Is The Motorola Solutions Rally Justified?

Motorola Solutions’ (NYSE:MSI) stock has rallied by close to 20% this year, touching multi-year highs of as much as $112 over the last few weeks. There have been multiple factors contributing to the rally, including strong land mobile radio (LMR) sales, a growing services backlog and the company’s recent track record of reducing operating costs. However, we are maintaining our $89 price estimate for the company, due to risks relating to its core LMR business, which faces a threat of being disrupted by the FirstNet system that the U.S. government is building out. In this note, we take a look at some of the key factors that have contributed to the run-up in the company’s stock price and why we remain cautious on the stock.

We have created an interactive dashboard analysis outlining Motorola Solution’s expected performance over 2018.

Recent Traction In Product And Services Business

Motorola Solutions’ products segment has seen significant traction, driven partly by demand for LMR products and services from public safety and commercial customers. During Q1, product sales expanded by 14% year-over-year, and the company increased its sales growth outlook to 14% this year, up from the prior outlook of about 11%. Motorola Solutions’ services business has been growing as a percentage of overall sales, driven partly by the company’s acquisitions in the managed and support services space as well as growth in software sales. The services backlog stood at $7.9 billion at the end of Q1, up by $973 million, or 14% versus last year. Motorola has also been gradually reducing its operating cost base. Between 2015 and 2017, the company cut its SG&A and R&D expenses by roughly 6%, with its gross margins largely holding steady. That said, margins could see some pressure in the near term, as the company sees a greater mix of services sales, which have lower margins compared to its LMR sales in the U.S. Moreover, the company is likely to incur some costs relating to its recent acquisitions.

The Company Still Faces A Long-Term Threat

Motorola’s LMR sales to U.S. government agencies account for a significant portion of its revenues and a bulk of its profits. The business has proved stable for Motorola, and switching costs have been fairly 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 appears to be potentially vulnerable to disruption, as the U.S. government has started to build out an independent, interoperable communication system for first responders dubbed FirstNet. The FirstNet system will support handsets and other devices from a host of vendors who can build on its standard, potentially bringing about significant competition and a more level playing field for device suppliers. While Motorola also intends to 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 in the U.S. for its traditional two-way radios. This could impact Motorola’s hardware revenues and gross margins, which currently stand at over 50%. (related: Will FirstNet Disrupt Motorola Solutions’ Cash Cow?).

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