Much has been made about the disastrous preannouncement by Motorola (MOT) that revenue estimates may have been a billion dollars or so too high, as the company struggles to find a spot in the cell phone market offering both share and margins. The company struggles to find a successor to the RAZR, and the consensus belief is that Motorola’s problems will take several quarters to address.
One of Motorola’s primary problems has been the increasing commoditization of the handset business, where new product releases have a short shelf-life and fat margins are quickly eaten away by copy-cat offerings from competitors. Part of the woes are self-inflicted, as Motorola's handling of RAZR prices has undoubtedly had a negative impact on revenues and earnings, but the underlying industry dynamics certainly are playing a role as well. Still, Motorola CEO Ed Zander shouldn’t be let off the hook with the classic attribution of problems to “difficult industry conditions” - because a $13 million pay package doesn’t typically go to a passenger along for the ride; he should be held accountable for the downturn in profitability.
With the 25% beating MOT shares have taken in the last 6 months, the company now has a market capitalization of $41.8 billion, although the large net cash position that prompted Carl Icahn to purchase a significant stake in the company means the company has an enterprise value of only $30.6 billion. Motorola’s cash hoard was considered by many to be meant for the purchase of smartphone maker Palm (PALM), but many consider that Motorola’s own internal struggles will stop it from buying Palm and having to deal with the issues facing that company as well.
Assuming the MOT/PALM deal is off the table, what is a company to do with $10 billion idle dollars? Coincidentally, Motorola’s primary competitor Nokia (NOK) also has its own $11.5 billion cash position. How should Nokia put that money to work? I think Nokia should seriously consider making an offer for Motorola while the shares are cheap during the latter’s troublesome transition.
How would I go about this if I was Nokia? I would give Motorola shares until the middle of next to shake out all the weak holders, and then I would make a $21 offer, or a 20% premium to Thursday’s closing price of $17.50. That would make the total buyout offer equal to $50 billion, but only about $39 billion after considering Motorola’s net cash reserves. Although profitability will decline this year, using trailing numbers No! kia would be paying 7.9x EBIT and 14.1x FCF, but those figures are before factoring in the real reasons behind the deal… synergies that can lead to cost savings, pricing power, and a multinational communications equipment giant with a 58% share of the global market (36% belongs to Nokia, 22% belongs to Motorola).
In FY2006, Motorola spent $4.1 billion on R&D and $4.5 billion on SG&A. Assuming a 1.25 Euro/USD conversion rate (the approximate average through 2006), Nokia spent $4.8 billion on R&D and $5 billion on SG&A. Envisioning the companies leveraging their respective sales forces in their dominant areas - Motorola is the market leader in America, whereas Nokia leads in the majority of overseas markets - the combined company could see significant cost savings from a reduction in employees.
As a rough conservative estimate, assume that 25% of expenses can be considered to overlap. Research and Development spending could be cut by $2.2 billion, and $2.4 billion could be saved from SG&A, for a cost savings from those units alone equaling $4.6 billion, meaning that Nokia would be paying 8.5x its annual savings alone - not a bad rate of return in itself, but combined with the added earnings power Motorola would bring, the deal begins to look extremely good.The intangible benefit I am not going to chance an estimate at is the renewal in pricing power this deal would give the combined company.
With both companies’ market shares growing and currently over a combined 55%, one would assume that between savings on production facilities and capital expenditures, along with that certain je ne sais quoi industry leaders have with pricing, this deal could give Motorola/Nokia the strength to slow the erosion in gross margins that normally comes with selling a commoditized product. s New Roman\">How does the deal sum up? If Motorola can generate $3 billion in annual EBIT going forward (a 40% decline from FY2006), adding cost savings of $4.6 billion would bring $7.6 billion in EBIT growth to Nokia.
With a $21/share takeover offer, Nokia is giving Motorola an enterprise value of $39 billion, for an EV/EBIT of 5.13. Nokia could finance over 25% of the deal with its cash reserves, and use its “A” credit rating to access debt to finance the rest of the deal. Given that Nokia had free cash flow in excess of $4.7 billion in FY2006 and Motorola had more than $2.8 billion in FCF, debt repayments should be no problem considering liquidity positions and the deal’s cost saving potential.
The bottom line? I think Nokia acquiring Motorola could be an extremely beneficial deal for NOK shareholders, and it would also bail out many who have seen their shares in MOT decline significantly. While a $50 billion buyout offer seems large, when the two companies’ cash positions are taken into account, as well as the accretive nature of the deal, the offer price doesn’t seem very high. Right now, Motorola, not Palm, presents the most compelling takeover value in the communications equipment industry.
MOT/PALM 1-yr comparison chart
Disclosure: Author has no position in any of the above-mentioned securities