EUR 850.00 For Business Accounts Only

Morningstar | Narrow-Moat Motorola Solutions Posts Another Durable Quarter for 3Q; $136 FVE Maintained

Motorola Solutions reported robust results for its third quarter of 2018, producing $1.862 billion in revenue and $1.94 in non-GAAP EPS, in line with our expectations. While we were pleased with the quarterly results, operating margins for third quarter and guidance for the fourth quarter was perhaps a little lighter than expected, but the revised full-year adjusted EPS range of $7.00 to $7.05 (above $6.79 to $6.89 last quarter) gives us confidence that the firm can hit its fiscal 2020 target of about $8 plus in adjusted EPS, with optionality to outperform that target. We are maintaining our fair value estimate of $136 and narrow moat rating. We think the firm is modestly undervalued today.

Similar to the past two quarters, the firm continues to benefit from strong revenue growth, up 13% year over year. The growth was largely driven by a number of acquisitions, but the firm also saw strong organic growth of 4%. Motorola is benefiting from a strong U.S. economy and minimal China exposure, in our view. The firm concurrently produced a record backlog of $9.5 billion. Our thesis since the start of 2018 has been that investors are likely underestimating Motorola solution’s pivot to both software offerings and recurring revenue streams.

The firm’s non-GAAP operating margins fell from 24.3% in fiscal 2017 for the third quarter to 21.4% this year, but this was largely the result of integrating new acquisitions such as Avigilon. Since the Avigilon acquisition at the start of 2018, we have been bullish on Motorola’s ability to bring its expertise in selling its offerings to public sector customers to Avigilon’s product lines, which have historically been private sector only. Looking ahead, we expect near 4% organic growth in fourth quarter and 2019, with about $500 million from the renewed airwave deal. We project Avigilon to grow at about 15% (off $400 million in 2017), and software offerings to grow between 15% and 20% in 2019 (off about $400 million in 2017).

In terms of wins in the third quarter, the firm saw software wins in Chesterfield County, VA and the city of Las Vegas. Looking ahead, we like the firm’s wins in the state of Florida which include replacing a Harris Corporation contract and a renewal of the Airwave contract.

In October 2018, it was announced that Harris Corporation will merge with L3 Technologies to form a defense conglomerate. While Harris is arguably Motorola’s chief competitor in the United States, we believe that the merger is a net positive for Motorola, especially as the piece of the combined business that competes with Motorola will compose a mere 3% of Harris and L3’s combined revenue. We are willing to bet that Harris’ Land Mobile Radio, or LMR, business is likely not a strategic imperative for the company, which is substantiated by Motorola’s ability to win major statewide LMR contracts from Harris customers, such as the state of Florida. Going forward, the LMR business likely becomes less of a strategic imperative for the combined L3 and Harris enterprise. One caveat to our positive take on the merger is if the LMR business was sold off in a private equity deal. However, we see no indication that a sell-off will occur.