Google’s (NASDAQ:GOOG) acquisition of Motorola in 2012, was widely regarded as a defensive play against any patent litigation that it might face from companies such as Apple (NASDAQ:AAPL). Google also sought to use these patents to block competition and as a means of collecting payments from competitors that infringed on these patents. However, this strategy has not worked for Google as it has lost most of its patent lawsuits and made very little money on the ones that it did manage to win.
A recent U.S. court judgement determined that Google’s Motorola Mobility unit was not entitled to the $4 billion per year that it sought from Microsoft for the use of its standard-essential patents (essential patents are operations that confer with International standards such as mobile phone signal etc). Instead of the $4 billion per year value of Motorola’s patents, the judge decided that the appropriate payment was lower at $1.8 million. Despite this seeming disappointment, we are not worried about the lower valuation of Motorola’s patent portfolio since owning these patents is critical for protecting Google’s Android platform.
How Much Are Motorola’s Patents Worth?
While Google paid $40 per share in cash for the acquisition of Motorola, it received ~$9 per share cash ($2.9 billion) and ~$8 per share in deferred tax assets.  We therefore estimate that the value of Motorola Mobility was close to ~$7.1 billion. Recently, it sold off Motorola’s home division to Arris for $2.35 billion. Considering this sale, we estimate that Google paid ~$4.7 billion for Motorola’s 17,000 patents and mobile handset division. However, Google values the total patent portfolio at $5.5 billion according to June 2012 10-Q filling. ((June 2012 10-Q))
Considering the recently passed U.S. court judgement and the past failed attempts for using standards-related patents to block competitive products, it’s reasonable to assume that any patent related benefits to the purchase have vanished. We believe that the total value of patents might be substantially lower and Google will have to start writing these down in the coming years.
However Motorola Is Important For The Android Platform
Although, Google does not make money directly from the Android platform, Google is the search engine provided on Android phones. The mobile search ads division is one of the biggest divisions and contributes almost 35% to Google’s estimated value by our estimates. Even though mobile search ads are expected to only generate 17% of the company’s total revenues in 2013, we expect this to reach to ~27% by 2016.
Gartner has predicted that worldwide mobile ad revenue will exceed $24 billion by 2016, and that the growth rate for ad revenue will exceed 400% between 2011-2016.  We consider this a huge opportunity on mobile devices to be largely be captured by the operating system leaders in the mobile industry, primarily because of their ability to control the application ecosystem.
This is the primary reason why Google needs to protect its Android Platform against any litigation, and Motorola’s patent portfolio helps shield this platform from any such infringement challenges.
According to Gartner, Android leads the smartphone OS market with ~75% market share.  As smartphone penetration increases further, Google will benefit from the expected tremendous growth in smartphone usage. We currently estimate that the number of smartphones in use will increase from nearly 1 billion in 2012 to more than 2.6 billion by end of our forecast period.
Furthermore, we expect Google to continue dominating the mobile search market due to Android’s leadership. Currently, we estimate that Google’s mobile search market will decline from 93% in 2012 to ~89% by the end of our forecast period. If Android improves its market share further, we can expect Google’s search market share to stabilize at ~95%. This will result in 5% upside to our stock price estimate.
We currently have a $802 price estimate for Google, which is approximately 10% below the current market price.Notes: