RealMoney Silver - Cash Flow Upturn Could Carry Motorola Upstream

Cash Flow Upturn Could Carry Motorola Upstream
By Bill Trent
RealMoney.com Contributor
9/10/2007 11:45 AM EDT

Editor's note: This is Bill Trent's debut column on RealMoney. Look for more of his commentary on technology and telecom stocks.

Though I consider myself a longer-term investor, I like to take a look at the stocks with unusual option activity on Stockpickr to see if there is anything sufficiently interesting to investigate further. Friday's list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT) , Arch Coal (ACI) and Yahoo! (YHOO) .

I dug a little deeper on Motorola, and came away thinking it might be worthwhile, even for those willing to wait longer than until October to see a return.

Motorola held an investor day Friday. It's hard to imagine that would produce an announcement worthy of a 20% up move. One could be forgiven for thinking there's only one such possible announcement: Ed Zander's resignation.

The company has struggled to match the RAZR's success, let alone one-up it. In Zander's own words: "In Mobile Devices, we did not achieve the level of sales and unit shipments that we had expected, primarily in Asia and the Middle East and Africa. Europe, as we have been saying all year, continues to be a challenge." The message boards are downright gruesome.

But if all it took for a 20% up-move in Motorola was a new CEO, the market could be accused of being awfully forgetful. After all, it was just four short years ago that the stock rallied 10% (from a far lower base) on the news that Chris Galvin was resigning to be replaced by Zander. It makes one wonder why Motorola keeps CEOs as long as it does; if I could get a 10% rally on every CEO firing, I'd say Motorola should do it at least once a year.

Zander is credited with putting the RAZR on the fast track and not much else. Why settle for anyone's second-best idea? Give them a few months to put their best one into action, then sayonara! It's time to find someone else, with a new best idea. Call it crowd-sourcing for CEOs.

In case you missed the sarcasm, color me skeptical that Zander's departure would do much for Motorola over the long term. And don't tell me it needs "compelling products" when Nokia (NOK) consistently produces the blandest, clunkiest, ugliest, bulkiest -- and best-selling -- phones on the market.

The analyst day highlighted a return to cash generation, which the company definitely needs in order for a turnaround to succeed, regardless of who is behind it.

Motorola generated cash flow from operating activity of $3 billion in 2004, $4.6 billion in RAZR-backed 2005 and $3.5 billion last year. For the last 12 months, however, it's down to $2.2 billion, $700 million of which went to capital expenditures. That's in the normal range; it could possibly be a little lower and improve free cash flow, but probably at least $500 million of the $700 million is absolutely required to keep up the existing plant.

Still, in a somewhat depressed year it's enough to make the free cash flow yield on Motorola's $35.6 billion enterprise value comparable with the current Treasury yield. All Motorola needs to do is get cash flow back to 2004 levels and today's investors will be compensated for accepting the risk.

If Motorola can get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there, I estimate the stock would be worth nearly $23, more than 25% above the current price. Management could do that pretty much just by trimming R&D expenses to the 2004 level (which was all they needed to produce the previous hit product anyway).

This scenario doesn't require Motorola to create the next RAZR, but if it did it'd be icing on the cake.

The obvious risk to this thesis is that cash flow could move in the wrong direction. It isn't hard to imagine possible scenarios where this would happen, especially given the lukewarm reaction the Street is giving the recent comments on cash flow improvement. It wouldn't be the first time a management team gave up on a promising strategy in order to give investors what they thought they wanted.

If you are a buyer on the cash flow story you'll probably want to run for the exits if the company announced anything that would eat up cash. Fortunately, however, Icahn is nipping at Motorola's heels. That might be enough to keep management from doing anything too rash.