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January 23, 2006

Motorola Earnings Summary

Motorola (MOT) shares reacted very poorly to the company's 4Q05 earnings report and 1Q06 forecast. My thoughts on the report are in the "Continue Reading" section. Those comments are an exact reporduction of what I posted on Street Insight and were written during and immediately after MOT's conference call on Thursday afternoon. With the benefit of a little hindsight and review of analyst commentary, I don't think my analysis emphasizes enough that while MOT reported a decent quarter and offered inline guidance, expectations were for another positive surprise and increased gudiance. Furthermore, given that management discussed supply chain issues that restricted 4Q05 handset shipments and margins and said that those issues were resolved, the guidance should have been stronger. This explanation certainly sounds like some shipments slipped out of the December quarter into the March quarter. All that said, my opinion remains bullish on MOT. The share price decline is an overreaction and is at least partially the result of analysts refusing to trust the turnaround at MOT. I think they will proven wrong in the next months and stand by my goal of selling the remaining holdings in MOT in the $26-28 range.

Motorola (MOT) traded down $1.75 after reporting in line numbers and 1Q06 guidance that merely matched current consensus estimates. I think investors were troubled that margins weren't better in handsets. I incorrectly noted that margins declined but it turns out there was a one-time item that impacted the reported number related to past use of Kodak intellectual property. Excluding that operating margins would have been 11%. I still think this is what troubled investors as most of the questions on the call were about handset margins. I believe that given the strength in units and ASPs analysts wanted more operating leverage. I also think that they would have expected a guidance bump for 1Q based on the strength in these factors in 4Q.

In response to these many questions, I think management gave satisfactory answers. This accounts for the partial rebound in the stock which rose 50 cents during the call. I think a further rebound is in the cards for tomorrow. Management noted that it overcame serious supply chain issues to meet the 4Q shipment target of 44.7 million. Component supply in mechanical, not silicon products, was the issue – stuff like hinges and keys. Given that the company introduced 26 new products in the quarter it is understandable that some issues cropped up. Management said the problem was dealt with and that there was no issue for 1Q related to this. Inventories were stated to be on target.

Further issues that held back operating leverage in handsets included upfront marketing costs for new product launches, investment in China and India in marketing distribution, and a sequential uptick in R&D. Given the confidence the company maintained in its competitive positioning and its forecast for 10-12% global handset growth in 2006, these investments are understandable.

Overall, I find the focus on these issues to show two things. First, there is still a lack of confidence on the part of the Street despite the amazing 2004 and 2005 financial, marketing, manufacturing, and shipping performance. For example, not one analyst noted that meeting estimates despite the supply chain challenges and investments was a positive. Second, analysts are rightly concerned about any company maintaining momentum in cell phones given the commodity characteristics of the product and the jumpy market shares of the leading players. I think this second factor partially explains the ongoing skepticism toward MOT noted in the first point. On that basis, I'll give the analysts some credit for coming around on MOT.

Outside of handsets, the other primary concern on the call was the weak quarter in Networks and the guidance that the division would be down again in 1Q. MOT is not as well positioned as Nokia or Ericcson in infrastructure but management did promise 2006 would be an up year. It is worth noting that Mobile Devices had 3.5 times the revenue of Networks last year. I don’t think there is any link between the phone a customer uses and the network infrastructure a service provider uses so I am not as concerned about the lagging performance in Networks. Additionally, the Government, Mobility, and Enterprise Systems segment is as large as Networks and showed reinvigorated growth in 4Q.

At $23, MOT trades at 17.6 times the 2006 consensus estimate of $1.29. Net cash per share is over $4, or $10 billion. Fully taxed net cash contributes a little over a dime to 2006 estimates. Adjust for the cash and the multiple comes down to 16 times. 1Q06 guidance calls for 15% growth on the top line and 23-32% growth in EPS. Growth in EPS for all of 2006 is currently projected at 15%. I think the current 2006 consensus estimate will prove but even if it doesn’t valuation is hardly a stretch. I entered the call hoping for a pop to $26-28 to lead me to an exit point on the shares. At $23, I am a firm holder of what I own and if the share drifted back toward $20-21 I'd buy more based n what I know now. I think $26-28 is still realistic for this year so if I weren't long already I'd be a buyer right here in anticipation that 1Q06 guidance will prove conservative.

Posted by Steve Birenberg at January 23, 2006 10:27 AM in MOT