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Google Gets Defensive With Motorola Buy

Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Google made a surprise announcement Monday that it is buying Motorola Mobility for around $12.5 billion. I'm here today with Rick Summer. He is a senior analyst here at Morningstar who covers Google. We'll take a look at what impact this could have on all the handset makers and manufacturers. Rick, thanks for joining me today.

Rick Summer: Sure thing. Good to be here.

Glaser: So, let's just take a quick look at this almost-$40-per-share offer for Motorola Mobility. It's a fair amount above our fair value estimate. Is Google overpaying for this?

Summer: Yeah. Clearly, we think it is. I mean you look at where Motorola is valued; it had a fair value estimate of $27. Obviously, there can be some synergy that Google gets out of this, but this isn't a financial transaction. This wasn't a opportunity that Google found. We don't think Google looked at Motorola as an undervalued asset and that Google needed to get in the handset business. But it is true Google probably overpaid. But you look more than a $200 billion market cap, it could be OK that Google overpaid by roughly $4 billion.

Glaser: So this was a strategic transaction. Let's talk about some of that strategy. Why does Google feel the need to actually start manufacturing handsets instead of just licensing the Android operating system as it was previously?

Summer: Sure. A great question. I mean, what does this give Google that it didn't give the firm before? It certainly gives it some baggage on the downside. The handset business is not a business we particularly like. It doesn't have a lot of competitive advantages. So you really look at the reasons why Google would have gone after the business. It certainly isn't transformative. It's not something that really creates a lot of great opportunity. So what is it? It's defensive by nature.

You can look at all the activities gone around with Android during the last couple of quarters, and they've all been litigation-related. Motorola Mobility has about 17,000 active patents. I think there was another 7,500 that are in filing right now around the world. Google has obviously been under assault, and its partners have been under assault. The firm recently lost a very large intellectual property auction for Nortel's assets out of bankruptcy, and it lost to an Apple-led consortium. A lot of noise was made about Google losing that auction at the same time. The firm has been shopping around looking for other asset portfolios, and this happens to be one where it actually can get some assets that are certainly relevant.

Glaser: So it sounds like Google wasn't that excited about the Droid as much as it was excited about the patents underlying that handset. But what does this mean for the other partners then now that they are in the business? If I'm HTC or if I'm Samsung, am I looking at other places other than Android for my smartphones?

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Summer: So I think even previous to this announcement they were. I mean we look at Microsoft, which is launching a new version of the Windows Phone, Samsung and HTC among lots of other partners, those are certainly the two primary partners we look at in terms of penetration globally, have been very active about saying they are going to support the Windows Phone, as well. The other thing we have to keep in mind is several of these handset manufacturers have already had to pay Microsoft for the rights to use Android, because of potential violations of intellectual property that these handset manufacturers have had using Android.

Glaser: So certainly it sounds like they are going to be shopping around. But looking at Microsoft maybe a little bit more closely, does this kind of solidify Windows Phone in many ways as a third operating system with Apple and Google as the other two planks? What does it mean to Microsoft's partnership with Nokia? Do you see any developments there?

Summer: So I think that obviously the one question that people are going to ask is about a deal around Nokia, and does Microsoft need to do that. I think that's a real big question. Sometimes people follow the herd in terms of chasing deals rather than doing something that would be logical. As a Google shareholder and as Google analyst, I think that it would strengthen Google's position if Microsoft were to actually acquire Nokia. It would make Google appear to be less unfriendly, if we can kind of parse through what that strategy would look like.

Still, when we look at this deal, nothing is happening in the short run. I think that these handset manufacturers that use Google's Android system need to continue to use that system. Apple's a big looming force that's out there. They need to have a competitive product to Apple. Windows Phone is not something that's credible and commercial today, and it's unlikely that someone would only make Microsoft their sole provider of that operating system by the same token. So, while there is certainly some heightened risk around handset manufacturers being concerned about Google endorsing a Motorola-led handset venture, it's really unlikely that they would fall into another camp much more actively.

Glaser: So, you talked about the three major operating systems, and that kind of leaves out Research in Motion, the maker of BlackBerry, which has been struggling recently. Is this just another nail in the BlackBerry coffin or do you think that the firm will be able to skate by without this having a big impact on it?

Summer: I think it's premature really to lead along those points. I still think it really heightens how important Android is and how RIM is not Android and RIM is not Apple. So, once again we will say that it still talks about RIM being largely irrelevant when we look at the smartphone ecosystem and the smartphone platform market and the battle that's occurring right now.

Glaser: So, if I'm a Motorola Mobility shareholder, is this a good deal? Should I just take it and run?

Summer: Take it and run. Spend it where you may and perhaps you could invest it in Google. We still think Google is undervalued at the same time, but yeah this is a great deal for Motorola shareholders. We still think they could have been challenged to actually reach some really significant profitability. It's a competitive business. It's really dependent on product cycles at the same time, and though they've been leading very significantly in many respects in their smartphone market and their ability to continue to launch products, we all know about the continued hiccups that Motorola continues to have.

Glaser: As you mentioned, Google looks little bit undervalued now. Does this deal affect your fair value estimate for Google, or is it really just a defensive move?

Summer: We look at the overpayment of being around $4 billion on the upside really. If Google is able to get some synergies out of that, it's going to be less than that. And when you look at north of the $200 billion value that we have in the company, it's just too immaterial to really matter. We're looking much more actively at the strategic implications. We've always had this as a high-risk-rated stock, which means we would require a much greater margin of safety before investing. It's still really attractive; we're looking at north of a 20% discount to our fair value estimate. It's really hard to really ignore this at this time, and it's really still a good solid investment. But we just have to watch the smartphone platform. It's a very, very important battle that's looming.

Glaser: Rick, thanks for your thoughts today.

Summer: Thanks for being here.

Glaser: For Morningstar, I am Jeremy Glaser.