Analysts covering Motorola Inc.’s stock were surprised and irritated last week after the company unexpectedly indicated wireless handset profits would face pressure the rest of the year.
Though the company exceeded Wall Street’s earnings estimate by a penny, Motorola’s stock fell 17.5 percent after the company’s conference call detailing the first quarter. And analysts began to downgrade.
“The way they handled the changing guidance was a little clumsy and contributed to some of the dramatic fall,” said Matt Hoffman, analyst with SoundView Financial Group, which downgraded Motorola from a “strong buy” rating to a “buy” rating. “The quarter message was clear. It was how they delivered the message for the year, which required us to do the calculations and figure out the consensus. That created an atmosphere where the positive message was lost.”
Motorola’s punishment comes at a time when press reports continue to herald the company’s turnaround that includes an aggressive entrance into the wireless Internet and third-generation equipment arenas. Motorola took beatings in 1998 for poor earnings and its slow move into the digital handset arena. It embarked on aggressive cost-cutting and restructuring measures in late 1998 and consistently reported higher-than-expected earnings in 1999.
Last Tuesday, Motorola, the No. 2 handset maker, found itself defending questions about its eroding handset operating margins, which fell from 7 percent in fourth-quarter 1999 to 1.5 percent in first-quarter 2000. The Shaumburg, Ill., company’s operating profits declined in the personal communications segment, which comprises handsets, paging equipment and consumer radio products, to $49 million, compared with $83 million a year ago.
Though wireless handset revenues increased 37 percent in the first quarter, profits fell because of a shift in the wireless phone product mix toward low-tier products with smaller margins, increased costs for certain components in short supply and significantly higher investments in engineering and advertising. In particular, wireless operators in Europe, the Middle East and Africa made dramatic shifts toward selling prepaid service.
Motorola’s higher-end Wireless Applications Protocol-enabled phone shipments were strong during the quarter, but were not enough to offset the loss, said the company. Motorola said the WAP market has taken longer to develop than it expected.
“The sector posted an extremely disappointing level of profitability in the first quarter, and the outlook for a rapid recovery in sector profitability is in question,” said J.P. Morgan Securities Inc. analyst Gregory Geiling, who downgraded Motorola from a “buy” rating to a “long-term buy” rating. “While the outlook for unit shipments and revenue growth for the handset segment remain strong, the mix shift toward lower-end products is likely to continue to strain margins in the near-term.”
This large shift to lower-end handsets used for prepaid services isn’t likely to affect Nokia Corp., which leads the worldwide handset market, or third-largest L.M. Ericsson, say analysts. Nokia has been able to make money on low-end phones while aggressively targeting the high-end Internet-enabled phone market.
“Motorola is a canary in a coal mine,” said Hoffman. “It will feel the pain before Nokia. Nokia will feel any effects last … It does not miss.”
Ericsson didn’t capture the low-end market to begin with and is improving its margins by moving its mix of products to the higher end, said Hoffman.
Overall, Motorola’s earnings, excluding special items, for the first quarter were $449 million, or 59 cents per share, up 144 percent from $184 million, or 26 cents per share, the previous year.
The dismal news in the personal communications sector shaded Motorola’s positive news in the semiconductor, wireless infrastructure and broadband business. The three businesses posted better-than-expected results, with the semiconductor business recording operating profits of $123 million from $10 million a year ago. The network systems segment grew 11 percent to $1.8 billion. Broadband profits grew to $91 million from $61 million a year ago.
