Motorola on Our Downgrade Watch

“Motorola trying it turn it around. Trying it turn the ship around. Think Royal Caribbean here. They lost a penny the street thought 4 cents so Motorola up big on earnings.” — Fox Business Network 7/30/2009

Motorola (NYSE: MOT) has seen shares surge as much as 12% this morning as the company pulled out a surprise profit in the second quarter. Primarily known for their production of mobile phone devices, the company has steadily lost market share for the last few years and sales continued to struggle last quarter. Motorola’s quarter was saved, as with so many other firms that have beaten earnings recently, by aggressive cost cutting measures among them about 8,000 layoffs already this year. The company earned $26 million or EPS of 1 cent, which is an improvement over the company’s $4 million net income a year ago. The results beat analysts estimates that had forecasted a loss of about 4 cents per share, and Motorola sounded an upbeat tone in the release saying that they expect things to continue improving through the rest of the year.

Shares of Motorola have already appreciated more than 60% so far this year, but that performance has not come with improving fundamentals as much as with general macroeconomic trends. Sales for the last quarter were atrocious falling 32% versus a year ago to $5.5 billion from $8.1 billion, as Motorola has fallen behind competitors for the must-have handheld devices. Motorola has not been able to recapture anywhere near the market share that they held with the Razr device that was extremely popular four years ago. Double digit sales declines have been the norm ever since, as the stronger competition of smart phones have arrived and dominated the scene. The last time we wrote about Motorola in August of 2008 (Goodbye, Moto?) it had just lost its spot as the second largest cell phone maker by shipments to Samsung. In less than a year, Motorola has dropped another spot to a distant 4th in the pecking order behind Nokia (NYSE: NOK), Samsung, and now LG Electronics.

Consumers have shown that they want the convenience and connectivity that smart phones offer and the early adopters like Research and Motion (NASDAQ: RIMM) and Apple (NASDAQ: AAPL) have cemented their places in the industry. Now, companies like Motorola are left playing catch up, and Co-CEO Sanjay Jha says that Motorola will have two new smart phones on the market by the holiday shopping season. The company is shifting allegiance to have the phones operate on the Google’s (NASDAQ: GOOG) Android platform rather than Microsoft’s (NASDAQ: MSFT) Windows Mobile. The smart phone market is getting more and more crowded, but we will wait to see how consumers react to the devices before drawing conclusions. At this point, Jha expects the cell phone unit will become profitable at some point next year. Motorola’s other divisions will have to carry the company forward until that time.

Even with Motorola’s relatively low share price we still are not considering this a good value stock given the significant erosion of fundamentals. There is no doubt that Motorola has missed the mark on its smart phones up until this point, which does not mean that the company cannot recover but it does make it far more challenging. Earnings have not been impressive and have bounced around break even since 1Q 2007; about the only thing that investors could count on from Motorola over this period is declining sales performance. Given the bounce that the stock got today based on still fundamentally unimpressive results, we will have to review our Fairly Valued rating on MOT for possible downgrade to Overvalued for next week’s report.

Motorola on Our Downgrade Watch

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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