Though I consider myself a longer-term investor, I like to take a look at the stocks with unusual option activity on StockPickr to see if there is anything sufficiently interesting to investigate further. Friday’s list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT - Annual Report), Arch Coal (ACI) and Yahoo! (YHOO). I dug a little deeper on Motorola, and came away thinking it might be worthwhile even for those willing to wait longer than October to see a return.
Motorola was having an investor day on Friday, though it is hard to imagine anyone thinking it would produce an announcement worthy of a 20% up move. In fact, there probably is only one such possible announcement, and that is of Ed Zander’s resignation. The company has struggled to find a follow-up that matches the RAZR’s success, let alone one-ups it. In Zander’s own words, “In Mobile Devices, we did not achieve the level of sales and unit shipments that we had expected, primarily in Asia and the Middle East and Africa. Europe, as we have been saying all year, continues to be a challenge.” The message boards are downright gruesome.
But if all it takes for a 20% up-move in Motorola is a new CEO, the market has gotten awful forgetful. After all, it was just four short years ago that the stock rallied 10% (from a far lower base) on the news that Chris Galvin was resigning to be replaced by Zander. It makes one wonder why they keep them as long as they do - if I could get a 10% rally on every CEO firing, I wish Motorola would do it at least once a year. Zander is credited with putting the RAZR on the fast-track and for… not much else. Why settle for anyone’s second-best idea? Give them a few months to put their best one into action, then sayonara! It’s time to find someone else, with a new best idea. Call it crowd-sourcing for CEOs.
So in case you missed the sarcasm, color me skeptical that Zander’s departure would do much for Motorola over the long term. And don’t tell me they need “compelling products” when Nokia (NOK) consistently produces the blandest, clunkiest, ugliest, bulkiest - and best-selling - phones on the market. The analyst day highlighted a return to cash generation - which will definitely be needed for a turnaround to succeed, regardless of who is behind it.
Motorola generated cash flow from operating activity of $3 billion in 2004, $4.6 billion in RAZR-backed 2005 and $3.5 billion last year. For the last 12 months, however, they are down to $2.2 billion - of which $700 million was used up in capex. Still, in a somewhat depressed year it is enough to make the free cash flow yield on Motorola’s $35.6 billion enterprise value comparable with the current treasury yield. All Motorola needs to do is get cash flow back to 2004 levels and today’s investors will be compensated for accepting the risk. If they can get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there I estimate the stock would be worth nearly $23 - more than 25% above the current price. They could pretty much do that just by trimming R&D expense to the 2004 level (which was all they needed to produce the previous hit product anyway.) This scenario doesn’t require them to create the next RAZR, but if they did it would make for a nice icing on the cake.
The obvious risk to this thesis is that cash flow could move in the wrong direction. It isn’t hard to imagine possible scenarios where this happens, especially given the lukewarm reaction the street is giving the recent comments on cash flow improvement. It wouldn’t be the first time a management team gave up on a promising strategy in order to give investors what they thought they wanted. If you are a buyer on the cash flow story you’ll probably want to flee for the exits if anything is announced that will eat up the cash. Fortunately, however, Icahn is nipping at Motorola’s heels. That might be enough to keep them from doing anything too rash.[1]
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