A Look At Some Of The Trends Impacting Motorola Solutions

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Motorola Solutions

Motorola Solutions (NYSE:MSI) stock has had a mixed year, remaining essentially flat since early January. While the company is expected to expand its operating profitability and EPS, driven by strong operating cost reductions and share repurchases, its bread-and-butter land mobile radio (LMR) business faces significant risks in the medium-term. In this note, we take a look at some of the key trends impacting Motorola Solutions.

We remain neutral on Motorola Solutions, with a price estimate of $86 per share.

See our complete analysis for Motorola Solutions

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Services Are Providing A Boost To Stagnant Products Growth

While the company’s top line has largely leveled off, amid weaker product sales, the service division has provided a boost of sorts. The division provides end-to-end solutions ranging from implementation, optimization, and integration of networks, devices, software, and applications to technical support and hardware maintenance. Over the first half of 2017, service revenues have increased by about 9.5% year-over-year to $1.23 billion, driven partly by acquisitions and new contract wins.  The company acquired Airwave – a British communications company which operates the network for the country’s emergency services –  in 2016. Motorola also announced a deal to acquire Kodiak Networks, which offers broadband push-to-talk technology to commercial customers and completed its purchase of Interexport, a Chile-based managed services provider. The company’s services backlog remains strong at about $6.9 billion, up $61 million from last year. While the services division does have lower gross margins compared to the products segment, it could nevertheless allow consolidated operating profits to continue to expand.

EPS Growth Driven By OpEx Reductions, Share Repurchases

While Motorola’s top line has faced pressures, the company’s operating margins have been trending upwards amid a significant reduction in operating costs. Over the last two years, Motorola’s selling, general and administrative expenses have declined by over $180 million, standing at around $1 billion in 2016.  R&D expenses also declined by $120 million over the same period, to about $550 million, amid headcount reductions and the company’s decision to shift employees to lower cost work sites.  This allowed the company to improve its operating margins to roughly 18% last year. Motorola is projecting further OpEx cuts this year, though the magnitude of the declines could moderate going forward. Motorola has also been buying back shares, with its remaining buyback authorization standing at about $1.9 billion. The continuous buyback activities are helping the company magnify the impact of its increased operating income. Motorola’s consensus EPS per Reuters is projected to increase by about 9% year-over-year in 2018.

LMR Cash Cow Faces A Threat As U.S. Builds Out FirstNet 

Motorola’s land mobile radio (LMR) sales to U.S. government agencies account for a significant portion of the company’s revenues and a bulk of its profits. The business has proved very stable for Motorola;  switching costs have been quite high for customers, as interoperability for LMR systems is low, with customers reluctant to experiment with other vendors given the mission-critical nature of their work. However, this business now looks somewhat vulnerable to disruption, as the U.S. government has started to build out an independent, interoperable communication system for first responders called FirstNet. The FirstNet system will support handsets and other devices from a host of vendors who can build on its standard,  bringing about significant competition and a more level playing field for device suppliers. While Motorola will make devices for FirstNet, they are unlikely to be anywhere near as profitable as its LMR radios. For instance, FirstNet devices are expected to sell for hundreds of dollars, instead of the thousands that Motorola charges for its traditional two-way radios. This could impact Motorola’s hardware gross margins, which currently stand at over 50%. (related: Will FirstNet Disrupt Motorola Solutions’ Cash Cow?)

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