Google Wins Motorola Battle, but Shareholders May Lose the War (Update 1)

Updated to reflect additional analyst commentary starting in third paragraph

NEW YORK (TheStreet) -- Google's(GOOG) success in snaring approval by regulators on its $12.5 billion purchase of Motorola Mobility(MMI) is an important battle victory in Silicon Valley, but industry analysts argue that it may point to a costly Cold War of attrition that will sap earnings power from the search- engine giant over the long term.

The unpredictability of Motorola Mobility's patents in future litigation, its projected dilution to Google's profit margins and overall acquisition size are cause for concern that the deal may be a major misstep for first year CEO Larry Page.

"This is not a deal with financial motivations in the near term. This is a deal for the long term sustainability of Google's mobile franchise," says Herman Leung an analyst with the Susquehanna International Group. That's because the company will pick up 18 patents already identified out of a portfolio of thousands that can be used to ward off infringement litigation from the likes of Apple, Leung adds.

"We think the biggest optical change for investors will be EBITDA margins, which would become significantly lower for the overall company," wrote Barclays Capital analyst Anthony DiClemente about Google's purchase of Motorola Mobility in a note following the European Commission's approval on Monday. Diclemente estimates that Google's earnings before interest, taxes, depreciation and amortization will fall to 40.9% from 55.2% prior to the acquisition on the Motorola Mobility's higher expense businesses.

Outside of profit margins, there are other risks to the acquisition such as Motorola Mobility's declining market share of wireless devices and phones, which "should begin to rapidly decline over time," according to DiClemente. Motorola Mobility is expected to add $13.2 billion in 2012 revenue, but Diclemente questions whether any profits will ever emerge. Motorola Mobility has lost money in each of its last four calendar years. DiClemente gives Google an "overweight" rating with a $700 price target on an expected $43.77 in 2012 earnings per share.

For Google co-founder Larry Page, the acquisition represents his first spar with regulators and his biggest management test yet after taking the reins as Chief Executive from Eric Schmidt in April 2011. With Motorola Mobility, Google will manage an additional 19,000 employees with hardware experience outside of the software expertise that's made Google a Web titan.

"I think it will be a big test. Google has never done this before," says Martin Pyykkonen an analyst with Wedge Partners about the Motorola Mobility integration for Page, citing the size of the company's operations, its higher cost structure and lower profitability.

Nevertheless, DiClemente and Pyykkonen see clear benefits, highlighted by Google's interest in protecting its Android operating system from patent litigation threats that could lead to user outflows.

Mountain View, Calif.- based Google is defending its Android smartphone ecosystem that extends to handset makers like HTC, Samsung and Motorola Mobility against claims by older tech giants like Apple(AAPL) and Microsoft(MSFT) that it infringes on their touch, antenna and positioning functions. That Android ecosystem is a push by Google to keep its core search functions relevant, even if consumers ditch desktop computers and laptops for smartphones and tablets.

To keep its search business dominant in a mobile world, Google bought Android in 2005 and since developed it to be the world's leading smartphone operating system, with a near 60% market share. A tremendously popular O/S, the Android strategy to move search horizontally onto mobile devices isn't certain to pay off in an earnings boost.

An open source company in its DNA, Google is also committing to not developing a closed-end smartphone device and operating system platform to match Apple $24.4 billion iPhone powerhouse.

Google missed fourth quarter earnings on falling costs per click on its search business and the lower rate paid to mobile clicks. The company's paid clicks rose 34% in the fourth quarter compared 2010, but the amount advertisers paid for each click fell by 8%, hitting revenue.

Google shares are off over 6% in 2012 after rising nearly 10% in 2011. Currently, shares sit at $605.66 in late afternoon trading.

"The bottom line is that we believe mobile provided about 25% of the [cost-per-click] decline, emerging markets about 25% and product mix shift about 50%... [These] factors, particularly the shift to mobile and new products, may continue to weigh on CPCs, but should be offset by continued strong growth in paid clicks," wrote Piper Jaffray analyst Gene Munster in a note following Google's Jan. 19 earnings. "We also believe mobile CPC rates are around 40% less than desktop CPCs," he added.

Munster cut his price target for Google from $675 to $612.20 on the earnings miss, but maintained his "overweight" rating for the company's stock.