Why Investors Aren't Dialing Motorola

You wouldn't know it from its stock price, but Motorola (MOT) has been on an upswing for much of the past year. Thanks to massive cost-cutting and growth in mobile-phone sales fueled by an aggressive marketing strategy, Motorola was able to battle back to profitability in the second half of 2002 after six quarters of losses. Its December, 2002, quarter -- when it posted stronger-than expected sales on 11% growth at its all-important handset division -- was a particularly nice surprise.

Yet the communications giant got no love from investors as a result and seems unlikely to anytime soon as it approaches the end of what's proving to be a lackluster first quarter. The stock has barely budged from this year's $8 floor -- even given the surge in the stock market in recent days. Motorola shares closed on Mar. 17 at $8.53, up only 49 cents, or 6%, from its Mar. 12 close, while the tech-heavy Nasdaq index has risen 9% over that time.

"Motorola is positioning itself for a strong comeback when the industry snaps back," says Jeff Kagan, an independent telecom industry analyst in Atlanta. "It's just hard to tell right now because growth in the industry has almost flattened out. There's a light at the end of the tunnel, but it's not this quarter."

TOO MUCH INVENTORY. Motorola will need to post a decent showing for the first quarter to win back credibility with investors, and that's going to be a high hurdle. Investors are focused mainly on its handset business, which delivered 40% of sales in 2002. Market trends there are proving weaker than hoped as consumer spending slows and competition heats up, especially from China. The average selling price of mobile phones is down, and excess inventory has built up. "That inventory needs to be cleared before companies can sell new handsets," says Ben Wood, senior mobile communications analyst at Gartner Dataquest.

According to Gartner's data, Motorola had 15.3% worldwide market share in 2002, up from 14.8% in 2001. But it didn't take any share away from Nokia (NOK), which commanded 35.8% market share in 2002 and 35% in 2001. Nor did it claim any from No. 3 Samsung, which claimed 9.8% of the market, up from 7.1% in 2001 (share gains for the top four suppliers came from weakness at small and regional manufacturers).

"Motorola is in a strong No. 2 position," says Wood, "but it needs to be looking over its shoulder at Samsung." To stay a solid second, Wood thinks Motorola, which is promising lots of innovative new handsets this year, will need to make sure that it delivers them on time to its customers -- wireless network operators, especially in Europe, the Middle East, and Africa. While concerned that Motorola may have lost market share at key customer Verizon this year, RBC Capital Markets analyst T. Michael Walkley says he believes the handset division will be able to meet its first-quarter estimates.

UNEXCITING CHIPS. Meantime, Motorola is combating ongoing weakness in the wireless infrastructure industry as the planned buildout of third-generation wireless systems, known as 3G, has been delayed. That division accounted for 17% of Motorola's 2002 sales. Nokia warned on Mar. 11 that its first-quarter sales would be disappointing because of weakness at its network-equipment division. And Ericsson (ERICY) is in the midst of installing a new management team to implement a massive restructuring plan that will confront ongoing weakness in infrastructure sales.

Motorola's third major division makes semiconductors (18% of 2002 sales), including communications chips sold to other cell-phone manufacturers, and is considered by analysts to be stable but unexciting.

At a Mar. 11 investor conference, Rob Shaddock, a general manager in Motorola's personal communications division, boasted that the company had top market share in handsets in greater China and North America (Gartner shows it basically neck-in-neck with Nokia there). While Shaddock conceded that selling prices had slipped a bit as competition in China has become more intense, he said inventory levels were "normal." (Motorola declined an interview request, citing its "quiet period" before its quarter ends.)

FASHION AND FEATURES. Most of Shaddock's prepared remarks, however, addressed Motorola's long-term strategy for strengthening its brand name, forging ever-stronger relationships with cell-phone carriers, and winning over new consumers with innovative phones. On Mar. 17 it announced two new handsets at the CTIA Wireless trade show in New Orleans -- the E310, which is optimized for interactive gaming, and the high-fashion V810.

Gartner's Wood believes that Motorola's emphasis on style and rich features will pay off for its handset business as the industry recovers this year. He notes that Motorola has shown a willingness to co-brand phones with carriers. That could help it compete against Nokia, which hasn't been as receptive to carriers' desire to put their own brands on phones.

Assuming that a war with Iraq doesn't lead to great geopolitical upheaval, Wood expects a mobile-phone replacement cycle to take hold in 2003, especially in Europe, driven more by appetite for new designs than by data-rich features. Even though Wood sees signs of first-quarter weakness, "that shouldn't lead to undue pessimism for the rest of the year," he says.

"MAJOR DISAPPOINTMENT." Motorola investors, however, have made it clear that they'll remain skeptical as long as sales look uninspiring. Even though profits jumped in 2002, thanks to cost-cutting, sales were down 11% from 2001 and are forecast to increase by only 3% in 2003, to $27.5 billion. Sales for the first quarter may not show even that much growth. When Motorola posted fourth-quarter results on Jan. 21, it forecast first-quarter revenues of $6 billion to $6.2 billion, flat to up 3% from a year ago -- and that was before industry trends showed signs of further weakness.

"That sales aren't growing from a depressed base is a major disappointment and suggests no top-line recovery is in sight," wrote Morningstar analyst Todd Bernier following that report. About the best Merrill Lynch could say in a Feb. 26 note is that "the right cost controls are in place, and the worst is behind us." It rates the stock a neutral.

Still, Bernstein Research analyst Paul Sagawa reported on Mar. 7 that communications technology companies, including Motorola, are showing better quality of earnings and stronger balance sheets. Even though Motorola has almost $9 billion in debt, Sagawa notes, the bulk of it isn't due until after 2005, by which time the industry should have recovered. But he concludes, "we believe near-term business catalysts for Motorola will be more negative than positive, and so we continue to rate the stock market-perform."

Even in a best-case scenario, the stock could have fairly limited upside given its valuation. Its price-earnings ratio based on its projected 2003 earnings is 24, yet its five-year growth rate is just 12%. For Motorola to really attract investors, it will have to surprise Wall Street in mid-April with better-than-expected results. With a weak first quarter likely looming, investors have so far been wise to take a wait-and-see approach. They could be waiting a while longer. By Amey Stone in New York

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