Motorola Solutions (NYSE:MSI) announced a mixed set of Q4 2013 results January 22nd, as disappointing guidance for first-quarter sales overshadowed what was otherwise a solid quarter. Revenues in the fourth quarter increased by about 2.6% over the same period last year and non-GAAP operating margins expanded y-o-y by 120 basis points on healthy cost controls. The top-line growth was driven mostly by government sales, which grew by 3.5% over the year-ago quarter, despite taking a higher-than-expected $150 million hit due to weakness in federal spending following the recent government shutdown in the U.S. The smaller enterprise business continued to reel under the effects of companies deferring orders and cutting down on spending, but is starting to show signs of recovery with its second consecutive y-o-y growth in several quarters. Revenues from enterprise customers were almost flat as compared to last year.
However, the company’s Q1 guidance of a 4-6% drop in revenues was somewhat disconcerting and increased uncertainty around its annual guidance as well, given that the company revised its revenue estimates downward three times last year. 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. We have a revised $62 price estimate for Motorola, about in line with the current market price.
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Narrowbanding cliff hurts 2013 revenues
Motorola’s government business has held up pretty well in the past year, growing by about 1% over 2012 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, Motorola found it tough 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 Q4. 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. Still, it is a good sign that despite the unexpected top-line hit, Motorola’s government revenues in the back half of the year were slightly up as 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. This could change soon, however, as macroeconomic concerns subside and business spending on infrastructure returns. Motorola’s improved performance on this front in Q3 and Q4 is a sign of the enterprise recovery that the company had guided for in the second half of the year. 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 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. 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 from 19.5% in the year-ago quarter to 19.7% this year. For the full year, the company’s operating margins increased by only 30 basis points to 17.6%. 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.