MOTOROLA SOLUTIONS INC MSI
May 16, 2012 - 3:45pm EST by
clark0225
2012 2013
Price: 49.00 EPS $2.61 $3.11
Shares Out. (in M): 305 P/E 18.8x 15.8x
Market Cap (in $M): 14,925 P/FCF 19.1x 17.7x
Net Debt (in $M): -2,237 EBIT 1,373 1,470
TEV ($): 13,206 TEV/EBIT 9.6x 9.0x

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  • cost reduction
  • Share Repurchase
  • Telecommunications
  • Government contractor
  • Electronics
  • winner

Description

Motorola was written up twice as long ideas in 2010.  Gary9 wrote up MOT in June of ’10 as a Sum of the Parts.  ValueGuy wrote up MSI (Motorola Solutions, the legacy non-handset business) in December of ’10 as an inexpensive industrial company with capital structure catalysts.  MSI turned out to be a good investment – from December 23, 2010  to today MSI is up 32% versus up 6% for the S&P 500.

I believe that MSI is more compelling today than it was then, and I’m recommending it (again) as a long.

If you already know the story, start here, if not, skip down to the “thesis” section.

WHAT’S CHANGED?

Positives

-          MSI’s two segments have produced record revenue (Government grew 4.3% organically in 2011, and Enterprise grew 11% organically, ex iDEN )

-          Sales leverage and expense reductions led to record margins in 2011 (280 bps of consolidated margin expansion)

-          The company has exceeded guidance and consensus every quarter since the split

-          MSI generated $900 million of free cash flow in 2011 (ex voluntary pension contributions), excluding all working capital FCF was $1.25B

-          MSI has announced $3B in share repurchase authorizations, of which $2.5B has been spent (16% of the float, at $45 per share)

-          MSI initiated an 88c dividend last year (1.8% yield)

-          The so called “narrow banding” tailwind thesis in Government has begun to play out (becoming more significant this year, with 11% Government growth in the first quarter)

-          In February, the US Government agreed to fund the nationwide rollout of a First Responder LTE Network with an initial $7B over 10 years (funds 80% of the cost, implying $9B of total spending)

-          The Enterprise business continues to benefit from the secular trend towards supply chain and inventory efficiency with some large retail wins announced in 2011

Negatives

-          Low interest rates at the end of 2011 caused a jump in the pension unfunded status (to $2.6B, from $2.4B), which has increased the annual cash contribution requirements by ~$70m

THESIS

MSI is worth $60+ today valuing the business at 14x 2013 EPS of $3.80, plus year end net cash and cumulative dividends of $10.00.  I expect earnings to compound in the low 20%’s for at least the next four years  through a combination of 1) mid single digit growth in the core businesses, 2) Incremental revenue growth from LTE, and 3) massive, continued, relentless, share repurchase activity.  Specifically, I expect the company to repurchase an additional $6B of its shares over the next three and a half years (an additional 30% of outstanding).  Earnings growth should lead to 20%+ annual returns in the stock.

FINANCIAL SUMMARY

2010

2011

2012E

2013E

2014E

2015E

 

 

 

 

 

 

 

 

 

Revenue

 

 

7,871

8,203

8,618

9,258

9,824

10,419

Growth

 

 

 

4.2%

5.1%

7.4%

6.1%

6.1%

 

 

 

 

 

 

 

 

 

EBITDA

 

 

1,231

1,539

1,635

1,871

2,082

2,305

Margin

 

 

15.6%

18.8%

19.0%

20.2%

21.2%

22.1%

 

 

 

 

 

 

 

 

 

EPS (Actual Shares)

 

$1.95

$2.61

$3.11

$3.98

$4.99

$6.27

FCF per Share

 

$1.85

$2.99

$3.28

$4.23

$5.38

$6.85

 

 

 

 

 

 

 

 

 

Share Count (Actual)

337

318

283

258

227

199

Share Repurchases

 

0

1,110

1,890

1,500

2,000

2,000

                 

VALUATION

 

   

2012E

2013E

2014E

2015E

 

 

 

 

 

 

 

 

 

EPS (Average Shares)

 

 

$3.12

$3.79

$4.67

$5.85

Multiple

 

 

 

 

14 x

14 x

14 x

14 x

Value

 

 

 

 

$43.71

$53.08

$65.44

$81.92

 

 

 

 

 

 

 

 

 

Plus: Cash

 

 

 

$8.73

$7.34

$4.14

$0.50

Plus: Cumulative Div

 

 

$1.19

$2.63

$4.38

$6.58

PRICE TARGET

 

 

 

$53.63

$63.05

$73.96

$89.00

THE BUSINESSES - GOVERNMENT

Motorola Solutions operates two unique businesses reported as separate segments.  The Government segment (65% of revenue, 60% of EBITDA) sells communication systems primarily to first responders globally.  MSI dominates this market with 80%+ of the share (very consistent over time).

Communications systems sold to first responders is somewhat of a razor / razorblade business.  Motorola will bid contracts for a total communication system within a municipality (for example), providing everything from planning and design to infrastructure construction and training, all of which are relatively low margin sales. 

Once a network is built, municipalities begin to “add” radios / devices, which are significantly higher margin.  In a typical contract, radios are a small percentage of initial revenues (~15%) due partly to the size of the system (in terms of dollars) vis-à-vis the cost of the radios, but also due to the fact that the deployment of radios happens generally over a longer period of time.  Again, in a typical situation, MSI will sell a small number of radios to a municipality on the implementation of a new network.  Initially, counties / cities will roll out only a small number of radios to a single group of users (i.e. the County Sheriff).  Over time the cities within the county and various first responder groups (police, fire, etc) will begin rolling out radios to work on the new system.  This creates a tailwind of high margin recurring revenues for MSI.

A typical network lasts 15 to 20 years, and a typical radio lasts 5 to 7 years, so there is an average of three radio replacement cycles over the life of a network.  With new cycles come new radios, typically at higher price points (due to inflation + technological improvements) – this is a revenue / margin tailwind.

Additionally, there seems to be consensus (from MSI, consultants and analysts) around the idea the existing infrastructure in the US, on average, is past due to for refresh averaging well over 15 years for existing networks.  That’s where the “narrow banding” shift creates an additional secular tailwind.

 The FCC has mandated that all public safety and commercial users of “land mobile” radio systems must cease operating 25 kHz and begin operating at 12.5 kHz by January of 2013 (actually, the FCC is saying municipalities must be showing progress towards complying by early 2013).  The intent of the switch is to free up spectrum for additional users / technology.  The reality of the switch is that municipalities and commercial radio users must install new systems and buy new radios. 

It is believed that less than half of municipal and commercial users have addressed the issue.  That’s beginning to change.  In the first quarter of 2012 Government revenue posted 11% organic growth, due primarily to a boost in systems installations.  Customers are waking up to the switch, and are beginning to install new systems.  That creates an infrastructure tailwind in the short term and a radio tailwind in the medium term. 

As a result of all of the above, the core Government business has a clear runway to mid single digits in the medium term (call it five years).

LONG TERM EVOLUTION (LTE)

In February, President Obama signed the Payroll Tax Credit Bill, which, among other things, allocated spectrum to, and funding for ($7 billion) a nationwide broadband network (i.e. LTE) for first responders.  The funding will take place over 10 years (beginning in early 2013).  The $7B will cover 80% of the cost with the remaining 20% to be funded by the municipalities creating an initial $9 billion opportunity.  This is ONLY related to the network / systems build out, this does not include the devices that will inevitably be used on the new network.

It is unclear what MSI’s share of the LTE market will be.  The company has been aggressively spending on R&D over the last five years in preparation for this network, but admittedly it is a new world, and MSI may not maintain the same level of dominance it has had in traditional radios.  To help the estimation process, we can look to LTE contracts that have already been won.   According to Pierre Ferragu at Bernstein, there have been 5 LTE awards in the US – MSI won three of those contracts (60%) with a dollar value equal to 80% of the market (“Motorola Solutions: Sizing The Public Safety LTE Upside” from 3/6/12).  So far, MSI seems to be maintaining market share.

We don’t know exactly how much money MSI will make as a result of this, and perhaps more importantly we don’t know when they will make it.  Management has talked about a $1.5B “pipeline” they can see today, the impact of which we will begin to be seen in 2013.

GOVERNMENT FINANCIALS

Government

2015E

2014E

2013E

2012E

2011

2010

2009

2008

                 

Core Revenue

6,148

5,941

5,740

5,546

5,358

5,135

4,876

5,259

LTE Revenue

400

300

200

0

0

0

0

0

Total Revenue

6,548

6,241

5,940

5,546

5,358

5,135

4,876

5,259

core growth

3.5%

3.5%

3.5%

3.5%

4.3%

5.3%

-7.3%

 

total growth

4.9%

5.1%

7.1%

3.5%

4.3%

5.3%

-7.3%

 
                 

EBIT

1,140

1,032

927

789

616

566

542

630

Add: Restructuring

0

0

0

0

102

(1)

33

23

Add: Amortization (below)

0

0

0

0

4

9

22

23

Add: Stock Comp

110

110

110

110

111

95

86

86

Operating Income (ex restructuring)

1,250

1,142

1,037

899

833

669

683

762

Add: Depreciation (core)

128

128

128

128

128

110

115

113

EBITDA

1,378

1,270

1,165

1,027

961

779

798

875

Less: Taxes (35%)

399

361

324

276

216

198

190

221

Less: Capex

175

175

175

175

159

172

115

194

Free Cash Flow

804

734

665

576

586

409

493

461

                 

Operating Margin

18.5%

17.4%

16.1%

14.2%

11.5%

11.0%

11.1%

12.0%

Adj Operating Margin

20.3%

19.2%

18.1%

16.2%

15.5%

13.0%

14.0%

14.5%

EBITDA Margin

22.4%

21.4%

20.3%

18.5%

17.9%

15.2%

16.4%

16.6%

FCF Margin

13.1%

12.4%

11.6%

10.4%

10.9%

8.0%

10.1%

8.8%

                 

Incremental Sales

308

301

394

188

223

259

(383)

 

Incremental EBIT

108

105

138

66

164

(14)

(79)

 

Incremental Margin

35.0%

35.0%

35.0%

35.0%

73.5%

-5.4%

20.6%

 

I believe 3.5% core growth to be very conservative.  I also believe my assumption for the incremental sales from LTE will prove to be very conservative.  For the flow through, since separation from Motorola the company has consistently exceeded 35% (including in the ‘system heavy’ first quarter of 2012 where the flow through was 37%).

THE BUSINESSES - ENTERPRISE

The Enterprise segment (35% of Revenue, 40% of EBITDA) manufactures “ruggedized” mobile devices used for supply chain and inventory management.  Most of this business is the old Symbol Technologies which MOT acquired in early 2007.  Symbol was best known for laser barcode scanners, for which MSI enjoys a dominant market share today (something in the 60% range).  Growth from this segment has come from the proliferation of “mobile data capture” devices, which greatly improves inventory efficiency.  Fed Ex and UPS use these devices when moving packages around the country.  Macy’s and Home Depot give these devices to salespeople so they can better update and turn inventory. 

For MSI, about 2/3s of the business is the “back of house” as I call it, or the line worker in a warehouse using a handheld device which includes a scanner.  Motorola dominates that market.  It is reaching saturation globally, but should continue to grow volumes with the growth in eCommerce (more shipping, which is good for MSI) and grow price at least with inflation (like the Government segment, the product life is 4 to 5 years and replacements are typically more expensive).

The remaining 1/3 of the business is what I call the “front of house” or retailers using mobile devices as a “force multiplier”, seeking to gain efficiencies in inventory management and payroll.  There is a very tangible and almost immediate ROI on the implementation of these products from increased inventory turns, and also from reduced payroll.  A good recent example is Home Depot – yesterday on its first quarter call, the HD CEO talked about the roll out of “(smart) phones” to all salespeople – these are MSI devices.  They allow salespeople to “float” around the store and have immediate and up to date inventory checks in the palm of their hand.  This has three implications for HD: 1) Sales – with immediate answers on inventory, sales conversion improves; 2) Customer satisfaction – customers get answers immediately, satisfaction goes up and 3) Fewer salespeople needed – since the salesperson doesn’t have to go into the back and check if they have supply of something, the time to serve is reduced and thus the need for employee count is reduced to achieve the same coverage.

The “front of house” is where the real growth is today, and it is still unclear who is going to win longer term, but it is clear that the pie is growing (and growing, and growing).  Listening to calls such as Home Depot yesterday (which uses  MSI products) and Lowe’s last quarter (which is testing Apple products) it becomes clear that there is a pretty significant secular trend towards efficiency, which fits right into MSI’s sweet spot.

Management and analysts believe this is a high single digit grower over the medium term due primarily to incremental volume.  Margins are substantial (22% EBITDA margin, with ~40% incremental margins), and returns on capital in this business are excellent at ~20%.

In 2012, growth will be a bit more challenged in this segment due to the secular decline of iDEN, a legacy “push to talk” cell phone technology.  Management estimates the lost sales to be ~$70m in 2012, about half of which came in the first quarter leading to a slight decline in total Enterprise revenue.  Despite this, the expectation is still for high single digit growth for the full year.

ENTERPRISE FINANCIALS

Enterprise

2015E

2014E

2013E

2012E

2011

2010

2009

2008

                 

Revenue

3,871

3,584

3,318

3,073

2,845

2,736

2,304

2,881

growth

8.0%

8.0%

8.0%

8.0%

4.0%

18.8%

-20.0%

 
                 

EBIT

892

778

671

527

242

212

28

(1,309)

Add: Restructuring

0

0

0

0

45

(33)

18

1,572

Add: Amortization

0

0

0

46

196

194

196

204

Add: Stock Comp

58

58

58

58

57

49

51

45

Operating Income (ex rest & imp)

950

836

729

631

540

422

293

512

Depreciation (core)

37

37

37

37

37

40

55

63

EBITDA

987

873

766

668

577

462

348

575

Less: Taxes (35%)

312

272

235

184

85

74

10

(458)

Less: Capex

30

30

30

27

27

20

21

63

Free Cash Flow

645

570

501

457

465

368

317

970

                 

Operating Margin

23.1%

21.7%

20.2%

17.2%

8.5%

7.7%

1.2%

-45.4%

Adj Operating Margin

24.6%

23.3%

22.0%

20.5%

19.0%

15.4%

12.7%

17.8%

EBITDA Margin

25.5%

24.3%

23.1%

21.7%

20.3%

16.9%

15.1%

20.0%

FCF Margin

16.7%

15.9%

15.1%

14.9%

16.4%

13.4%

13.8%

33.7%

                 

Incremental Sales

287

265

246

228

109

432

(577)

 

Incremental EBIT

115

106

98

91

118

129

(219)

 

Incremental Margin

40.0%

40.0%

40.0%

40.0%

108.3%

29.9%

38.0%

 

EUROPE

I feel obliged to talk briefly about Europe given it is the crisis du jour.  MSI has 21% of revenues coming from “EMEA”, and has said that total exposure to traditional Western Europe is closer to ~10% of revenues.  Of that, I believe the Government segment (which is much less economically sensitive) is 2/3s and the Enterprise segment is about 1/3.  In a disastrous European situation, only about 3 to 5% of your consolidated revenue is at risk.  If that revenue were to go to zero tomorrow, the consolidated business should still grow in 2012.   

CAPITAL STRUCTURE

MSI exited the relationship with Motorola Mobility in January of 2011 with a substantial pile of cash.  At the end of 2011 net cash was $3.6B or $11.30 per share (on the then share count).  Management has made three commitments with regard to the capital structure:

1)      That MSI would spend ~45% of operating cash flow on repurchases / M&A (mostly repurchases)

2)      MSI would spend ~30% of operating cash flow on dividends (currently spending ~22%)

3)      To get to ~1x Net Debt to EBITDA by 2014 (2x Adjusted Net Debt to EBITDA, which includes pension)

MSI will generate ~$1.2B of operating cash flow this year, growing to $1.6B by 2015.  That will require $2.5B of cumulative share repurchases (17% of the current market cap) and $1.6B of cumulative dividends ($5.50 on the current share count).

Additionally, to fulfill the third obligation, management will need to spend an additional $4 billion on share repurchase through 2014 (2011 net cash of $3.6B, plus $2B in 2014 EBITDA, minus $1.3B repurchased in the first quarter).

The repurchase activity puts a huge bid underneath MSI for the next three years and provides a significant boost to earnings growth.

OTHER CONSIDERATIONS

MSI does have a significant pension with ~$2.6B in gross unfunded liabilities.  Somewhat offsetting that is a $1.4B NOL that should be substantially used up in the next four years.  The pension is frozen and the NOL was a legacy asset from investments MSI made in the handset business.

I’m valuing the business on an earnings / free cash flow basis.  My estimates above assume the current cash impact of the pension persists into perpetuity (which is a conservative assumption in my opinion given insanely low interest rates).  Additionally, my earnings DO NOT include any benefit from the NOL’s.  I am using a 34.5% tax rate in my earnings estimates (versus the 20% MSI will be paying).  I accrue the tax savings and use the cash to buy back stock.

CONSOLIDATED FINANCIALS

Income Statement

2015E

2014E

2013E

2012E

2011

2010

2009

2008

                 

Product Sales

       

6,068

5,870

5,259

6,306

growth

       

3.4%

11.6%

-16.6%

 

Service Sales

       

2,135

2,001

1,921

1,834

growth

       

6.7%

4.2%

4.7%

 
                 

Cost of Products

       

2,723

2,673

2,374

2,880

Gross Profit

       

3,345

3,197

2,885

3,426

gross margin

       

55.1%

54.5%

54.9%

54.3%

                 

Cost of Services

       

1,334

1,281

1,237

1,171

Gross Profit

       

801

720

684

663

gross margin

       

37.5%

36.0%

35.6%

36.2%

 

6.05%

6.12%

7.43%

5.06%

4.22%

     

Total Revenue

10,419

9,824

9,258

8,618

8,203

7,871

7,180

8,140

CoGS

       

4,057

3,954

3,611

4,051

Gross Profit

       

4,146

3,917

3,569

4,089

                 

SG&A

       

1,912

1,910

1,703

1,845

R&D

       

1,035

1,079

1,041

1,106

Other

0

0

0

46

341

150

255

1,817

                 

Operating Income

1,972

1,749

1,538

1,256

858

778

570

(679)

                 

Interest

(106)

(76)

(46)

(45)

(74)

(129)

(133)

35

Gains on Sales

0

0

0

0

23

49

108

64

Other

(25)

(25)

(25)

(25)

(69)

(7)

92

(417)

                 

Pre Tax Income

1,841

1,648

1,467

1,186

738

691

637

(997)

Income Taxes

635

569

506

409

(3)

415

191

2,481

Tax Rate

34.5%

34.5%

34.5%

34.5%

-0.4%

60.1%

30.0%

-248.8%

                 

Non-Controlling Interests

0

0

0

0

(6)

17

23

4

Net Income

1,206

1,080

961

777

747

259

423

(3,482)

FD Shares

210

239

270

295

340

338

330

324

EPS

$5.73

$4.52

$3.56

$2.63

$2.20

$0.77

$1.28

($10.76)

Adjusted EPS (per mgmt)

$6.28

$5.00

$3.98

$3.11

$2.61

 

 

 

Free Cash Flow (fully taxed)

$5.68

$4.47

$3.52

$2.77

$2.56

$1.97

$2.11

$2.48

CONSENSUS

$4.50

$4.19

$3.53

$3.06

$2.56

     
                 

Operating Income

1,912

1,689

1,478

1,196

858

779

570

(679)

Add: Restructuring

0

0

0

0

147

(34)

51

1,595

Add: Amortization

0

0

0

46

200

202

218

227

Add: Stock Comp

168

168

168

168

168

144

137

131

LESS: HIGHER PENSION EXPENSE PLUG (1/25/12)

(60)

(60)

(60)

(60)

0

0

0

0

Adj Operating Income

2,140

1,917

1,706

1,470

1,373

1,091

976

1,274

DA

165

165

165

165

166

140

170

176

EBITDA

2,305

2,082

1,871

1,635

1,539

1,231

1,146

1,450

Less: Interest & Other

(131)

(101)

(71)

(70)

(74)

(129)

(133)

35

Less: Taxes (at 34.5%)

(614)

(548)

(485)

(388)

(321)

(213)

(168)

(328)

Less: Capex

(205)

(205)

(205)

(202)

(186)

(192)

(136)

(257)

Less: Pension Contributions (CASH)

(370)

(370)

(370)

(370)

(239)

(143)

(90)

0

Add: Pension Costs (Expensed)

211

211

211

211

151

110

79

(99)

Free Cash Flow

1,195

1,069

951

815

870

665

697

801

                 

Operating Margin

18.9%

17.8%

16.6%

14.6%

10.5%

9.9%

7.9%

-8.3%

EBIT Margin

20.5%

19.5%

18.4%

17.1%

16.7%

13.9%

13.6%

15.7%

EBITDA Margin

22.1%

21.2%

20.2%

19.0%

18.8%

15.6%

16.0%

17.8%


Catalyst

Second quarter earnings (early August)
   - Expect earnings to beat (which shouldn't surprise)
   - Expect full year guidance to be increased
   - Expect an increase in the dividend (to ~$1.25)
   - Expect additional share repurchase authorization
 
2013 Outlook (in Jan '13)
   - Expect updates on LTE expectations for the year, which will be incremental to sell side estimates
 
    sort by    

    Description

    Motorola was written up twice as long ideas in 2010.  Gary9 wrote up MOT in June of ’10 as a Sum of the Parts.  ValueGuy wrote up MSI (Motorola Solutions, the legacy non-handset business) in December of ’10 as an inexpensive industrial company with capital structure catalysts.  MSI turned out to be a good investment – from December 23, 2010  to today MSI is up 32% versus up 6% for the S&P 500.

    I believe that MSI is more compelling today than it was then, and I’m recommending it (again) as a long.

    If you already know the story, start here, if not, skip down to the “thesis” section.

    WHAT’S CHANGED?

    Positives

    -          MSI’s two segments have produced record revenue (Government grew 4.3% organically in 2011, and Enterprise grew 11% organically, ex iDEN )

    -          Sales leverage and expense reductions led to record margins in 2011 (280 bps of consolidated margin expansion)

    -          The company has exceeded guidance and consensus every quarter since the split

    -          MSI generated $900 million of free cash flow in 2011 (ex voluntary pension contributions), excluding all working capital FCF was $1.25B

    -          MSI has announced $3B in share repurchase authorizations, of which $2.5B has been spent (16% of the float, at $45 per share)

    -          MSI initiated an 88c dividend last year (1.8% yield)

    -          The so called “narrow banding” tailwind thesis in Government has begun to play out (becoming more significant this year, with 11% Government growth in the first quarter)

    -          In February, the US Government agreed to fund the nationwide rollout of a First Responder LTE Network with an initial $7B over 10 years (funds 80% of the cost, implying $9B of total spending)

    -          The Enterprise business continues to benefit from the secular trend towards supply chain and inventory efficiency with some large retail wins announced in 2011

    Negatives

    -          Low interest rates at the end of 2011 caused a jump in the pension unfunded status (to $2.6B, from $2.4B), which has increased the annual cash contribution requirements by ~$70m

    THESIS

    MSI is worth $60+ today valuing the business at 14x 2013 EPS of $3.80, plus year end net cash and cumulative dividends of $10.00.  I expect earnings to compound in the low 20%’s for at least the next four years  through a combination of 1) mid single digit growth in the core businesses, 2) Incremental revenue growth from LTE, and 3) massive, continued, relentless, share repurchase activity.  Specifically, I expect the company to repurchase an additional $6B of its shares over the next three and a half years (an additional 30% of outstanding).  Earnings growth should lead to 20%+ annual returns in the stock.

    FINANCIAL SUMMARY

    2010

    2011

    2012E

    2013E

    2014E

    2015E

     

     

     

     

     

     

     

     

     

    Revenue

     

     

    7,871

    8,203

    8,618

    9,258

    9,824

    10,419

    Growth

     

     

     

    4.2%

    5.1%

    7.4%

    6.1%

    6.1%

     

     

     

     

     

     

     

     

     

    EBITDA

     

     

    1,231

    1,539

    1,635

    1,871

    2,082

    2,305

    Margin

     

     

    15.6%

    18.8%

    19.0%

    20.2%

    21.2%

    22.1%

     

     

     

     

     

     

     

     

     

    EPS (Actual Shares)

     

    $1.95

    $2.61

    $3.11

    $3.98

    $4.99

    $6.27

    FCF per Share

     

    $1.85

    $2.99

    $3.28

    $4.23

    $5.38

    $6.85

     

     

     

     

     

     

     

     

     

    Share Count (Actual)

    337

    318

    283

    258

    227

    199

    Share Repurchases

     

    0

    1,110

    1,890

    1,500

    2,000

    2,000

                     

    VALUATION

     

       

    2012E

    2013E

    2014E

    2015E

     

     

     

     

     

     

     

     

     

    EPS (Average Shares)

     

     

    $3.12

    $3.79

    $4.67

    $5.85

    Multiple

     

     

     

     

    14 x

    14 x

    14 x

    14 x

    Value

     

     

     

     

    $43.71

    $53.08

    $65.44

    $81.92

     

     

     

     

     

     

     

     

     

    Plus: Cash

     

     

     

    $8.73

    $7.34

    $4.14

    $0.50

    Plus: Cumulative Div

     

     

    $1.19

    $2.63

    $4.38

    $6.58

    PRICE TARGET

     

     

     

    $53.63

    $63.05

    $73.96

    $89.00

    THE BUSINESSES - GOVERNMENT

    Motorola Solutions operates two unique businesses reported as separate segments.  The Government segment (65% of revenue, 60% of EBITDA) sells communication systems primarily to first responders globally.  MSI dominates this market with 80%+ of the share (very consistent over time).

    Communications systems sold to first responders is somewhat of a razor / razorblade business.  Motorola will bid contracts for a total communication system within a municipality (for example), providing everything from planning and design to infrastructure construction and training, all of which are relatively low margin sales. 

    Once a network is built, municipalities begin to “add” radios / devices, which are significantly higher margin.  In a typical contract, radios are a small percentage of initial revenues (~15%) due partly to the size of the system (in terms of dollars) vis-à-vis the cost of the radios, but also due to the fact that the deployment of radios happens generally over a longer period of time.  Again, in a typical situation, MSI will sell a small number of radios to a municipality on the implementation of a new network.  Initially, counties / cities will roll out only a small number of radios to a single group of users (i.e. the County Sheriff).  Over time the cities within the county and various first responder groups (police, fire, etc) will begin rolling out radios to work on the new system.  This creates a tailwind of high margin recurring revenues for MSI.

    A typical network lasts 15 to 20 years, and a typical radio lasts 5 to 7 years, so there is an average of three radio replacement cycles over the life of a network.  With new cycles come new radios, typically at higher price points (due to inflation + technological improvements) – this is a revenue / margin tailwind.

    Additionally, there seems to be consensus (from MSI, consultants and analysts) around the idea the existing infrastructure in the US, on average, is past due to for refresh averaging well over 15 years for existing networks.  That’s where the “narrow banding” shift creates an additional secular tailwind.

     The FCC has mandated that all public safety and commercial users of “land mobile” radio systems must cease operating 25 kHz and begin operating at 12.5 kHz by January of 2013 (actually, the FCC is saying municipalities must be showing progress towards complying by early 2013).  The intent of the switch is to free up spectrum for additional users / technology.  The reality of the switch is that municipalities and commercial radio users must install new systems and buy new radios. 

    It is believed that less than half of municipal and commercial users have addressed the issue.  That’s beginning to change.  In the first quarter of 2012 Government revenue posted 11% organic growth, due primarily to a boost in systems installations.  Customers are waking up to the switch, and are beginning to install new systems.  That creates an infrastructure tailwind in the short term and a radio tailwind in the medium term. 

    As a result of all of the above, the core Government business has a clear runway to mid single digits in the medium term (call it five years).

    LONG TERM EVOLUTION (LTE)

    In February, President Obama signed the Payroll Tax Credit Bill, which, among other things, allocated spectrum to, and funding for ($7 billion) a nationwide broadband network (i.e. LTE) for first responders.  The funding will take place over 10 years (beginning in early 2013).  The $7B will cover 80% of the cost with the remaining 20% to be funded by the municipalities creating an initial $9 billion opportunity.  This is ONLY related to the network / systems build out, this does not include the devices that will inevitably be used on the new network.

    It is unclear what MSI’s share of the LTE market will be.  The company has been aggressively spending on R&D over the last five years in preparation for this network, but admittedly it is a new world, and MSI may not maintain the same level of dominance it has had in traditional radios.  To help the estimation process, we can look to LTE contracts that have already been won.   According to Pierre Ferragu at Bernstein, there have been 5 LTE awards in the US – MSI won three of those contracts (60%) with a dollar value equal to 80% of the market (“Motorola Solutions: Sizing The Public Safety LTE Upside” from 3/6/12).  So far, MSI seems to be maintaining market share.

    We don’t know exactly how much money MSI will make as a result of this, and perhaps more importantly we don’t know when they will make it.  Management has talked about a $1.5B “pipeline” they can see today, the impact of which we will begin to be seen in 2013.

    GOVERNMENT FINANCIALS

    Government

    2015E

    2014E

    2013E

    2012E

    2011

    2010

    2009

    2008

                     

    Core Revenue

    6,148

    5,941

    5,740

    5,546

    5,358

    5,135

    4,876

    5,259

    LTE Revenue

    400

    300

    200

    0

    0

    0

    0

    0

    Total Revenue

    6,548

    6,241

    5,940

    5,546

    5,358

    5,135

    4,876

    5,259

    core growth

    3.5%

    3.5%

    3.5%

    3.5%

    4.3%

    5.3%

    -7.3%

     

    total growth

    4.9%

    5.1%

    7.1%

    3.5%

    4.3%

    5.3%

    -7.3%

     
                     

    EBIT

    1,140

    1,032

    927

    789

    616

    566

    542

    630

    Add: Restructuring

    0

    0

    0

    0

    102

    (1)

    33

    23

    Add: Amortization (below)

    0

    0

    0

    0

    4

    9

    22

    23

    Add: Stock Comp

    110

    110

    110

    110

    111

    95

    86

    86

    Operating Income (ex restructuring)

    1,250

    1,142

    1,037

    899

    833

    669

    683

    762

    Add: Depreciation (core)

    128

    128

    128

    128

    128

    110

    115

    113

    EBITDA

    1,378

    1,270

    1,165

    1,027

    961

    779

    798

    875

    Less: Taxes (35%)

    399

    361

    324

    276

    216

    198

    190

    221

    Less: Capex

    175

    175

    175

    175

    159

    172

    115

    194

    Free Cash Flow

    804

    734

    665

    576

    586

    409

    493

    461

                     

    Operating Margin

    18.5%

    17.4%

    16.1%

    14.2%

    11.5%

    11.0%

    11.1%

    12.0%

    Adj Operating Margin

    20.3%

    19.2%

    18.1%

    16.2%

    15.5%

    13.0%

    14.0%

    14.5%

    EBITDA Margin

    22.4%

    21.4%

    20.3%

    18.5%

    17.9%

    15.2%

    16.4%

    16.6%

    FCF Margin

    13.1%

    12.4%

    11.6%

    10.4%

    10.9%

    8.0%

    10.1%

    8.8%

                     

    Incremental Sales

    308

    301

    394

    188

    223

    259

    (383)

     

    Incremental EBIT

    108

    105

    138

    66

    164

    (14)

    (79)

     

    Incremental Margin

    35.0%

    35.0%

    35.0%

    35.0%

    73.5%

    -5.4%

    20.6%

     

    I believe 3.5% core growth to be very conservative.  I also believe my assumption for the incremental sales from LTE will prove to be very conservative.  For the flow through, since separation from Motorola the company has consistently exceeded 35% (including in the ‘system heavy’ first quarter of 2012 where the flow through was 37%).

    THE BUSINESSES - ENTERPRISE

    The Enterprise segment (35% of Revenue, 40% of EBITDA) manufactures “ruggedized” mobile devices used for supply chain and inventory management.  Most of this business is the old Symbol Technologies which MOT acquired in early 2007.  Symbol was best known for laser barcode scanners, for which MSI enjoys a dominant market share today (something in the 60% range).  Growth from this segment has come from the proliferation of “mobile data capture” devices, which greatly improves inventory efficiency.  Fed Ex and UPS use these devices when moving packages around the country.  Macy’s and Home Depot give these devices to salespeople so they can better update and turn inventory. 

    For MSI, about 2/3s of the business is the “back of house” as I call it, or the line worker in a warehouse using a handheld device which includes a scanner.  Motorola dominates that market.  It is reaching saturation globally, but should continue to grow volumes with the growth in eCommerce (more shipping, which is good for MSI) and grow price at least with inflation (like the Government segment, the product life is 4 to 5 years and replacements are typically more expensive).

    The remaining 1/3 of the business is what I call the “front of house” or retailers using mobile devices as a “force multiplier”, seeking to gain efficiencies in inventory management and payroll.  There is a very tangible and almost immediate ROI on the implementation of these products from increased inventory turns, and also from reduced payroll.  A good recent example is Home Depot – yesterday on its first quarter call, the HD CEO talked about the roll out of “(smart) phones” to all salespeople – these are MSI devices.  They allow salespeople to “float” around the store and have immediate and up to date inventory checks in the palm of their hand.  This has three implications for HD: 1) Sales – with immediate answers on inventory, sales conversion improves; 2) Customer satisfaction – customers get answers immediately, satisfaction goes up and 3) Fewer salespeople needed – since the salesperson doesn’t have to go into the back and check if they have supply of something, the time to serve is reduced and thus the need for employee count is reduced to achieve the same coverage.

    The “front of house” is where the real growth is today, and it is still unclear who is going to win longer term, but it is clear that the pie is growing (and growing, and growing).  Listening to calls such as Home Depot yesterday (which uses  MSI products) and Lowe’s last quarter (which is testing Apple products) it becomes clear that there is a pretty significant secular trend towards efficiency, which fits right into MSI’s sweet spot.

    Management and analysts believe this is a high single digit grower over the medium term due primarily to incremental volume.  Margins are substantial (22% EBITDA margin, with ~40% incremental margins), and returns on capital in this business are excellent at ~20%.

    In 2012, growth will be a bit more challenged in this segment due to the secular decline of iDEN, a legacy “push to talk” cell phone technology.  Management estimates the lost sales to be ~$70m in 2012, about half of which came in the first quarter leading to a slight decline in total Enterprise revenue.  Despite this, the expectation is still for high single digit growth for the full year.

    ENTERPRISE FINANCIALS

    Enterprise

    2015E

    2014E

    2013E

    2012E

    2011

    2010

    2009

    2008

                     

    Revenue

    3,871

    3,584

    3,318

    3,073

    2,845

    2,736

    2,304

    2,881

    growth

    8.0%

    8.0%

    8.0%

    8.0%

    4.0%

    18.8%

    -20.0%

     
                     

    EBIT

    892

    778

    671

    527

    242

    212

    28

    (1,309)

    Add: Restructuring

    0

    0

    0

    0

    45

    (33)

    18

    1,572

    Add: Amortization

    0

    0

    0

    46

    196

    194

    196

    204

    Add: Stock Comp

    58

    58

    58

    58

    57

    49

    51

    45

    Operating Income (ex rest & imp)

    950

    836

    729

    631

    540

    422

    293

    512

    Depreciation (core)

    37

    37

    37

    37

    37

    40

    55

    63

    EBITDA

    987

    873

    766

    668

    577

    462

    348

    575

    Less: Taxes (35%)

    312

    272

    235

    184

    85

    74

    10

    (458)

    Less: Capex

    30

    30

    30

    27

    27

    20

    21

    63

    Free Cash Flow

    645

    570

    501

    457

    465

    368

    317

    970

                     

    Operating Margin

    23.1%

    21.7%

    20.2%

    17.2%

    8.5%

    7.7%

    1.2%

    -45.4%

    Adj Operating Margin

    24.6%

    23.3%

    22.0%

    20.5%

    19.0%

    15.4%

    12.7%

    17.8%

    EBITDA Margin

    25.5%

    24.3%

    23.1%

    21.7%

    20.3%

    16.9%

    15.1%

    20.0%

    FCF Margin

    16.7%

    15.9%

    15.1%

    14.9%

    16.4%

    13.4%

    13.8%

    33.7%

                     

    Incremental Sales

    287

    265

    246

    228

    109

    432

    (577)

     

    Incremental EBIT

    115

    106

    98

    91

    118

    129

    (219)

     

    Incremental Margin

    40.0%

    40.0%

    40.0%

    40.0%

    108.3%

    29.9%

    38.0%

     

    EUROPE

    I feel obliged to talk briefly about Europe given it is the crisis du jour.  MSI has 21% of revenues coming from “EMEA”, and has said that total exposure to traditional Western Europe is closer to ~10% of revenues.  Of that, I believe the Government segment (which is much less economically sensitive) is 2/3s and the Enterprise segment is about 1/3.  In a disastrous European situation, only about 3 to 5% of your consolidated revenue is at risk.  If that revenue were to go to zero tomorrow, the consolidated business should still grow in 2012.   

    CAPITAL STRUCTURE

    MSI exited the relationship with Motorola Mobility in January of 2011 with a substantial pile of cash.  At the end of 2011 net cash was $3.6B or $11.30 per share (on the then share count).  Management has made three commitments with regard to the capital structure:

    1)      That MSI would spend ~45% of operating cash flow on repurchases / M&A (mostly repurchases)

    2)      MSI would spend ~30% of operating cash flow on dividends (currently spending ~22%)

    3)      To get to ~1x Net Debt to EBITDA by 2014 (2x Adjusted Net Debt to EBITDA, which includes pension)

    MSI will generate ~$1.2B of operating cash flow this year, growing to $1.6B by 2015.  That will require $2.5B of cumulative share repurchases (17% of the current market cap) and $1.6B of cumulative dividends ($5.50 on the current share count).

    Additionally, to fulfill the third obligation, management will need to spend an additional $4 billion on share repurchase through 2014 (2011 net cash of $3.6B, plus $2B in 2014 EBITDA, minus $1.3B repurchased in the first quarter).

    The repurchase activity puts a huge bid underneath MSI for the next three years and provides a significant boost to earnings growth.

    OTHER CONSIDERATIONS

    MSI does have a significant pension with ~$2.6B in gross unfunded liabilities.  Somewhat offsetting that is a $1.4B NOL that should be substantially used up in the next four years.  The pension is frozen and the NOL was a legacy asset from investments MSI made in the handset business.

    I’m valuing the business on an earnings / free cash flow basis.  My estimates above assume the current cash impact of the pension persists into perpetuity (which is a conservative assumption in my opinion given insanely low interest rates).  Additionally, my earnings DO NOT include any benefit from the NOL’s.  I am using a 34.5% tax rate in my earnings estimates (versus the 20% MSI will be paying).  I accrue the tax savings and use the cash to buy back stock.

    CONSOLIDATED FINANCIALS

    Income Statement

    2015E

    2014E

    2013E

    2012E

    2011

    2010

    2009

    2008

                     

    Product Sales

           

    6,068

    5,870

    5,259

    6,306

    growth

           

    3.4%

    11.6%

    -16.6%

     

    Service Sales

           

    2,135

    2,001

    1,921

    1,834

    growth

           

    6.7%

    4.2%

    4.7%

     
                     

    Cost of Products

           

    2,723

    2,673

    2,374

    2,880

    Gross Profit

           

    3,345

    3,197

    2,885

    3,426

    gross margin

           

    55.1%

    54.5%

    54.9%

    54.3%

                     

    Cost of Services

           

    1,334

    1,281

    1,237

    1,171

    Gross Profit

           

    801

    720

    684

    663

    gross margin

           

    37.5%

    36.0%

    35.6%

    36.2%

     

    6.05%

    6.12%

    7.43%

    5.06%

    4.22%

         

    Total Revenue

    10,419

    9,824

    9,258

    8,618

    8,203

    7,871

    7,180

    8,140

    CoGS

           

    4,057

    3,954

    3,611

    4,051

    Gross Profit

           

    4,146

    3,917

    3,569

    4,089

                     

    SG&A

           

    1,912

    1,910

    1,703

    1,845

    R&D

           

    1,035

    1,079

    1,041

    1,106

    Other

    0

    0

    0

    46

    341

    150

    255

    1,817

                     

    Operating Income

    1,972

    1,749

    1,538

    1,256

    858

    778

    570

    (679)

                     

    Interest

    (106)

    (76)

    (46)

    (45)

    (74)

    (129)

    (133)

    35

    Gains on Sales

    0

    0

    0

    0

    23

    49

    108

    64

    Other

    (25)

    (25)

    (25)

    (25)

    (69)

    (7)

    92

    (417)

                     

    Pre Tax Income

    1,841

    1,648

    1,467

    1,186

    738

    691

    637

    (997)

    Income Taxes

    635

    569

    506

    409

    (3)

    415

    191

    2,481

    Tax Rate

    34.5%

    34.5%

    34.5%

    34.5%

    -0.4%

    60.1%

    30.0%

    -248.8%

                     

    Non-Controlling Interests

    0

    0

    0

    0

    (6)

    17

    23

    4

    Net Income

    1,206

    1,080

    961

    777

    747

    259

    423

    (3,482)

    FD Shares

    210

    239

    270

    295

    340

    338

    330

    324

    EPS

    $5.73

    $4.52

    $3.56

    $2.63

    $2.20

    $0.77

    $1.28

    ($10.76)

    Adjusted EPS (per mgmt)

    $6.28

    $5.00

    $3.98

    $3.11

    $2.61

     

     

     

    Free Cash Flow (fully taxed)

    $5.68

    $4.47

    $3.52

    $2.77

    $2.56

    $1.97

    $2.11

    $2.48

    CONSENSUS

    $4.50

    $4.19

    $3.53

    $3.06

    $2.56

         
                     

    Operating Income

    1,912

    1,689

    1,478

    1,196

    858

    779

    570

    (679)

    Add: Restructuring

    0

    0

    0

    0

    147

    (34)

    51

    1,595

    Add: Amortization

    0

    0

    0

    46

    200

    202

    218

    227

    Add: Stock Comp

    168

    168

    168

    168

    168

    144

    137

    131

    LESS: HIGHER PENSION EXPENSE PLUG (1/25/12)

    (60)

    (60)

    (60)

    (60)

    0

    0

    0

    0

    Adj Operating Income

    2,140

    1,917

    1,706

    1,470

    1,373

    1,091

    976

    1,274

    DA

    165

    165

    165

    165

    166

    140

    170

    176

    EBITDA

    2,305

    2,082

    1,871

    1,635

    1,539

    1,231

    1,146

    1,450

    Less: Interest & Other

    (131)

    (101)

    (71)

    (70)

    (74)

    (129)

    (133)

    35

    Less: Taxes (at 34.5%)

    (614)

    (548)

    (485)

    (388)

    (321)

    (213)

    (168)

    (328)

    Less: Capex

    (205)

    (205)

    (205)

    (202)

    (186)

    (192)

    (136)

    (257)

    Less: Pension Contributions (CASH)

    (370)

    (370)

    (370)

    (370)

    (239)

    (143)

    (90)

    0

    Add: Pension Costs (Expensed)

    211

    211

    211

    211

    151

    110

    79

    (99)

    Free Cash Flow

    1,195

    1,069

    951

    815

    870

    665

    697

    801

                     

    Operating Margin

    18.9%

    17.8%

    16.6%

    14.6%

    10.5%

    9.9%

    7.9%

    -8.3%

    EBIT Margin

    20.5%

    19.5%

    18.4%

    17.1%

    16.7%

    13.9%

    13.6%

    15.7%

    EBITDA Margin

    22.1%

    21.2%

    20.2%

    19.0%

    18.8%

    15.6%

    16.0%

    17.8%


    Catalyst

    Second quarter earnings (early August)
       - Expect earnings to beat (which shouldn't surprise)
       - Expect full year guidance to be increased
       - Expect an increase in the dividend (to ~$1.25)
       - Expect additional share repurchase authorization
     
    2013 Outlook (in Jan '13)
       - Expect updates on LTE expectations for the year, which will be incremental to sell side estimates
     
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