Motorola May Be on the Razr’s Edge

06/25/2007 12:00 am EST

Focus:

Michael Murphy

Former Editor, New World Investor

Michael Murphy, editor of New World Investor, says the venerable producer of wireless and broadband communications products may be on the cusp of big-and profitable-change.

The cell phone is absorbing function after function, making other stand-alone products obsolete, especially at the entry level, [and] the relentless drop in technology prices insures that high-end cell phones will cost half as much in two years.

The imminent launch of the Apple iPhone on June 29 is creating a lot of buzz right now, and assuming it is not another flop like the Apple TV, it should get some market share, as well.

But another company will give us good exposure to the cell phone industry: Motorola (NYSE: MOT ). After a wonderful run with its Razr phones, Motorola is now the odd man out. Why? The Razr is a bit long in the tooth, Nokia has some hot new products, and Samsung's phones are just as good and cheaper. I think MOT's stock is sold out, which is to say the risk is low.

[Meanwhile], MOT has attracted the attention of several private equity funds. Carl Icahn bought a 1.4% stake in January and demanded a board seat in a private meeting with MOT's CEO Ed Zander. MOT subsequently announced a lousy March quarter, although the company did implement a $7.5-billion buyback. On May 9 [Icahn] lost the fight, but got an amazing 45% of [shareholders'] votes. So the board is on notice that if the company doesn't start doing better, fast, they will have to find a new CEO with a better strategy.

Icahn is not the only holder, though. Eddie Lampert bought Sears and only owns six stocks, one of which is MOT. Highfields Capital, Jana Partners, Pzena Investment Management and Third Point Capital, all well-known activist investors, have been buying the stock aggressively under $20.

I think something big is going to happen here. It could be a new line of phones that knocks Nokia off its pedestal. It could be a big restructuring with an accompanying special cash dividend. It could easily be a whopping $65-billion buyout at $28 a share. I'm not sure which, or when, but my guess is the restructuring and cash dividend in the next 12 months. (One argument in favor of the buyout, though, is that after Zander left Sun Microsystems in June 2002, he was a Managing Director of a technology buyout firm, Silver Lake Partners.)

MOT closed Friday at $17.89. I think you could pay up to $19 for it. Going from $19 to $28-my target price for January 2009-is a 47% return in 18 months. Not bad, but we can do better. I want you to buy the Motorola January 2009 $17.50 LEAP calls (VMAAW) up to $4 for a $10.50 target ($28 minus $17.50) in January 2009. That's a 162.5% return, more than three times what you would make on the common stock.

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