Google Wins Motorola Battle, but Shareholders May Lose the War (Update 1)
Updated to reflect additional analyst commentary starting in third paragraph
NEW YORK (
) --
Google's
(GOOG) - Get Report
success in snaring approval by regulators on its $12.5 billion purchase of
Motorola Mobility
(MMI) - Get Report
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.
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"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) - Get Report
and
Microsoft
(MSFT) - Get Report
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.
But a quarters worth of revenue figures may mask what Google sees as a successful build out that has laid the foundation for what may become a more diverse, adaptive and dominant search business.
"Google wants to maintain its position as searches and Internet usage in general migrate to mobile devices. So far, Google has been very successful, with mobile market share around 95% compared to 65% on computers. CPCs have been lower on mobile search, but this could change as mobile provides highly targeted users," says Clayton Moran an analyst at brokerage the
Benchmark Company
.
Even if the change to mobile won't be a boost to earnings in the near-term, it nonetheless was a necessary shift to match ever-changing Web habits. Only a few years ago, Google could count on Web searchers sitting at their desktops and laptops to account for over 98% of its revenue, just as competitors portal platforms by
AOL
(AOL)
and
Yahoo's
(YHOO)
combined search and portal business faltered.
Credit Page, Schmidt, co-founder Sergey Brin and in-house mobile guru Andy Rubin for staying adaptive and building out a dominant smartphone platform, in reaction to the immensely popular iPhone. Google's competitiveness in mobile after all is a key to the 2011 Silicon Valley patent M&A wars and its Motorola Mobility buy.
"Motorola also has a strong patent portfolio, which will help protect Android from anticompetitive threats from Microsoft, Apple and other
s," said Chief Executive Larry Page when announcing the deal. Antitrust regulators came to agreement, although Page and Google needed to make assurances that watered down a direct earnings justification for the buy. "We built Android as an open source platform and it will stay that way," said Page in August. Google pledged to license Android to Motorola as if it were any other customer, without exclusivity after the merger.
The
European Commission
and
Department of Justice
approved the purchase, stating that Google's patent purchase wouldn't harm smartphone competition, where Google's Android operating system commands a dominant market share. However, with the purchase, Google committed to an "entente" on any smartphone push, which may be a relief to competitors like Apple and Microsoft. The company won't be changing its policy of giving away its Android operating system to handset makers, while it's also not expected to develop Google handsets or wrench out higher licensing rates from Motorola Mobility.
The decision "does not mean that the merger clearance blesses all actions by Motorola in the past or all future action by Google," the statement said EU competition commissioner Joaquín Almunia. The DoJ added that Google is unlikely to change Motorola Mobility's patent licensing, in its approval.
In its ruling, the DoJ also approved a $4.5 billion sale of
Nortel's
patent portfolio to
Research In Motion
(RIMM)
, Apple, Microsoft
Sony
(SNE) - Get Report
and
EMC
(EMC)
on grounds that the not use patents to block competitor product rollouts or charge exorbitant license fees.
There is potential for significant licensing revenue for the 17,000-plus patents in Motorola Mobility's portfolio, but Google is unlikely to go after a monetization path that would make the deal an earnings boost. "I doubt Google wants to enforce the patents; what it hopes to do is use the threat of enforcing them to protect Android from the Microsoft and Apple suits," says Mark Lemley of Stanford Law School.
Cases with big Android implications are coming to a nexus. In December, Apple won a patent lawsuit against HTC forcing the Taiwanese smartphone maker to stop importing phones that infringe on patents by April. Last week Apple went after Samsung's Galaxy Nexus smartphone on some if its voice command and device lock features. The suits signal that while Motorola Mobility may help Google, threats to its Android ecosystem persist.
While European Commission and U.S. regulators are likely to watch Google with a close eye, it doesn't mean there isn't a war brewing with Apple in tech devices.
"We believe GOOG could potentially use MMI's Home Business to develop set-top boxes that could help to bring Google into the living room, and potentially give it more leverage in its bid towards providing a more robust platform for professionally produced independent content through YouTube", wrote DiClemente of Barclays Capital. That comes just as the
about a 2012 Apple TV launch.
Meanwhile, Pyykkonen of Wedge Partners also says that opportunity is now ripe for a branded Google Tablet device, a market that's been dominated by Apple and only partly being challenged by
Amazon's
(AMZN) - Get Report
Kindle. At the 2012 Consumer Electronics Show, Pyykkonen noted that few tech players were marketing Tablets after companies like
Hewlett Packard
(HP) - Get Report
gave up on 2011 plans.
It means that even if Page is playing an Android defense that can be a boost to search revenue and margins in future quarters and years, Google's Motorola Mobility buy may still crank up the device competition against Apple.
Analysts polled by
Bloomberg
give Google an average price target of $711 and a price target of $575 for Apple.
Interested in more on Google? See TheStreet Ratings' report card for
this stock
.
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Tech Trends
.
-- Written by Antoine Gara in New York
