Losing Its RAZR's Edge

A one-time laggard, the handset company more than doubled earnings last year on 17% revenue growth. A snazzy little phone called RAZR had a lot to do with it, of course. But that wasn't all. Under Chief Executive Ed Zander, operations were streamlined and costs were cut.

A year ago today I wrote a piece detailing how Motorola shares would benefit from new management and sleek, fiercely popular phone offerings. A great call, it turns out: The stock has soared 40% since then.

But does this year hold the same promise for Motorola shares? I'm doubtful. The easy money has been made, in my opinion. Don't get me wrong. Motorola remains a good company with earnings growth ahead of it, but I don't think investors should expect the kind of returns they saw last year. So far, they're not getting them: Motorola's stock is down nearly 5% year to date.

What's changed? The product cycle, competitive environment and, most importantly, expectations. Let's address that last bit first. Simply put, investors' expectations of Motorola have inflated drastically in the course of a year. Success has a way of doing that. "Expectations are high for Motorola now," says John Slack, equity analyst at Morningstar. "There weren't any expectations for Motorola a year ago."

And those heightened expectations come at a time when the RAZR is getting a little long in the tooth. When the RAZR handset hit the scene, it was a fashion statement, a refreshingly slim departure from a crowded field of chunky phones. Best yet, it commanded premium prices, which juiced Motorola's handset division nicely. But about a year and a half after its launch, RAZRs are now more of a value phone, says Casey Ryan, an analyst at Nollenberger Capital Partners, a San Francisco research and money-management firm.

Compounding the issue, competitors are now selling ultra-thin phones of their own. "It's certainly going to be the case that the competitive environment gets tougher this year," says Edward Snyder, analyst at Charter Equity Research.

What Motorola needs is a stellar second act, and some analysts aren't sure if it's got one. The company's latest offerings don't have the same kind of dazzle as RAZR, they say. SLVR, a thin, candy bar-shaped handset, is selling fairly well, but sales for PEBL and ROKR, Motorola's widely panned iTunes phone, are slow going. And its Q phone, an eagerly expected offering designed to compete with Research In Motion's (RIMM) BlackBerry and Palm's (PALM) Treo, is delayed.

What's more, SLVR, introduced in January, isn't commanding the same kind of price that RAZR did at its launch. When it was first unleashed on the cellphone masses, RAZR sold for $500 or more — some even snapped up the phone without a wireless service plan, which typically lowers a handset's cost, says Nollenberger's Ryan. Importantly, that helped boost operating margins in Motorola's handset division. (Handsets represent about 60% of the company's sales.) But SLVR is retailing for about $200. "It seems very hard to capture [the same] amount of margin with these less-hot phones," he says.

There's also the matter of last week's RAZR recall. A limited number of phones using GSM technology (the wireless standard in Europe) were cleared from store shelves at Cingular Wireless and T-Mobile because of a glitch. Analysts by and large don't see the temporary suspension as having a major impact on the quarter, although Caris & Co., citing potentially slower sales, downgraded the stock. Quality problems, it goes without saying, are never welcome, especially for Motorola, a company that until relatively recently had a spotty record.

Against this backdrop, Motorola has to execute and execute well. Morningstar's Slack still sees upside to the stock — he has a $25 fair value estimate on it, which represents a 17% increase from current levels. He thinks there's still room for operational efficiencies, particularly from outsourcing and tightening up the supply chain. That would be a great return, of course, but he's not counting on a surge like last year's.

Others are decidedly more skeptical. Nollenberger's Ryan doubts Motorola will be able to increase market share — as it's repeatedly said it wants — and grow margins. As such, he expects Wall Street's earnings estimates to be ratcheted lower in 2006. For this year, he projects a profit of $1.30 a share, in line with the Thomson First Call consensus estimate (which, it should be noted, was revised a penny lower on Wednesday). But for 2007, Ryan expects the company to earn $1.39 a share, vs. the First Call consensus of $1.48.

Bottom line, this year could be a tougher road for Motorola, and that's a call investors might not be expecting.