Motorola Doubles Down on Cell Phones with Mobility Unit Spin-Off, But Should Investors Tread Carefully?

 

Motorola’s long-planned corporate break-up became official last week as the stock split into two distinct business units; Motorola Mobility Holdings (MMI) and Motorola Solutions (MSI). The former will encompass Motorola’s consumer unit (cell phones and cable set-top boxes) whereas the latter will serve the enterprise sector.

Analysts have been praising Motorola Mobility as a way for investors to play the rise of Android smartphones and Motorola’s success with the Droid product line. In fact, just this morning Bank of America Merrill Lynch initiated coverage of MMI with a buy rating and $38 price target (the shares currently trade around $32).

Making a bet on a cell phone pure play, without a stronghold on a certain niche of the market a la Apple or RIM, seems risky to me. After all, this industry is extremely competitive and aside from Apple and RIM, companies make very little money selling cell phone hardware. Palm was forced to sell itself to HP and after their success with the RAZR phone many years ago, Motorola struggled mightily before their Droid came along. Other giants in the space like Samsung and LG have diversified electronics product offerings so they do not need to rely on cell phones for strong profits. And new competitors enter the market all the time. We just learned that LCD TV maker Vizio is planning to launch Android phones and tablets and HP is set to launch a line of phones this year based on the Palm webOS operating system they acquired.

Perhaps the biggest reason to be cautious about Motorola Mobility is the fact that Apple is set to give Verizon the iPhone shortly. The Droid has done pretty well on Verizon in large part due to the fact that Verizon is the largest U.S. phone carrier but has not had access to the iPhone before. Loyal Verizon users have been using Blackberry and Droid phones but that could change dramatically when Apple’s products are made available to them.

All in all, it seems that everyone is jumping on the Android bandwagon. This is definitely good for consumers but I have to question how all of these players are going to make good money by selling what is essentially the exact same commoditized product. Is a Motorola smartphone or tablet computer running Android really going to be able to differentiate itself from an Android-based product from Samsung, LG, Dell, or anyone else? Seems unlikely, and without doing so these hardware companies are going to be at each others’ throats, which reduces pricing power and mostly importantly, profit margins. Computers makers like Packard Bell and AST have long been extinct because they could not outsell their competitors with largely identical products (Windows-based computers). Why would the tablet PC market or the phone market be any different?

Digging into Motorola Mobility’s numbers hardly paints an overly bullish picture either. While it is true that the company has stemmed losses in its cell phone division, which was losing hundreds of millions of dollars just a few short quarters ago, the business is still not making money (operating margins were 0% last quarter). With a strong launch of the Droid and reduced competition within Verizon’s customer base, Motorola still isn’t making a dime selling smartphones today. It is hard for me to see how that situation improves materially after the iPhone launches on networks outside of AT&T, but Motorola’s long-term goal is an operating margin of 8-12%. Seems overly optimistic to me.

The overseas markets could potentially be a strong area of focus for Droid, but Motorola Mobility gets 68% of their revenue from North America, so they are not big players in Europe or Asia. MMI is also more than just cell phones, with one-third of their revenue coming from a leading market share position in the cable set-top box market, but that industry seems poised for competition too. Would it surprise anyone if Apple or Google eventually launched their own cable box to compete with digital cable? Growth potential in set-top boxes seems lackluster and Motorola’s leading market share could come under fire. In fact, I just read that companies are already working on ways to build cable box technology directly into television sets, thereby eliminating the need for cable subscribers to have a separate cable box at all.

All in all, color me pessimistic about the outlook for Motorola Mobility, the company’s new pure play cell phone company. At $32 per share, MMI shares trade at 18 28 (corrected 11:50am) times 2011 earnings estimates of $1.16 and given that the company lost money in 2010, I think those projections for future quarters may prove difficult to achieve. MMI does give investors a strong balance sheet ($3.5 billion in cash and no debt), but given high research and development costs, coupled with a cell phone business that is only breaking even right now, and it is entirely possible that their cash hoard may dwindle over time.

Full Disclosure: The portfolio that Peridot Capital manages on Wealthfront was short shares of MMI at the time of writing, but positions may change at any time

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4 Thoughts on “Motorola Doubles Down on Cell Phones with Mobility Unit Spin-Off, But Should Investors Tread Carefully?

  1. Hi Chad,
    You didn’t mention MMI’s tablet –(XOOM). It was Digital Trends’ favorite tablet from the Consumer Electronics Show. What are your thoughts on how that factors in? I suspect there will be numerous successful tablets; do you?
    Jeff

  2. Chad Brand on January 15, 2011 at 10:33 AM said:

    @Jeff-
    The Palm Pre was the talk of CES once upon a time and it went nowhere. In such a crowded market I really don’t see how more than a handful of hardware makers can make good margins on these devices, even if they are “cool” products that are designed well (like the Pre). If we have dozens of Android tablets I don’t envision the companies being able to differentiate themselves. Can you name the top 5 best selling Windows-based laptops? I doubt anyone can. There are no standouts because they are the same product essentially.

    Other than Apple nobody has really been able to differentiate their products. I don’t see the race to build Android phones and tablets as being any different. If I’m wrong, though, surely there is a lot of upside for Motorola or whomever. I just don’t think the history of the tech world supports such a view at this time.

  3. Thanks for your reply. Your analogy related to Windows-based laptops makes a lot of good sense.

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