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Razr-thin margins in Motorola strategic divide

Billionaire investor Carl Icahn sees a top phone maker that's lost its edge, and he's ready to act. But what about the CEO's vision?

Razr-thin margins in Motorola strategic dividenews analysis What do you do with $11.3 billion in net cash? That's the question fueling a potential battle between Carl Icahn, the infamous billionaire investor, and executives at Motorola, the world's No. 2 seller of mobile handsets.

Last week, Icahn, who owns a 1.39 percent stake in the company, notified Motorola's board of directors that he wants to be considered for a seat on Motorola's board. A vote on Icahn's nomination will take place at the annual shareholder meeting (a date hasn't been set yet, but the meeting typically takes place the first week of May). Motorola hasn't commented on whether its board of directors will support the nomination or not.

Icahn, who has a history of getting involved with companies he thinks aren't being managed properly, believes Motorola's stock is undervalued. While little is known about his actual plans, he has said publicly that he wants Motorola to spend the majority of the $11.3 billion in cash it has in the bank to buy back company shares and help boost the fledgling stock price. Shares have declined about 30 percent since October and hit a 52-week low of $17.90 on January 12.

Meanwhile, Motorola has already initiated two share buyback programs. The first ended in May 2005 and cost the company $4 billion. The second, launched this summer, will likely cost the company $4.5 billion.

Icahn's move presents a strategic dilemma for Motorola CEO Ed Zander, because satisfying Icahn could make it hard for Zander to execute his own vision for the company. Zander has said he wants to keep a good portion of the company's cash in the bank and use some of it to buy smaller companies that can help Motorola broaden its product portfolio and reach into new markets. The company has already been on a shopping spree, announcing 10 new purchases in 2006, including the $4.9 billion purchase of the mobile enterprise equipment supplier Symbol Technologies.

While share buybacks can drive up stock prices by creating a demand for shares on the market, often the bump is only temporary. By contrast, the route Zander is taking with the company's cash may mean greater risk, but it can lead to higher rewards. Many acquisitions fail and rarely return meaningful value to shareholders, experts say. Still, acquisitions can yield valuable technology and expertise that can be translated into new products to build value for the company down the road.

And make no doubt, Motorola needs new products as the buzz for its hit Razr cell phone slows. In fact, a company that still isn't even in the cell phone market, Apple, has engendered the most excitement in the industry for an upcoming product--the iPhone, which is expected to hit stores in June. But buzz and long-term vision aren't what concern Icahn, say people who have dealt with him.

"Carl does what he does to make money," said an attorney who has dealt with Icahn in other proxy battles but didn't want his name used. "He manages other people's money as well as hedge funds. His priority is to provide investors with fat returns. And you don't do that by staying in a stock long-term."

Carl Icahn
Carl Icahn

Icahn's move for a board seat comes after Motorola reported its second weak quarter in a row for its mobile-phone business. Even though the company shipped a record number of handsets--almost 66 million worldwide--during the quarter, its net income fell some 48 percent compared with the previous year. CEO Zander attributed the stumble to several factors, including plummeting prices on the popular Razr phone and missed sales targets of newer phones like the Krzr.

Zander, who is well-regarded on Wall Street, has acknowledged the company's problems, calling the recent shortfall "unacceptable." During a conference call with analysts and investors in January, he outlined steps to improve profitability. In addition to cost-cutting measures, he also mentioned plans for building next-generation handsets and investments in new markets such as Internet Protocol television (IPTV), the mobile enterprise and WiMax.

Some analysts believe that Icahn, who has waged knock-down-drag-out fights with other companies, such as Time Warner, for a seat on their boards, could help provide a needed reality check to Motorola's management team whether he actually gets on the board or not.

"I think management may have been a little overconfident in where they're headed," said Doug Christopher, an equities analyst with Crowell, Weedon & Co. "So Icahn's involvement at the very least could force management to address some key issues and put together an understandable strategy."

Motorola is a huge company with its fingers in several pots, so to speak. But the company generates roughly 66 percent of its revenue and about 67 percent of its profits from the mobile-handset division. This means that even a minor stumble in the company's mobile-handset business will have a profound effect on the overall performance of the company.

Since becoming CEO in December 2003, Zander has made impressive improvements to the company's balance sheet, market share standing, and overall profitability. From the time Zander took over until the end of 2006, Motorola's worldwide market share jumped from 15 percent to 23 percent. One in four handsets sold around the world in the fourth quarter were from Motorola, the company said. Sales have grown 97 percent since 2003, and operating earnings (profit before interest and taxes) have leapt more than 200 percent.

But a lot of Motorola's handset success has been tied to its wildly popular ultra-thin phone, the Razr, which debuted in 2004. Even though the company is still selling the phone in high volume, the product is now being sold by all major carriers in the United States, and as a result, prices have fallen drastically. This in turn has collapsed profit margins.

Motorola introduced other new phones recently, namely the Krzr and the Rizr, but sales of these phones in the fourth quarter were unable to compensate for the losses caused by falling Razr prices.

"He has virtually unlimited resources, and he is always in it to win. So if your interests are aligned with his, then it's definitely a good thing."
--Michael Stortini, Robino Stortini Holdings, on Carl Icahn

Meanwhile, Motorola's competitors, Nokia and Sony Ericsson, a joint venture between Japanese consumer electronics maker Sony and Swedish telecommunications equipment maker Ericsson, have recently reported strong results. Nokia, the No. 1 handset supplier in the world, reported that profits surged 19 percent in the fourth quarter, even though the average price of its handsets has been steadily falling. In the fourth quarter, the average price was $116 compared with a year ago, when the average price was $128.

Sony Ericsson, which recently climbed to the No. 4 spot in handset shipments, is addressing the high-end market with expensive phones. The strategy is working well, helping boost overall profits for parent company Ericsson in the fourth quarter.

Motorola's management team says its priority is to return to double-digit operating margins by the second half of 2007. It plans to do this by controlling costs and focusing on improving gross margins with a slew of new phones designed to wow consumers. But Zander also said the company has a long-term strategy to diversify its business by boosting its presence in new markets, such as mobile enterprise and IPTV.

In 2006, Motorola announced several acquisitions to help it build expertise in those markets, including the purchase of Netopia, which makes home gateways, and Tut Systems, which has IPTV video-encoding technology. Motorola will add this technology to its "Connected Home" division, which already includes its cable set-top box family of products.

And the company's purchases of Symbol Technologies, which makes bar-code-scanning technology, and Good Technologies, a mobile-software developer, will help Motorola develop new products for the corporate market.

Motorola is also investing in new technologies, such as WiMax. In August, Sprint Nextel selected Motorola as a strategic partner to help it build a new 4G wireless network built on the wireless digital communications system.

"We have the right strategy, seamless mobility and the mobile Internet," Zander said during the conference call in January.

But for Icahn, this strategy doesn't appear to be enough. He wants more immediate results, and he believes they could be obtained through a more aggressive share buyback program, which would likely force Motorola to take on more debt.

Currently, Motorola's debt load is only $4.4 billion, and Dave Devonshire, Motorola's chief financial officer, has said he doesn't expect it to increase. Adding more debt to a telecom equipment maker's balance sheet goes against conventional wisdom, because manufacturing equipment is a capital-intensive business, so keeping debt loads relatively low is often seen as a positive.

Icahn has made a name for himself in recent years as a so-called investor activist. Last year, he tried to take over the media conglomerate Time Warner through a proxy fight. He wanted Time Warner's CEO Richard Parsons to step down, and the company split into four parts to unlock shareholder value. Eventually, he backed down when it became obvious that investors weren't supportive of his radical plan. But he did so only after the company took some of the steps he had proposed.

Michael Stortini, who manages the private hedge fund Robino Stortini Holdings, recently settled litigation with Icahn and his associates over a deal the two groups were involved in. He said Icahn is a whiz at maximizing shareholder value.

"I'd never be partners with him again," he said. "But as a Motorola shareholder, I'm glad to see him get involved. He has virtually unlimited resources, and he is always in it to win. So if your interests are aligned with his, then it's definitely a good thing."

But analysts covering Motorola say it's unlikely Icahn would have much power to do anything, even if he were elected to the board of directors. Jeff Kvaal, an equities analyst with Lehman Brothers, wrote in a research note this week to investors that "should Carl Icahn achieve a board seat, we believe changes to Motorola's plan would be modest given the size of the board (there are 13 board members) and our view that Motorola's 2007 plan has investor support."

CNET News.com's Dawn Kawamoto contributed to this report.

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