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7/23/2004
03:55 PM
William Schaff
William Schaff
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Taking Stock: Restructuring Pays Off For Motorola

The handset division was instrumental in its solid 2Q results.

Remember 1993? The year included notable characters such as Lorena Bobbit and Beavis and Butt-Head. It also saw the premiere of Jurassic Park. In some respects, a lot has happened in the intervening 11 years. In others, change has been more muted. Like Motorola's stock price.

In mid-'93, it was trading at $15, just as it is today. In other words, Motorola's return to investors has been about 0%, a tad behind the S&P 500 index, up 143% for the same period. As a company, though, Motorola appears vastly improved relative to a few years ago, I believe.

Motorola has restructured as profitability lagged far behind its peers. The financial situation worsened so much that the company had to assure investors it could service its debt. This is all past as Motorola reported a jump in revenue of 41% for the second quarter of '04 relative to a year ago. The company said it expects revenue to grow by 25% to 30% in the third quarter. The profitability improvement was even more impressive as operating margins before charges rose from a meager 2.0% to 9.9%. While all divisions contributed to the solid results, its mobile-phone handset division (nearly 45% of second-quarter revenue) was pivotal. The division finally is delivering handsets consumers want, combined with a cost structure that makes them profitable. Revenue in this division grew nearly 67% in the second quarter from a year ago. Motorola, which has been taking market share from industry leader Nokia, is selling more high-end cell phones with features such as built-in cameras leading to flat average selling prices during the quarter. In comparison, most competitors have seen average selling prices decline. Motorola has struggled to turn a profit from its handset business but posted a 10.2% operating margin this quarter, up from 3.9% a year ago.

It's also worth highlighting the telecom infrastructure business (nearly 17% of second-quarter revenue), which posted revenue growth of 38% relative to a year ago. Motorola expects increased spending from telecom carriers. The improvement in profitability also was pronounced for this division as operating margins expanded from 1.8% in the year-ago quarter to 14.4% this quarter, above the 10% to 12% that's the company's long-term profitability goal for the telecom equipment division.

Investors seem uncertain how sustainable these nice profits are. If the current operating margin for the telecom equipment division is above that of the target long-term goal, that would imply a drop is likely. Decreases in profit margins are generally not viewed favorably by investors. For its handset division, fears are that Nokia will lower prices further in order to capture market share. If the price drops are steep enough, I believe Motorola is likely to hurt.

Motorola is finally delivering good financial results under new CEO Ed Zander, but the stock is hardly cheap, in my view. Using price-to-sales and price-to-book multiples, the stock looks to be trading around the middle of its historical range. At 19 times this year's consensus earnings estimate, it doesn't appear overwhelmingly cheap either, in my opinion. If the stock were to drop to the low teens, that would be a different story.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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