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April 26, 2005

Motorola Finally Getting Some Respect

Beginning with the first quarter of 2004, Motorola (MOT) has reported five consecutive quarterly earnings reports that have matched or exceeded Wall Street estimates. Unfortunately, MOT shareholders have gone largely unrewarded for this impressive string of results as Wall Street has failed to embrace MOT's turnaround despite mounting evidence. Following last week's better than expected earnings report, it appears that the reward may finally be at hand because MOT management reinforced perceptions of its turnaround by providing a forecast for the current quarter that exceeded current Wall Street consensus. It was this fact that appeared to win Wall Street over and led to a 7% jump in MOT shares last Thursday. I think MOT shares have another 15% in gains ahead….

On its quarterly conference call, MOT laid out a clear plan to boost market share and increase margins in the highly competitive cellular handset industry. Essentially, MOT is trading some of the margin benefit it gets for success with higher end, more expensive phones like the RAZR for market share in lower end phones priced at $40 and less intended for emerging markets. This effort is being supplemented by a renewed focus on the company's supply chain that offers 300 to 500 basis points of margin expansion potential. Presently, MOT earns a margin of 10% on its handset business, while industry leader Nokia earns a 15% margin. Nokia sells about twice as many phones per quarter as MOT, so economies of scale should allow it to earn higher margins. However, as the #2 supplier, MOT should be able to close the margin gap and gain economies of scale by being more aggressive in the high volume low priced handset market.

With a well thought out plan to drive revenue and margin, profits should follow. In fact, the first quarter showed clear evidence the plan could work when MOT earned 22 cents against 19 cents predicted by Wall Street. Wall Street analysts responded favorably to the report by raising MOT's 2005 earnings estimate by about 5 cents to just short of $1.00 per share. The five cents was made up of the 3 cents extra earned in the just completed quarter and two cents from the company's better than expected forecast for the current quarter. The analyst at Smith Barney, long a skeptic of MOT shares, also upgraded his rating to Buy.

I think MOT shares are well positioned to perform well for at least the next several months. Given the momentum in the business, analysts still have room to raise estimates further as additional evidence of success in the new strategy emerges. Furthermore, as the estimates rise, growing confidence in the company's turnaround should lead to a somewhat higher price-earnings multiple for the shares. I believe the shares are headed to $18-19 on the basis of an 18-19 P-E on what will likely turn out to be $1.00 in 2005 earnings per share. With 15% upside in the cards, MOT was purchased last week for client accounts that had not previously the shares.

Posted by Steve Birenberg at April 26, 2005 10:28 AM in MOT