3 Reasons Why Motorola Needs the Buyout More Than Google

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by: Follow My Alpha

It wasn’t easy being Motorola (NYSE:MMI) these days until Google (NASDAQ:GOOG) came in and offered to buy them out. The firm has suffered during its turnaround, and seen its shares plunge roughly 44 percent over the last decade (buyout offer excluded). While some assume that the company is destined to suffer the same fate as Sprint (NYSE:S), we haven’t reached that conclusion. We’ll hold off from saying the company is a “dead man walking,” given its recent turnaround in 2010, the fact that it still holds a quick ratio greater than 1.0 ($3 billion in cash), and Google is anxious to buy it out. Still, if one thing is clear it’s that Motorola needs this buyout to happen a lot more than Google does.

We initially reviewed Motorola because of the dark cloud that originated from Hewlett Packard (NYSE:HPQ) – namely the price cut on the HP tablet. This appears to be a bad omen not only for Hewlett Packard, but for Motorola as well. At this point, we rate the company a “pass” if the Google deals falls through (lawsuits have already been filed in relation to the offer). The firm doesn’t have any sustainable competitive advantage, the tablet market is intensely competitive, and its lucrative cable TV-equipment business is transitioning into a more commoditized market.

Where is the Secret Weapon?

Motorola is truly a mobile phone company for better or worse. The firm has engineered a successful turnaround. However, the firm has largely been riding on the coattails of Google’s Droid. Looking ahead, we don’t know what will keep Motorola ahead of the pack if the Google deal doesn't happen.

Profitability Trends 2008 2009 2010 TTM
Gross Margin 16.49 19.48 25.87 26.10
Operating Margin -11.93 -10.96 0.66 0.57
EBT Margin -11.33 -12.08 -0.03 0.27
Click to enlarge

EBT margin trends show a continued position of weakness, although the firm has evolved from a strong negative to a marginally positive position. Our fear is that, if the consumer market softens, Motorola could return to the red. Further, we don’t envision Motorola coming out with a “new” secret weapon or disruptive product launch that will bring people running over to the firm. Droid is probably the best thing that has happened to Motorola in a long time. But, of course, that had nothing to do with Motorola’s internal R&D - it was simply Motorola taking advantage of the opportunity.

The Tablet Booby Trap

Before they even knew what they were really getting into, Research in Motion (NASDAQ:RIMM), Hewlett Packard, and Motorola all jumped in behind Apple (NASDAQ:AAPL) in a market free-for-all. All they saw was Apple creating the tablet market with the iPad and they wanted a piece of the action. They seemed to think that if Apple was going for it, it must be a huge market. It is – but perhaps it’s just not a market for them.

The Apple iPad launch was sneaky. Essentially, Apple launched the iPad only after building one of the largest and most brand-loyal consumer followings in the world. It unveiled a product that could destroy competitors that immediately followed. In our view, the tablet market looks booby-trapped. Motorola may now pay dearly for not doing more competitive homework. The first sign that things are about to get challenging is HP’s recent price cut. This could easily lead to a price war and razor-thin margins. For Motorola, that means what could have been easy money (simply by replicating Apple) will turn into a dangerous gamble. We guess it won’t be so easy to ride the coattails of Apple’s iPad as it was with Google and the Droid.

Commoditizing the Cable

The one enduring strength for Motorola is its cable TV equipment business. This business is most easily recognized for its DVRs, back-end equipment, set-top boxes, and other business-to-business services. The problem we see is that the equipment market is being commoditized and more competitive as costs get slashed. Of course, there will be switching costs and other associated expenses but we don’t anticipate these will deter hungry competitors or churning customers. Everyone is looking at the bottom line and finding places to cut costs. While this isn’t a big problem today, the firm’s reliance on this business segment could become dangerous.

Conclusion:

Motorola must develop sustainable competitive advantage or some type of X-factor before we again become bullish on the firm. Still, Google’s offer looks like the best potential outcome for Motorola shareholders so we hope nothing goes wrong with the deal. Still, lawsuits have already been filed questioning whether Motorola management has broken fiduciary duties by not shopping the firm around first.

With the market’s volatility, Motorola may become a favorite short, given its weak independent position or if there is a real sign that the Google deal may fall through. Some signs indicate that the name was already becoming a short favorite since 7.5 percent of floating shares are currently shorted (as of July 29, 2011). There isn’t much reason to take any risk on this company while it remains in this defensive position & now has lawsuits cropping up relative to the Google buyout. We rate it a pass.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.