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January 13, 2006

Motorola: Looking For One More Move Up Before Selling

Northlake clients have been long Motorola (MOT) for over a year and were well-rewarded in 2005 when the shares rose over 30%. I lightened the position once in the low $20s and have been hoping to sell the balance in the $26-28 range. Analysts have begun to preview the company's 4Q earnings report due on January 19th with most expecting another strong quarter but probably without the upside surprise that accompanied several of the earnings reports in 2004 and 2005. Key metrics in the quarter will be handset sales, handset margins, and ASPs for phones.

I don’t think the quarter is likely to disappoint from a financial perspective but the stock is more likely to react the 1Q06 and 2006 guidance comments anyway. Here is where there is a difference of opinion on the Street. There seems to be a consensus forming that 1Q06 will be strong. Analysts are pointing to datapoints from the supply chain that indicate the usual seasonal decline in handset shipments will be below average. This would mean that the surprising strength in the global handset market in 2005 will continue early in 2006. However, beyond 1Q06 analysts are beginning to split on how strong the handset market will be. Consensus calls for 10% growth for the full year which would be healthy but a clear deceleration in growth....

Decelerating market growth is risky for MOT because its leading product, the RAZR, is getting old by usual cellphone market product standards. Maybe more important to the company's 2006 outlook though is continued growth in handset margins. Management has said that margins could head to 13-15% but has never given a timetable. Despite the positive surprise in unit shipments in 2005, the market remains brutally competitive. Will MOT be able to expand margins in 2006 against slowing market growth? The answer to this question is complicated by the loss of royalties from Qualcom (QCOM) which carried a margin of virtually 100%.

My strategy for Northlake's MOT position is to look for further strength off the 4Q report to sell the position. The shares still aren’t all that expensive, trading at less than 20 times the 2006 consensus estimates with several dollars per share in cash on the balance sheet. I think a multiple of 20 on EPS adjusted for interest on cash plus the cash is a reasonable target and that would get to my $26-28 exit target. However, I do think the risk-reward tradeoff has worsened (mostly due to the great performance on the stock) due to lesser growth in the handset market and slowing, though still strong, earnings momentum at MOT.

Posted by Steve Birenberg at January 13, 2006 08:55 AM in MOT