InformationWeek

September 27, 1999

Taking Stock:
A Merger That Makes Sense

Motorola's acquisition of General Instrument puts it in a good position in the fast-growing broadband access market

William Schaff o-hum--another technology merger. It's almost getting boring these days. Must be too many investment bankers with nothing better to do. But strangely enough, Motorola Inc.'s merger with General Instrument Corp. actually makes strategic sense. The overall push into the fast-growing broadband access market makes the deal more logical than ever. I expect that this will be one of the strongest drivers of future growth for Motorola Inc. (MOT�NYSE).

Everyone seems to know a lot about Motorola's semiconductor and wireless businesses but very little about its broadband division. For example, Apple (AAPL� Nasdaq) investors have been having nightmares lately regarding Motorola's chip capacity and production woes (haven't we heard this refrain before?). Motorola has benefitted greatly from the growth of Nextel (NXTL�OTC), one of the leading independent wireless companies and supplier of derivative products such as handsets and infrastructure equipment. The company's only problem recently has been Iridium, the global wireless communications venture that Motorola has been trying to put behind itself as fast as possible.

Many investors have taken only a casual glance at the soon-to-be formed Internet and networking division that will house Motorola's current cable business and the newly acquired General Instrument. As an investor in General Instrument over the years, I've always believed that one day the set-top box would be used not only for cable access but for other product and information delivery as well. It seems that day has come--and the deal with Motorola goes a long way toward making this a reality. Motorola is already participating in the cable modem business. It will gain the immediate benefit of General Instrument's relationship with AT&T's cable subsidiary, TCI, and all the related cable entities, which are already well-established in the set-top box business. This makes Motorola a dominant player in this alternative broadband access space.

If that weren't enough, Motorola also will benefit from General Instrument's subsidiary Next Level, a major player in xDSL, the high-speed access technology over copper wire. If broadband is going to be delivered to the masses, it's clear that Motorola will have a say in almost all pathways into the home and many businesses. This would seem limiting if it only applied to data and video traffic, but it's clear that IP voice telephony over cable is also going to be developed. After all, we know AT&T is not content to win just Internet traffic.

Large mergers are not without risk. It's unlikely that shareholders will tie up the merger, and Securities and Exchange Commission and competitive issues seem to be minimal, but merger synergies are always suspect. Delays in integrating infrastructure, systems, and sales forces always seem to cause short-term disruptions. Obviously, Motorola is banking on AT&T's vision of cable and cable telephony service. This is a high-risk strategy for Motorola customers.

Under the terms of the deal, which should close by the first quarter of 2000, Motorola will pay .575 shares of its stock for every share of General Instrument. The deal will be accounted for under pooling, an accounting method that's being eliminated next year. General Instrument will have 214 million shares outstanding fully diluted. This translates into 123 million more Motorola shares on top of the 622 million shares already outstanding. The immediate impact on earnings will be dilution of around 15 cents next year, assuming no synergies.

If management is right about accelerating growth to the low to mid-teens next year and getting some cost synergies, the deal could actually be neutral to earnings per share the first year. As usual, I'll be conservative and say that the deal will have a slight negative impact to my original 2000 earnings-per-share estimate of $3.10--let's say $3.05. At $88, Motorola sells at a forward multiple of 29 times earnings--not cheap, but not a bad play for a strong technology franchise firing on most cylinders. If it fired on all cylinders, I wouldn't recognize the company.

William Schaff is chief investment officer at Bay Isle Financial Corp. in San Francisco, which manages the InformationWeek 100 Stock Index. You can reach him at bschaff@bayisle.com

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