Published: February 12, 2010

Certain stocks are either loved or hated. Investors shun them when sales and profits are sliding, yet become quickly enamored when results start to improve. But any rebound in a company's operating picture can come in fits and starts, so when speed bumps emerge in the story, momentum-chasing investors tend to dump a stock. In the case of Motorola (NYSE: MOT), their loss could be your gain.

Roughly 18 months ago, it appeared Motorola was headed for ruin as operating losses grew. Investors questioned whether the company's disparate divisions still held any value. Shares moved down below $4 for much of the market downturn, and even briefly breached the $3 mark when the market collapsed. But management finally understood the depths of the problems and decided to take a big cut at expenses while maintaining research and development on products. Those moves steadily paid off and the shares began to rise from the ashes to a recent high of $9.45.

Such meteoric ascents are often the work of momentum investors typically seeking to ride a wave of good news, and then flee at the appearance of any bad news. When Motorola reported tepid fourth-quarter results, it was a race for the exits. Shares are down roughly -30% in the past three months, putting them back into value territory. To get a sense of that value, you need to look at the company as a series of distinct parts. Taken together, those parts appear to be worth about $9.

Let's start with the balance sheet, where the company has roughly $4.1 billion in net cash ($1.77 a share). Motorola is expected to generate $2 billion to $3 billion in free cash flow this year, so the cash position should be at least $6 billion by year-end, but we'll stick with that $1.77 a share calculation for now.

We can next assess the value for the company's Enterprise & Mobility Segment (EMS), which sells communications equipment to public safety agencies and asset monitoring equipment (acquired through its purchase of barcode and RFID vendor Symbol Technologies a few years back). The EMS division is likely worth roughly $9.5 billion ($4.08 a share), based on an assumption of seven times projected 2010 EBITDA (on an enterprise value basis). That multiple is lower than pure play companies in the EMS segment such as Zebra Technologies (Nasdaq: ZBRA) and Intermec (NYSE: IN).

Together, Motorola's EMS division and current cash balance are worth around $6, not far below the current stock price. Investors are getting the company's remaining two divisions for free. The first is the Home & Networks Mobility (HMS) division, which makes set-top cable boxes and other telecom hardware. The unit generates about $8 billion in annual sales and $700 million in operating cash flow, and is likely worth four or five times cash flow -- let's call it $3 billion ($1.30 a share).

Then we can look at the much-maligned mobile phone division, which was an industry leader just five years ago with its Moto phone, but is now an industry laggard. This division hemorrhaged cash in recent years, but massive cost cuts have shrunk those losses and management believes the division will become profitable by the end of 2010.

The optimism stems from a decision to get behind Google's (Nasdaq: GOOG) Android operating system. Google-based smartphones have become an early hit for Motorola, as two million units were sold in the fourth quarter of 2009. Motorola is also working with Google to sell a smartphone direct to consumers through the Web, similar to Google's collaboration with HTC on the Nexus One phone.

Motorola gets more than $400 for each of these smartphones, well more than the $120 average sale price for traditional cell phones. Notably, Motorola understated revenues in this segment by $200 million in the fourth quarter due to an accounting provision. This early success is having an understated impact on the income statement thus far, but that will change in 2010 when new rules are adopted that require only a portion of smartphone sales to be deferred.

So how do you value a struggling mobile phone business that has been showing new promise? Dell (Nasdaq: DELL) trades at just 0.3 times revenue, while Nokia (NYSE: NOK), Palm (Nasdaq: PALM) and RIMM (Nasdaq: RIMM) trade at 0.9x, 1.1x, and 1.7x, respectively. If Motorola's division traded at 0.5 times revenue, the division would be worth $4 billion, or $1.65 a share. Taken together, the HMS and mobile phone divisions are likely worth about $3 a share. This means we're looking at a nearly +50% appreciation from the current price to become fairly valued .

Management has acknowledged that Motorola has become an unwieldy conglomerate. It knows these assets need to be monetized to truly unlock shareholder value. Whether that will come in the form of splitting the company in two or a selloff of one of the units (both have been discussed) remains to be seen. As that process unfolds, shares of Motorola should again re-visit recent peaks.

-- David Sterman
Contributor
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