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January 19, 2007

Motorola 4Q Earnings Review

Motorola (MOT) reported 4Q earnings in line with its recently lowered forecast. Key to the stock performance over the next six months is the 2007 outlook and unfortunately it is hard to get a read on this off the earnings conference call. MOT has a second two hour call scheduled for later this morning to further discuss 2007, so comments on the quarterly call were somewhat limited. However, based on what I heard, I think there is reason to be cautious. It does not sound like MOT's outlook will support a quick rebound in margins. Furthermore, much of MOT's ability to increase its handset margins is beyond the company's control. MOT appears addicted to volume but does not have price leadership. This leaves the company in a defensive position. Making matters worse is that it appears that MOT is saying that competition and pricing is difficult across the entire product line, including the high end 3G phones that are required to drive margins.....

Operating margins in the handset business collapsed from nearly 11% to less than 5%. Assuming all else goes well at MOT, not an assumption I would have 100% confidence in, the sole driver of the stock price will be when, whether, and to what level margins recover. Based on the limited commentary on the 4Q call, I do no think investors will walk away form the 2007 guidance call with a lot of confidence that the rebound in margins will be large or soon. Complicating matters from a valuation perspective is that the answers to the margin rebound largely reside in Finland as Nokia is driving pricing downward in emerging markets where volume gains are greatest. Leaders get premium valuations, followers trade at a discount. MOT's comments also indicate the company is on the defensive in established markets where the competitive for high margin 3G handsets is fierce.

Two final points. First, I think CEO Ed Zander is addicted to unit volume. He probably has no choice as he can’t cede significant market share and satisfy Wall Street. Nevertheless, the mentality appears to be to sell phones no matter what the margins. I suppose that really is a commentary on the state of the mobile handset business but the only conclusion that can be drawn is that this is a low multiple business (excepting the high end Blackberry type devices where growth is very strong). Second, I think that the $10.5 to $10.6 billion 1Q07 revenue guidance implies a poor quarter for handsets. On the call management confirmed that this figure includes recently acquired Symbol Technologies. Symbol has a $500 million quarterly revenue run rate. Based on a very limited sample of analyst reports, I think that the true guidance comparison is $10 billion vs. a consensus estimate of $10.4-10.6 billion. I could be wrong here by a few hundred million dollars but I would be cautious interpreting the revenue guidance as "in line."

Barring surprises on the outlook conference call, I see no reason to be long MOT shares for the next several months. I think the risks to a meaningful recovery of handset margins in 2007 are high. I also think that MOT's ability to control margins is limited. This outlook means that MOT shares aren’t nearly as cheap as they look.

Posted by Steve Birenberg at January 19, 2007 11:08 AM in MOT