I Cahn’t (turn Motorola around)

Motorola investors, Bento: I worry they are not too bright. Today Carl Icahn scored a major “victory” in his proxy battle against Motorola, effectively winning the war he started last year. Now he gets to stuff the board with his creatures and restructure the company. The stock is up modestly today, and this is almost certainly a mistake.

 

I blogged the story here almost exactly a year ago. Addressing Moto shareholders, I wrote

For god’s sake vote for Icahn; he probably knows nothing about handsets, and won’t be able to do anything to turn the company around for the next 6-9 months. But it will be the first step on the road to some degree of recovery for what has been, in the past, a great company, which employs thousands of people. Otherwise this nose-dive is only set to continue.

 As for me, unless something changes, I’m not buying Moto until it hits $11-12. It’s at $17 and change right now.

They didn’t of course, possibly because very few of them read Ultimi Barbarorum, and have no interest in Spinoza. Well, now MOT is at $9.80, and I still don’t own it. In fact, I’ve felt for some time that the decline has probably become terminal. Now I’m almost certain that Moto knows it too. How do I know this? Because they just handed Icahn the keys. 

 

Consider the evidence: Moto management has suddenly changed tune, previously holding off from full disclosure of its books, forcing poor Icahn to sue them only a few weeks ago, amidst the firing off of many bad tempered “open letters”, wherein Moto described the proxy battle as an “unnecessary distraction”. Things have clearly changed. Why now?

  • Firstly, the turnaround in attitudes to Icahn coincides with what seems to be a rather worrying slowdown in the overall handset market in the US and Europe, at the same time as aggressive and extremely sophisticated new entrants like Apple and Research in Motion are taking share. Not a good market to do any recovering in.
  • Secondly, I (and everyone else who can be bothered to look into this) have reliable intelligence from component contacts in Asia that something quite horrible may be about to happen to Moto’s handset volumes in Q1 and Q2 of this year. And no doubt Q3 and Q4, as well. Suspicious readers will note that has Moto rolled over for Icahn less than a week after Q1 ended.
  • Thirdly, the highly public search for a potential buyer for the handset division turned out badly. The only interested party left is this Indian outfit called Videocon who no-one has heard of and who – by the fact that they are interested in buying Motorola – clearly have no idea about the handset industry, q.e.d. Moto managers would rather spin handset off to shareholders for free than sell to these guys, it would seem.
  • Fourthly, and most importantly, the 2 big handset shows have been and gone: any big new model launches are going to ramp in 2H now. We now know everyone’s handset lineup for the next 6 months, and Moto’s is absolutely nowhere.

The problem is the handset market is one of the least forgiving sectors in technology, and there are precedents for this sort of thing. Of the 4 great original handset brands of the mid 1990s, Nokia, Ericsson, Siemens and Motorola, only two remain, and soon it will be one, Ericsson having ended up in JV with Sony and with less than 10% joint market share, and Siemens disappearing off the face of the planet, after briefly mating with BenQ and giving them a terminal social disease.

 

Handsets are about scale. You need to a) spend a lot of R&D and marketing in a highly intelligent and productive manner to continue a pipeline of product of sufficient depth and breadth that you can more or less guarantee a top selling handset all the time in the high, mid and low end, and you also need b) to sell enough phones to be able to buy enough components to get a bigger volume discount than the majority of your rivals, so as to have sufficient margin that you can spend enough on a). No prizes for seeing this is a self-reinforcing cycle. Once it is broken, it is a devil to get back. To make it worse, Moto has another problem, a negative brand image among handset dealers and retailers. They simply do not believe Moto can make a hit handset from here, and remember the huge inventory they were left with in Q1 2007 when Moto handsets stopped selling. Moto’s next handsets are going to have to be awfully good to be bought into by the channel.

 

Now this Icahn is supposed to be a canny old bird, but for the life of me I cannot think what he can do here, unless he is a highly talented handset designer. Were I him, I would try and engineer some sort of short squeeze in the stock so I could exit with some degree of intact honour, or try and do a deal with those weirdos at Videocon, and hope they’re serious and won’t notice when absolutely every single handset engineer jumps ship. But it will be hard, and any momentum he can generate will likely be offset by a barrage of negative short term newsflow as competitors take the rest of Moto’s 12% remaining handset market share at a rate of about 2-3% a quarter.

 

This is why I have reluctantly come to the conclusion that the most likely value attributable to Moto’s handset division is something less than zero, just as Siemens eventually ended up paying Taiwanese handset minnow BenQ EUR300m to take their loss-making handset division off their hands. As it was, Siemens handsets sucked up about EUR600m of BenQ’s money in restructuring and bankrupted BenQ. Now neither of them makes handsets. As of now, Moto handsets are likely heavily loss making, and it will be extremely difficult to shed costs as quickly as the division loses market share and revenues through the rest of this year. What is MOT stock worth if you took away the handset bit? What would remain would be the cable TV set top box-, and the government and enterprise mobility divisions. These are worth maybe $5-6 a share, I calculated recently.

 

From here poor Icahn (who started buying at $19), far from being the annoyance dogging Moto’s relatively new but apparently dastardly and cunning post Zander management, can become the rather useful patsy, because from here on in he gets to share the blame. Who knows, maybe he can even pull a rabbit out of the hat. If the handset unit lasts long enough for it to be spun off, maybe he can even take charge of it, leaving the current lot to look after the more profitable bits, and make some serious wonga, replacing their increasingly worthless MOT stock options with shiny new ones in Moto Newco.

 

Anyway, that’s what I think. If I am wrong I will hopefully change my mind quickly enough to make a lot of money owning the shares. Flexibility, Bento, is much more important than being right. Remember also, dear reader, not to sue poor Baruch if you go any short MOT and you get your face ripped off, because in no way does this blog post or any other on this site constitute investment advice.

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