Google: New Phones Could Generate 15% Upside

May.24.12 | About: Alphabet Inc. (GOOG)

May is turning out to be a banner month for Google (NASDAQ:GOOG) as the Internet giant is enjoying good news on several fronts that are bound to have a positive effect on its financials. That includes a jury verdict finding it innocent of infringing on a competitor's patents and drawing more users to its Chrome browser than Microsoft's (NASDAQ:MSFT) Internet Explorer. These feats are important in their own right, but the one that trumps them is Google's acquisition of Motorola Mobility (NYSE:MMI), enabling it to build its own handsets and install its ever-popular Android operating system on them.

Let's start with the jury verdict. It stemmed from a lawsuit filed by Oracle (NASDAQ:ORCL). Outraged and convinced about what it perceived as theft, the software company took Google to court last year, and at one point it wanted billions of dollars in damages. The judge and Google scoffed at that, forcing Oracle to back off, but only a little. It lowered its damage estimates to be in the millions. It was widely reported that it wanted as much as $6 billion, but settled for about $100 million.

On Wednesday, May 23, a California jury found that Google did not infringe on the patents of Oracle. Oracle had been steadfast in its accusations that Google stole parts of the Java technology to build its Android operating system. Oracle had sought hundreds of millions of dollars in damages for the alleged infringement. Also, the software maker said that Google had committed copyright infringement.

Oracle obtained the Java computer programming language when it bought Sun Microsystems in 2010. About a year after that, it sued Google in the U.S. District court in San Francisco, charging that Android-powered mobile phones infringed on the Java software. Then this year, after neither side was able to reach an agreement, Google went on trial. The trial began in April, with the focus being on Google committing copyright infringement. The jury found that Google infringed on Java's application programming interfaces, also called APIs. However, the jury was unable to decide if that infringement broke U.S. protections regarding fair use. When all was said and done, the jury found that Google had not infringed on two key Oracle patents. So the case is over for now. Oracle will likely appeal the decision.

I was surprised that there was no settlement reached between these two parties early on. The fact that the case reached a jury shows how fierce competition is within the technology sector. There is a lot at stake, and clearly neither Oracle, nor Google, wanted to back down on key copyrights and patents.

Google immediately hailed the "victory as one not just for [it], but for the entire Android ecosystem." While the verdict may give Google a breather from Oracle, it still faces other lawsuits. For example, Apple (NASDAQ:AAPL) has accused Google of stealing from it in developing Android. Apple is also suing HTC, Motorola and Samsung, all of which manufacture Android devices.

While these types of lawsuits are not new to the technology industry, it is clear that they are becoming more frequent. I believe this is due to the extreme success of Android. It is perhaps one of the biggest threats technology companies have seen in the last 10 years. During the first quarter of this year, Samsung, which makes the most handsets powered by Android, took the top spot for leading smartphone maker from Apple, selling 38 million units compared with Apple's 33 million.

The growth of Google's Android operating system has definitely been a threat to Apple and other competitors. What better way to slow its progress than to sue?

Now let's discuss Chrome, Google's version of an Internet browser. Its Chrome browser was used more than Microsoft's Internet Explorer at least twice within the last three months based on tracking done by StatCounter. This becomes extremely noteworthy when you consider that no other company can claim this feat. Not Apple and its Safari browser, nor Mozilla with its Firefox browser.

Now, let's discuss the biggest news of all - Google's closing on a $12.5 billion acquisition of Motorola. The transaction is the largest ever for Google. It paves the way for the Internet giant to make its own phones and install its Android OS system on them. No more relying on any particular manufacturer. This is a boon for Google, but it is also important for Motorola, which has struggled in recent years to keep up with the competition. Its devices, like so many others that used to be so popular, were losing appeal as more people chose iPhones and Android-powered devices.

Google's deal to buy Motorola had been in the works since the fall of last year, but only received approval from China in May. Motorola was attractive to Google because of its strong patent portfolio. Hopefully, by acquiring Motorola, Google will be able to better defend its self against patent infringement charges.

In announcing the closing of the transaction, Google said buying Motorola will enable it to supercharge the Android ecosystem and enhance competition in mobile computing. Motorola will still be a licensee of Android and Android will remain open. Google plans to run Motorola as a separate business.

This move can help Google shield itself from patent infringement lawsuits.

In the short term, the purchase of Motorola may cause Google's margins to shrink. This will especially be the case for its operating margins due to the costs of producing its own smartphones. Its operating margins are 3.11%. As it rolls out its own handsets, I have little doubt they will be popular leading to strong sales results. I foresee at minimum a 10% to 15% gain in Google stock within 24 to 36 months on strong sales of handsets.

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