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October 19, 2006

Motorola: A Few Kinks

Although all client holdings of MOT were sold a few months ago, I am posting the latest earnings summary on the main page as the latest quarter highlights some of the reason why I sold the stock

There was some good and bad in the Motorola (MOT) earnings report but the bottom line is that the company is back in the penalty box. A miss on the top line, 4Q revenue guidance below consensus, a 1.5-2 million miss on handset units, falling ASPs, a hiccup in iDEN shipments, and the return of restructuring charges will bring back fears that MOT is reverting to the inconsistent company it was for many years prior to Ed Zander’s arrival. I suspect that is too harsh a verdict as there is plenty of good stuff happening at MOT but for the stock price this battle for investor respect has been lost and the after hours whack in the shares is well deserved.

I’d be surprised if investor confidence in MOT was quickly rebuilt. There are some legitimate concerns about the competitive environment for handsets in 4Q and the sustainability of long-term growth as some markets like the US mature. Also, iDEN has always been viewed as risk since the Sprint-Nextel merger so the shortfall there will renew fears. MOT will have to report a clean quarter in a favorable environment for handsets to get the shares back on track. I think we’ve seen the highs for the year and I am not anxious to buy the shares prior to the next quarterly earnings report 90 days from now....

For 3Q06, MOT reported adjusted EPS of 34 cents, exactly in line with expectations. Revenues were light at $10.6 billion vs. expectations for a consensus of $11.1 billion. Management attributed the shortfall to weaker than expected shipments of GSM phones into the Europe, Mid East, and Africa region and an inventory adjustment for iDEN phones at Sprint ahead of new product introductions. The shortfall was evenly split among the two factors and led to handset shipments of 53.7 million vs. expectations of around 55 million. Despite the shortfalls on revenue, MOT continued to make solid progress on handset margins and gained market share.

The Networks and Enterprise segment had a sluggish quarter. Revenues were flat and a tough comparison led to an 8% decline in operating income. Connected Home made up the slack as strength in the cable industry flowed through and led to a 9% revenue and sharply expanding margins.

MOT provides limited quarterly guidance with only revenue projected. For 4Q, the forecast is $11.8 to $12.1 billion, which would be up 17-20%. In fact, in 3Q revenue growth was 17%. So again, there is plenty of good things happening at MOT including double digit revenue growth, expanding margins, significant free cash flow generation, large share repurchases, and on-time product introductions.

Nevertheless, MOT’s rough history and the always tough competitive environment in handsets will likely leave investors in a show me mode, keeping a lid on the stock for the next few months.

One final comment: management was extremely forthright on the call about the shortfalls in handset units. There was no sugar coating and no attempt to talk their way out of the miss. They admitted some mistakes in forecasting and execution. I think this will help limit the damage and will allow for an easier rebound in the share price if 4Q results shape up well.

Posted by Steve Birenberg at October 19, 2006 03:22 PM in MOT