Motorola Solutions (NYSE:MSI) is scheduled to announce its Q4 earnings on January 22. The company has decreased its 2013 revenue guidance three times already, and will enter this earnings call with flat revenue growth expectations set for the full year – down from 3-4% set in April. Most of the recent weakness in top-line growth was due to the government shutdown in the U.S., which hit federal spending and caused Motorola to reduce its full-year revenue forecast by about $100 million. 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. However, the company’s Q4 results are likely to have benefited from traditional fourth-quarter seasonality in its government business, which accounts for almost 70% of its total revenues.
The enterprise side of Motorola’s business has been reeling under the impact of macroeconomic uncertainty, which has caused customers to defer their spending or break their bigger orders into smaller ones. However, while enterprise sales continue to be weak, the segment showed signs of improvement in Q3 when it recorded 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. To deal with the uncertain macro-environment, Motorola has been looking to improve margins by reducing costs and driving efficiency through operations. As a result, the company expects to improve 2013 operating margins by 70 basis points over the previous year.
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Government Business To Return To Growth In 2014
A big reason for Motorola’s lackluster top-line growth in 2013 was the expiry of the narrowbanding deadline at the start of the year. Motorola’s government revenues in 2012 had received a boost from 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 in the last few quarters.
As a result, Motorola’s government revenues were flat in the first three quarters of 2013 as compared to the same period last year, 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 2014 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.
Steady Recovery In The Enterprise
While government revenues are somewhat shielded from the effects of a tough macroeconomic environment, enterprises have proved to be more vulnerable to spending cuts across business verticals. With the government revenues not improving by much as compared to an exceptionally good 2012, the effect of the enterprise decline is being more acutely felt. However, this could change soon as macroeconomic concerns subside and business spending on infrastructure returns. Motorola’s improved performance on this front in the third quarter is a sign of the enterprise recovery that the company had guided for in the second half of the year. We will be looking at the Q4 results for signs that the enterprise recovery can be sustained going forward or not.
Despite the tough business environment, Motorola has been focusing on maintaining market share within the enterprise segment through important acquisitions such as Rhomobile in 2011, and Psion in 2012. 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 helped Q3 margins improve to 18.8% from 18% last year. For the full year 2013, Motorola 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 this 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.