first quarter of 2011, the Home segment contributed 30% of the company’s consolidated net revenues, compared to 34% for the first quarter of 2010.
With 70% of revenue coming from the Mobile segment, investors view the fate of MMI as linked to the performance of MMI’s smart phone and tablet products. While MMI was early to adopt Google’s (GOOG) Android platform, other companies like HTC and Samsung (SSNLF.PK) followed suit, removing any operating system differentiation MMI had achieved.
The mobile and tablet markets are incredibly competitive and dominated by arguably the greatest consumer electronics innovators in history, Apple (AAPL), which is at the top of its game with a long runway of future versions of the iPhone and iPad, as well as the potential for future product innovations.
MMI is trading at approximately $21 per share. It has a market capitalization of $6.2 billion and an enterprise value of $3.1 billion. MMI has a debt-free balance sheet with $3.1 billion of cash or approximately $10.50 per share representing half of its value.
The core question regarding MMI going forward is about profitability. Simply put, can the company be profitable -- and if so, when?
A close read of MMI’s financial statement reveals that the company has significant deferred tax assets (DTA). Footnote 5 of MMI’s most recent 10-Q beginning on page 12 provides detail.
MMI has $2.4 billion of DTA, of which $2.3 billion is subject to a valuation allowance. Said another way, MMI and its accountants are not yet convinced that they can generate enough pre-tax profit to utilize their deferred tax assets, hence the valuation allowance. Of course, this makes sense given that the company isn't yet profitable. Also note that one quarter of profit or even stringing together several quarters does not necessarily result in the removal of the valuation allowance. The company has to be profitable and expect to be profitable on a go-forward basis such that it could use the DTAs.
Wall Street consensus operating profit for the quarter ended June 2011 is $37.9mm on sales of $31.2 billion. This implies an operating margin of only 1.2%. For the full year 2011 consensus operating profit is 2.3% moving up to 4.1% in 2012. This means that it could be sometime before the DTA valuation allowance is lowered.
But who cares? The valuation allowance and boost to earnings that would come with a reversal in and of itself does not generate a single penny of cash. The value here to MMI and its shareholders is the tax shield the DTAs result in over time – but only if there is taxable income to shield. So if you believe MMI will sustainably generate pre-tax income, calculate the implied present value of the deferred tax assets, remember that the company has over $10 in case per share, and think about how the market is actually valuing the operating business.
Personally, given the competition in the mobile and tablet markets, and my impression of the Zoom tablet compared to the iPad, the Samsung Galaxy, and the new HP (HPQ) tablet makes me apt to wait until I see profitability for several quarters before I make an investment decision.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.