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January 21, 2005

Motorola: Good Quarter, Bad Stock

Motorola (MOT) shares have traded down about 9% since reporting fourth quarter earnings after the close on Tuesday after the market closed. The quarter was excellent, but there were just enough issues to cause a still skeptical Wall Street to sell the shares. I think the reaction is wrong and still believe the shares belong in the range of $19-22...

The details on the fourth quarter included: (1) EPS of 28 cents and revenue of $8.84 billion easily beat consensus of 24 cents and $8.46 billion, (2) handset voulme that was much better than expected with shipments of 31.8 million vs. expectations of 28 million, a 300 bps increase in mkt share, and (3) first quarter 2005 guidance for EPS of 17 to 20 cents is in line with consensus but dissappointing relative to the excellent third fourth quarter results.

One issue that is troubling the stock is the extraordinarily high handset volume and market share gain was partially driven by unexpected strength in low to mid-end handsets. This caused margins to be below expectations in the handset division. Lower-end phones are less profitable, and a mix shift of several hundred basis points internally toward lower-priced phones brought handset margins and average selling prices lower.

The other issue is that first quarter EPS guidance was not good enough at 19 cents or in line with analyst estimates. Revenue guidance was ahead of consensus for the first quarter indicating the margins are the issue.

I believe the Street will eventually give MOT credit for its vastly improved execution. Not long ago investors worried if MOT could even ship handsets on time. Now, shipment issues are so straightened out the company can meet unexpected demand in low to mid-end handsets. Rather than reward the company, the Street chooses to remain in fear of the brutally competitive handset market and MOT's past missteps.

Since the earnings report 12 analysts raised their 2005 earnings estimate and 8 analysts lowered their estimate. Overall, the estimate is up by a penny to 93 cents, giving the stock a P-E of 17. My thesis on MOT has been that the estimates for 2005 would prove low by at least a nickel and as they rose the multiple would expand to the low 20s. I have to admit that the guidance the company provided for the first quarter challenges this thesis. As of now, investors are unwilling to pay 20 P-E for handsets no matter how well the company is executing.

I believe that management is being conservative given the company's prior missteps. Thus, as of now, I plan to hold the shares and look for a rebound as the emotion surrounding the quarter subsides. I will also be on lookout for signs that the first quarter is shaping up well. If I don't see that evidence then it might be time to reconsider the thesis.

Posted by Steve Birenberg at January 21, 2005 10:05 AM in MOT