Motorola Solutions Faces Top-Line Concerns In Q1; Margins Key

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Motorola Solutions

Motorola Solutions (NYSE:MSI) is expected to announce its Q1 2014 results on May 1st. The company has had a tough last few quarters, especially on the enterprise front, as businesses deferred orders and cut down on spending in response to the prevailing macroeconomic uncertainty. The bigger and more stable government business has been the saving grace for the company, despite some weakness in federal spending seen following the recent government shutdown in the U.S. Amid these uncertainties, Motorola has had a tough time providing revenue guidance, with the company decreasing its expectations three times last year before ending with flat revenue growth for the year.

Its Q1 guidance of a 4-6% drop in revenues was also somewhat disconcerting and increased uncertainty around its annual guidance for 2014. Motorola said that the anticipated Q1 decline is more of a timing issue rather than an overall decline in demand, which is why it expects sales growth in the subsequent nine months to be in the 2-4% range. To deal with the uncertain macro environment, Motorola is looking to improve margins by reducing costs and driving efficiency through operations. Last year, the company saw its operating margins increase by 30 basis points to 17.6% on healthy cost controls. Our $62 price estimate for Motorola is about in line with the current market price.

See our complete analysis for Motorola Solutions here

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Government Business Stable

Motorola’s government business has held up pretty well in recent quarters, growing by about 1% in 2013 despite the expiry of the narrowbanding deadline at the start of the year. Motorola’s government revenues in 2012 were boosted by 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 in 2012 was due to this increase in U.S. public safety spending. However, with the deadline for this transition passing on January 1, 2013, it was difficult for Motorola to emulate the same kind of growth in its government business last year.

What added to the tough y-o-y comparison was the government shutdown in the U.S. at the start of the fourth quarter. Motorola estimated the revenue hit to be about $100 million during the Q3 earnings call, but the actual decline turned out to be 50% higher. Moreover, since most of this shortfall isn’t deferred, it is unlikely that Motorola will realize any of these lost revenues in the coming quarters. Still, it is a good sign that despite the unexpected top-line hit, Motorola’s government revenues in the back half of last year were slightly up compared to the same period in 2012. The company expects government sales to grow in low-single digits in 2014, 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.

Steady Enterprise Recovery And Margin Expansion

Since government sales account for more than two-thirds of its overall revenues, Motorola is somewhat shielded from the effects of a tough macro environment. However, enterprises have proven to be more vulnerable to spending cuts across business verticals. The effect of the enterprise decline was felt acutely in 2013 since government revenues did not improve by much compared to an exceptionally good last year. However, this could change soon, as macroeconomic concerns subside and business spending on infrastructure returns. Motorola’s improved performance on this front in Q3 and Q4 could be a sign of a recovery in enterprise spending. Compared to a y-o-y decline of almost 5% in the first half of 2013, Motorola saw growth of 1.3% in enterprise sales in the latter half of the year.

Despite the challenging 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. The company has secured contracts with multiple major customers such as Wal-Mart in the U.S. and China Healthcare in China. It also launched the TC55, which is an enterprise-grade mobile computer with the form factor of a smartphone and runs on Android Jelly Bean. 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 helped margins improve year-on-year by 20 basis points last quarter. In 2014, the company expects margins to improve by almost a percentage point to 18.5%, 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.

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