Motorola Solutions (NYSE:MSI) announced a mixed set of Q3 results on October 23, as the company decreased its revenue guidance for the third time this year, but continued to expand operating margins on healthy cost controls. Revenues in the third quarter declined about 2% over the same period last year, mostly due to unexpected weakness in federal spending towards the end of the quarter which preceded the recent government shutdown in the U.S. Motorola said that this led to a reduction of about $100 million in its full year-year revenue forecast. The company therefore expects revenues for the year to be flat as compared to last year, down from the earlier guidance of 0-1% growth in July and 3-4% in April.
However, while enterprise sales continued to be weak, the segment showed signs of improvement with its first y-o-y growth in several quarters. Revenues from enterprise customers increased 2% over the year-ago quarter – most of which was, however, due to the Psion acquisition which was completed in Q4 last year. Excluding Psion, enterprise sales declined 5% y-o-y, but that was still an improvement over the 12% y-o-y declines seen in the preceding quarters. A gradual recovery in the enterprise market, together with the ongoing management efforts at reducing costs and driving efficiency through operations, helped the company improve its operating margins by 80 basis points y-o-y and maintain its guidance of 18% for the full year. We have also revised our margin estimates upward in the near term to account for the company’s increasing operating leverage. Our revised $59 price estimate for Motorola is about in line with the current market price.
Narrowbanding Cliff Is Seeing Government Growth Slow…
Motorola’s last fiscal year was a solid one, as government business posted y-o-y revenue growth rates in excess of 10% each quarter. While the company started 2012 cautiously, setting guidance of only 5% growth for the full year due to macroeconomic uncertainty surrounding the Euro debt crisis, government spending held up pretty well. However, a portion of the outperformance last year was due to the narrowbanding mandate issued by the Federal Communications Commission (FCC), which necessitated a switch to a more efficient spectrum band for public safety operations. About 3% of the full year growth in government revenues was due to this increase in U.S. public safety spending. However, with the deadline for this transition passing on January 1, 2013, Motorola has found it tough to emulate the same kind of growth in its government business this year.
As a result, Motorola’s government revenues have been flat this year in the three quarters so far, unlike the double-digit growth rates posted last year. The company expects growth in this segment to return in Q4, which should sustain itself in the next year as well, unless federal spending weakens further. The downside in this case is also limited by the fact that public safety is usually down the priority list of areas in which governments will look to cut their spending. As a result, we see any impact to government revenues from sequestration, or the spending cuts that the federal government started implementing recently, being fairly muted.
…Accentuating Enterprise’s Weak State
Since government sales account for about two-thirds of its overall revenues, Motorola was shielded from the effects of a tough macro environment in 2012. On the other hand, enterprises have proved to be more vulnerable to spending cuts across business verticals. The effect of the enterprise decline is only being felt more acutely this year since government revenues are not improving by as much compared to an exceptionally good last year. This could change soon, however, as macroeconomic concerns subside and business spending on infrastructure returns. Motorola’s improved performance on this front in Q3 is a sign of the enterprise recovery that the company had guided for in the second half of the year.
Despite the tough environment, the company is focusing on maintaining market share within the enterprise segment through important acquisitions such as Rhomobile in 2011, and the more recently completed Psion. The company has already leveraged its Rhomobile acquisition to launch an application framework targeted at enterprise developers and promote sales of its rugged handheld devices. The Psion purchase will help it expand globally and strengthen its mobile computing portfolio. We see Motorola’s enterprise focus helping it tide over the near-term macroeconomic concerns while preparing itself for the high future demand for enterprise mobile computing devices.
It is also a good sign for the future that the company has been successful in driving efficiency through its operations, which have helped margins improve from 18% in the year-ago quarter to 18.8% this year. For the full year, the company is confident of achieving operating margins of 18%, which is a growth of 70 basis points over last year. The company also expects to increase its margins by another 100 basis points next year, benefiting from not just the cost controls in place but also an expected recovery in enterprise spending. Over the longer term, however, we expect margins to decline as competition rises in the coming years from rivals increasingly addressing the ongoing transition of public safety networks from analog to digital in the coming years.