Is Motorola next in line to be acquired?

Though it has plenty more customers, Motorola's struggling handset business may not be as juicy an acquisition target as Palm turned out to be.

Wednesday, Hewlett-Packard announced it is buying Palm for $1.2 billion, bringing to an end what was once a pioneer in the mobile-computing space. HP executives made it clear why they found Palm so appealing: the well-reviewed Web OS mobile operating system.

For Motorola, the decision to focus on building smartphones powered by Google's Android operating system could spell trouble for finding a similar suitor.

"I don't think anyone would be interested in buying Motorola now," said Frank Marsala, a research analyst at market research firm Gartner. "If they had a differentiated operating system like Palm has or their business was growing like some of its competitors that would make it much more attractive."

When it comes to smartphones, software is the piece of the puzzle that is the most valuable. Apple has proven this with the successful iPhone. Mobile applications are what has been driving sales of that device. Apple has driven this market by creating a robust developer community and ecosystem as well as an easy to use online store for distributing those applications to consumers.

Palm released its WebOS operating system a year ago first on the much hyped Palm Pre and later on the Palm Pixi. The software has gotten high marks from reviewers for its capabilities and its interface.

For HP, which had said before it was looking for software to differentiate its products, Palm is a good a fit. It's clear that HP saw value in the software itself and the ecosystem around it. The fact that HP was willing to spend even $1.2 billion on Palm, which was on track to barely generate $400 million in revenue this year, is further testament that it valued owning software versus licensing it or getting it free from Google.

Todd Bradley, executive vice president of HP's Personal Systems Group, said on Wednesday's conference call after the acquisition was announced, that HP plans to invest heavily in WebOS, increasing the already budgeted $190 million in research and development Palm was spending annually. Bradley said the company will use the software in several different types of devices, such as slate PCs, Netbooks, and phones.

The value in owning software is that it provides the company with more control. For example, HP will be able to dictate who can make applications for its devices. Controlling the OS also means that HP has more say over how the applications are built to ensure that hardware and software work together on the device. And it helps the company set its devices apart from the competition by offering different user interfaces and even different features.

Research In Motion, which is the No. 1 smartphone maker in the U.S., and Apple, now the No. 2 smartphone maker in the U.S., have been so successful in part because they make their own hardware as well as create and control their own operating system software.

Meanwhile, Motorola has been forced to take a different route. The company, which has struggled to find a hit phone since it came out with the Razr four years ago, is focusing on building phones using Google's Android operating system. Motorola has committed to introducing 20 Android-powered smartphones to the market in 2010. So far it has already started selling eight new devices, including the Backflip, Cliq, and the popular Droid, which is sold exclusively for Verizon Wireless.

Android strategy appears to be working
The strategy seems to be paying off in terms of increasing smartphone sales. During the first quarter of 2010, Motorola outperformed when it came to selling smartphones, shipping 2.3 million smartphones during the quarter. Wall Street only expected it to sell 1.8 million smartphones. But overall shipments fell short of Wall Street's forecast for total cell phone shipments. It shipped a total of 8.5 million handsets. Analysts had expected it to ship a total of 10 million handsets.

Smartphones are more expensive and generate more money per sale for Motorola. The average selling price of the company's phones increased to $192 from $169 in the prior quarter. Analysts agree that Motorola is moving in the right direction, but they caution that the company still has a long way to go.

"Motorola's handset business is in a state of transition right now," Gartner's Marsala said. "It's selling more smartphones, which have better margins. But the legacy phones used to generate revenue. Until the company gets to a point where smartphones represent the bulk of their sales their business isn't that attractive."

Increasing the volume of handset sales is important for Motorola, which plans to split the company into two independent entities early next year. One business will combine wireless handsets and set-top boxes, while the other business will include enterprise wireless networking products and other commercial radio products.

There's been speculation that once the company is split up that it will try to sell the new handset company. But given that Motorola is only expected to break-even in terms of sales by the year end, it's difficult to see how it could command a high price tag.

"I'd say if it executes well all year, the value of the company at the end of the year could be around $3.4 billion," Marsala said. "If this business were firing on all cylinders like Research In Motion where it's growing 20 percent a year, I'd say it could be worth $14 billion."

Mike Sapien, an analyst with research firm Ovum, said that the HP/Palm deal may prompt some companies to look at Motorola. But he doesn't see anybody pulling the trigger on a deal until at least early next year when Motorola is officially broken into two companies.

"Motorola needs to get more work done on improving their business," he said. "And I don't think Dell or anyone else interested in the company loses anything by waiting."

The company's poor performance coupled with the fact that it doesn't use its own software for its operating system puts the company is a weak position when it comes to shopping itself around. Following HP's acquisition of Palm, other computing companies, such as Lenovo or Dell could be interested in Motorola. Lenovo had been rumored to be interested in Palm.

Dell may be a likely candidate to buy Motorola because Ron Garriques, president of Communication Solutions at Dell, used to be in charge of Motorola's handset division. But even with this personal connection, it's hard to make the case for Dell buying Motorola given that any company could build a smartphone using Android on their own.

"The problem with using Android is that you don't control the software," Marsala said. "I'm not sure what Dell or anyone else would get from buying Motorola. I don't think the product portfolio and distribution is worth more than $3 billion when Dell is already using Android to build its own smartphones."

Motorola's co-CEO Sanjay Jha recognizes the value in owning the software that runs the company's phones.

"Owning your own OS is important if you have the ecosystem and the ability to scale to keep up with leading edge technologies," he said during the company's quarterly conference call Thursday. "At some point, we could own our own OS. But for now Google is the fastest innovating ecosystem. It's delivering very good results for us. And we are committed to it."