Motorola Solutions (MSI) reported results and guidance that disappointed the market. The stock has been down 8%–10% today.
However, I think this overreaction provides an potentially attractive entry point for an investor, especially in light of the fact the company is under-leveraged and continues to return large amounts of capital to shareholders in the forms of dividends and share repurchases.
About the Company
MSI provides mission critical communication infrastructure, devices, software and services to government and enterprise customers. Their Government segment includes sales of public safety communications systems, commercial two-way radio systems, devices, and software. Service revenues included in the Government segment are primarily those associated with the design, installation, and maintenance of equipment for public safety networks.
MSI's Enterprise segment includes sales of rugged and enterprise-grade mobile computers and tablets, laser/imaging/RFID based data capture products, wireless local area network and integrated digital enhanced network infrastructure and software. Service revenues for Enterprise are primarily maintenance contracts associated with the above products.
Predictable and Profitable
About 25% of sales are related to services as opposed to products, which gives some stability and predictability to cash flows. The company is also highly profitable with ~45% gross margins and 20%+ returns on equity, which is impressive given the low debt to equity ratio of 20%.
Under-leveraged: The Case for a Slow Recap or an Eventual Buyout
Given the low level of net debt at the company (net debt to EBITDA is –0.51) and the profitable and predictable nature of the business, I believe the company can take on significantly more debt. At the bare minimum, this gives management the ability to continue to return capital to shareholders for a long period of time. Alternatively, management can take on debt and announce a significant special dividend or a tender offer for shares. The final scenario is that private equity or a larger public company would purchase all of MSI.
Below is a table showing the resulting net debt / EBITDA for varying amounts of additional debt.
I believe MSI could easily take on another $5 billion of debt. Whether it's for the purpose of returning capital to shareholders or because someone else is acquiring the company, with current enterprise value of about $8.8 billion, another $5 billion would represent a >50% return.
As a result of recent, weak results, I think MSI is a very interesting idea. I think it's obvious to most people that MSI is under-leveraged. I think MSI would be a prime target for private equity or a larger public company (like Danaher or GE, or perhaps one of the defense companies) given its current capital structure.
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