Motorola: Back on Top
By Ken Leon, CPA
At Standard & Poor's, we view Motorola (MOT ; 5 STARS, or buy; recent price: $20) as one of the market leaders in wireless, broadband, and automotive communications technologies and embedded electronic products. We expect total sales growth in 2004 of 31%, to $35.6 billion, based on our view of strong handset and wireless infrastructure markets, as margins stay in the mid-30% range.
Wireless communications represents approximately 75% of total sales. Motorola provides a diverse offering of wireless handsets, which transmit and receive voice, text, images, and other forms of information and communication. To support handsets, Motorola designs, manufactures, and markets public and enterprise wireless infrastructure systems for cellular, personal services, commercial specialized, and government markets.
It has gained market share in handsets, with 25.3 million shipped in the first quarter. Handset sales advanced 67% in the first quarter from a year earlier, and the average selling price trended higher, as color displays, short-text messaging, Web capability, and integrated camera phones became more popular. Last year, Motorola was late to the market with new handsets, but we believe it's now in a position to ship 25 or more new handset models in the second half of 2004.
We expect Motorola to take advantage of what we see as Nokia's (NOK ; 4 STARS, or accumulate; $13.50) weakness -- its lack of attractive, clamshell camera phones, models that Motorola says are in high demand. Because of what we view as competitive products in a strong global market for handsets, we expect Motorola to gain market share from the mid-teens to the upper-teens in 2004, while Nokia's share erodes from the upper-30% to the low-30% level. Motorola says its increase in market share is primarily tied to a gain in Europe, the Middle East, and Africa (EMEA), to retaining its leadership in the Americas, and to a slight market-share lead in China despite intense competition.
In broadband communications, which makes up 6% of Motorola's total sales, the company develops and deploys end-to-end digital broadband entertainment, communication, and information systems for the home and office. In automotive and other integrated electronics systems (7% of sales), Motorola is recognized for its leadership in embedded "telematics," which enable automated roadside assistance, navigation, and advanced safety features for autos as well as integrated electronics used for powertrain, chassis, sensors, and interior controls.
Motorola's semiconductor business (about 10% of sales) is a major producer of embedded processing and connectivity products for the automotive, networking, and wireless-communications industries. Sales were up 21% in the first quarter. The company is scheduled to do an initial public offering of its chip business by the end of June and spin off to shareholders the remaining ownership interest before yearend.
Management remains cautiously optimistic about the economic recovery for information-technology products, especially in the areas of communications and related industries. We think the appointment of new CEO Ed Zander has stimulated improved execution, with various programs to accelerate the timely delivery of products with higher levels of quality. We believe Motorola can improve its cost structure and customer focus, as well as increase its brand recognition and investment in research and development.
We estimate earnings per share of 73 cents in 2004, up from our prior 50-cents projection. In late April, we raised our 2005 estimate to 86 cents, from 60 cents per share. Motorola has strong momentum for the June quarter and the rest of 2004, in our opinion, with all businesses expected to show double-digit sales growth.
If accounting rules change and companies are required to include stock-option expense in their income statement, our operating earnings outlook would be lower. Our Standard & Poor's Core Earnings analysis suggests our 2004 GAAP EPS estimate for Motorola of 81 cents would be reduced by 12 cents if projected stock-option expense and other adjustments such as pension costs were included along with one-time special items.
We believe Motorola has reached a new level of performance, with strong year-over-year results in the March quarter and a robust outlook for the June quarter. It's improving its competitive position in wireless handsets, wireless infrastructure, and the broadband business, in our opinion. We believe the planned IPO and spin-off are positive initiatives that should help realize Motorola's enterprise value.
Our investment recommendation and 12-month target price have several risks, in our view. These include macroeconomic conditions such as any prolonged period of weakness in global economics, potential market-share gains from handset competitors, less favorable trade policy in key foreign markets such as China, and any weakness in capital spending from wireless service providers, cable operators, and the automotive and government sectors.
Our discounted cash-flow model indicates a fair value of approximately $25 per share. Our model assumes a weighted average cost of capital of 12% and a terminal growth rate for free cash flow of 7% after year 15. Our assumption for approximately 22% cash-flow growth for the next five years followed by a gradual decrease to 10% in year 15 may prove to be too optimistic, considering the uncertainty and volatility of the telecom equipment industry. However, we expect Motorola's key lines of business to realize double-digit cash-flow growth over the next five years.
Our 12-month target price of $25 is also based on a sum-of-the-parts valuation and forward price-to-sales analysis. We see the planned IPO and spin-off of the semiconductor business as a catalyst to realize part of our $25 target price. With Motorola priced well below peers, at 1.4 times our 2004 sales estimate, we would buy the shares.
Note: Kenneth Leon has no stock ownership or financial interest in any of the companies in his coverage area. He's a registered representative of Standard & Poor's Securities, Inc. (SPSI). Affiliates of SPSI received non-investment banking compensation from Motorola during the past 12 months. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com
Analyst Leon follows wireless telecommunications stocks for Standard & Poor's Equity Research
Edited by Karyn McCormack