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Morningstar | MSI Updated Star Rating from 03 Aug 2018

Narrow-moat Motorola Solutions reported durable second-quarter results, producing $1.76 billion in revenue and $1.46 in non-GAAP EPS, both modestly exceeding our expectations, prompting us to raise our fair value estimate to $136 per share, from $127 previously. Motorola now has an ending backlog of over $9.4 billion, giving us confidence that Land-Mobile Radio, or LMR, technology demand remains robust. The firm's revenue of $1.76 billion represented 18% year-over-year growth, largely aided by recent acquisitions as organic revenue growth sat at 6%. We highlighted Motorola's shares post-February analyst day, as our raised estimates resulted in a stock that traded at nearly a 20% discount to our fair value. Today, after the recent quarter, we still foresee modest upside for Motorola. We think the market is beginning to appreciate the higher growth software and Avigilon assets, the muted impact of FirstNet at this time, and the shift to recurring revenue, aided by the new segment breakouts.

Motorola's LMR products and services continue to do well and we see the extension of Airwave on the horizon. First, key deals in the quarter were indicative of robust LMR demand, in our view. Most prominently, Motorola was awarded a five-year IDIQ contract capped at $495 million for the U.S. Army, providing P25 compliant unit radios, accessories, and ancillary services. Second, we note that management expects the extension of Airwave to be announced in the current quarter, likely for five years, with Motorola's leadership indicating that it expects Airwave to remain relevant.

One of the underappreciated stories with Motorola Solutions, is the firm's burgeoning public safety command center (built through internal R&D and the acquisitions of Spillman and Plant CML) and video surveillance & analytics (from Motorola's acquisition of Avigilon for $1 billion earlier this year) businesses, which represent addressable markets of $5 billion and $11 billion, respectively.

We see these two opportunities as intertwined as the command center is evolving. 911 command centers are no longer contending with just 911 landline calls and LMR voice interactions. These digital networks have meant that text, media, fixed and bodyworn camera videos, LMR data, location, and sensors are all relevant data points that need to be aggregated and collected at crime scenes. The next stage of this software evolution is poised to be workforce smart mapping, crime prediction, and video analytics, which we think will be aided by the 2018 acquisition of Avigilon.

In terms of the public safety command center, Motorola's tools combine 911 call handling, computer-aided dispatch, or CAD, and records & evidence, which have historically been separate offerings. This end-to-end functionality allows the firm to provide a greater value proposition for government customers. Estimates suggest Motorola's software subsegments are around $400 million annualized in terms of revenue.

Avigilon's solutions, parts of which could largely be labeled as video surveillance as a service, or VSaaS, help reduce the burden of managing physical infrastructure. Avigilon Blue, the firm's solution in this space, is deployed via a hybrid cloud VSaaS model, whereby video footage is stored both in the cloud and through storage on a network video recorder, or NVR. While Motorola intends to keep Avigilon as a siloed business, we see opportunities emanating from Motorola's ability to bundle Avigilon's technology with the legacy LMR offerings. Avigilon was primarily a private sector-focused, company selling to enterprises, and we believe Avigilon is set to benefit from Motorola's close relationships with state and municipal governments in the U.S. We started to see some of that this quarter, as Avigilon's growth reportedly outpaced the firm's internal expectations.

Looking ahead, we track near management's approximate financial targets of $8 billion in revenue and near management's $8 per share in non-GAAP EPS target by fiscal 2020. Management will need to execute on a potential Airwave extension in the U.K., robust software growth, and effective management of Avigilon. We will be closely tracking any outsize shifts in Motorola's customer base from their P25 platform to FirstNet over the ensuing quarters.