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Google's Googlomerate Valuation Mess - Is Motorola an Albatross?
Submitted by Scott Cleland on Wed, 2012-02-29 11:50
In anticipation of Google formally closing its "transformative" Motorola acquisition, investors soon will have to figure out the appropriate new valuation model/multiple for GOOG-MMI. Arguably, few major companies have undermined or confused their valuation model/multiple more for investors than Google, which acquired a major company that is it's investment, financial, operational, and cultural opposite.
Per Google's longstanding practice, Google has given investors precious little guidance: 1) Google bought Motorola for its patents to defend Android; 2) Google will keep Motorola as a separate entity; and 3) Google has built a "firewall" between Android and Motorola.
So in addition to having a big revenue miss in 4Q11 that spooked investors, and in addition to establishing a track record with investors of fast-growing and often unpredictable operating and capital expenses and headcount, Google's first major acquisition, Motorola, necessarily forces a reassessment of the appropriate financial valuation model/multiple for Google given that Motorola is now so material to Google's financial results financially going forward, whether or not Google transparently presents consolidated financials.
1. Motorola transforms Google's financial metrics: Per Yahoo financials, Google's $38b in revenues are growing ~26% and enjoy a ~26% profit margin, while Motorola's $13b in revenues suffer from flat growth and a -2% profit margin, meaning the combination will reduce Google's revenue growth rate and profitability by a ~third -- before any potential investment/bailout resources come from Google in order to give Motorola any chance of returning to expected growth and profitability in the future. Motorola represents about ~25% of Google's combined ~51b in annual revenues, but represents about ~5% the market cap; that means that Motorola, which enjoyed a significant acquisition premium, has a less than one fifth the price-to-sales value of Google.
So what does an investor make of this odd cross-species mating? Does Google have any experience in taking a much-less-profitable major acquisition and substantially raising its margins, like say Oracle has been able to do with Sun? If Google keeps Motorola largely separate operationally from Google, then will this transaction have near zero merger synergies or efficiencies that normally help finance a transaction of this type? And how many billions will Google invest in Motorola over what period of time to turn Motorola to profitability and growth? Or could Motorola in the end be a $13b+ Clearwire-like investment that Google then starves?
2. What valuation model/multiple is appropriate for Google-Motorola? Do investors model a significantly lower conglomerate-like valuation, or some percentage thereof, signaling a significant haircut from Google's current valuation? Do investors impose a complexity, uncertainty, and lack of transparency discount to the combined entity?
How should an investor try and value Motorola inside Google? Ironically, if investors look to Nokia as a comparable to Motorola, Nokia is valued much less than Motorola is. And doesn't Google already enjoy a substantial valuation premium over Apple by almost every measure despite Apple growing almost three times faster than Google? When investors start doing the sum-of-the-parts analysis and comparing Google and Motorola and Google-Motorola to potential market comparables and the rest of the market, and also compare the relative execution and regulatory risk that Google-Motorola faces relative to comparable companies, it is challenging to see how Google could get the benefit of the doubt that the relative valuation opportunity is greater and risk lower than other comparable companies.
Given this material valuation model/multiple reset of Google-Motorola, it is problematic that Google has no real business peers given its overwhelming dominance of Internet advertising. Should Google be compared with other dominant tech companies in their space like Microsoft or Oracle, which the market subjects to relatively tougher valuation models/multiples? Should Google be modeled after other advertising companies or other complex conglomerates, which the market subjects to much tougher valuation models/multiples?
3. Integration assumptions? Given that Google is proposing to be business "neutral" towards Motorola and not accord Motorola any special treatment or business advantages that a normal company would provide to a normal acquisition, how do investors devise reasonable assumptions of what will happen going forward?
Do investors model an execution risk discount given the potentially lose-lose dynamics of the combination -- i.e. if Google favors Motorola, they could lose Android partners like Samsung and HTC, or if they don't advantage Motorola, Motorola languishes as an under-performing albatross?
Moreover, how can investors trust that Google will be "neutral" towards its new Motorola property when it has a track record of highly-favoring most all its previous 100+ acquisitions? And wouldn't it be weird to buy a company a company for ~$13b and then not help it succeed?
Furthermore, how is an investor to model the profound Android-Motorola business conflict? If Google does not favor Motorola with special treatment or advantages over other Android partners like HTC, Samsung, etc, in order to keep those strategic partners in the Android fold and not have them jump ship to another operating system, (which would undermine Google's Android-driven advertising revenue growth), then how does Google plan to grow and strengthen Motorola financially and business-wise so it does not remain a valuation ball-and-chain around Google's proverbial neck?
4. Extraordinary headline and regulatory risk: Arguably no major successful publicly-traded company has ever faced the cumulative depth and breadth of headline and regulatory risk as Google faces at this point in time. Google faces serious regulatory franchise risks in the U.S. and around the world in three areas: antitrust, privacy and property rights infringement liability.
On antitrust, the EU is poised to declare Google a monopoly and sanction Google for advantaging its properties in its search results while penalizing its vertical search competitors. The EU and DOJ recently warned Google/Motorola to not anti-competitively abuse their standards-essential patents and both Apple and Microsoft have filed antitrust patent complaints against Google/Motorola in the EU.
And on property rights infringement, in addition to the patent antitrust suits from Apple and Microsoft, Google faces a potential loss in the Viacom vs. Google-YouTube lawsuit which could greatly increase Google's liability going forward for its ongoing systematic property infringement.
5. Employee option re-pricing risk -- again: Google's acquisition of Motorola also undermines the upside for the many thousands of Googlers who have stock options as a central part of their incentive compensation. If the Motorola acquisition turns out to be a wet blanket on Google's stock price, Google will face pressure to reward those employees with re-pricing their stock options -- again. Investors remember that Google already has set the precedent that when management fails to generate stock appreciation gains, Google management will take hundreds of millions of dollars from shareholders and redistribute it to employees to pay for Google management's compensation system mistakes.
In sum, the closing of GOOG-MMI is an important action-forcing event for Google investors or investors interested in Google. From its inception as a public company, Google has long claimed it is focused; its philosophy statement states: "It is best to do one thing really well: We do search." It's hard to see how Motorola helps Google's search business. It is also hard to see how Motorola does not seriously complicate Google's pure search advertising valuation model/multiple.
Before this transaction closes, most all of Google's revenues come from search advertising; after it closes <75% of Google's revenues will come from search advertising. For Google investors, this is now the Googlomerate Era.