Stifel Equity Trading Desk analysts Aaron C. Rakers, Sanjiv R. Wadhwani, Joseph Quatrochi, Andrew Shinn and William C. Peterson rate Apple Inc. (NASDAQ:AAPL) as a Buy as Google Inc (NASDAQ:GOOG)’s announcement to sell Motorola to Lenovo Group Limited (OTCMKTS:LNVGY) (HKG:0992) may impact U.S. and European market share and increase competition in the smartphone market.
After the close, Google Inc (NASDAQ:GOOG) announced that they had signed an agreement to sell Motorola to Lenovo for $2.9 billion. Google will retain the vast majority of the 17,000 patents it acquired from Motorola (Lenovo will receive 2,000 patents). The patents will be licensed back to the handset business for its continued operations.
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Lenovo Group Limited (OTCMKTS:LNVGY) (HKG:0992)’s acquisition includes the Motorola brand. As a reminder, Google Inc (NASDAQ:GOOG) paid $12.5 billion for Motorola in 2011. Since then, Motorola’s smartphone share has slipped, down to 1.3% in September 2013, from 3.7% in September 2011. We estimate that Motorola shipped around 4.5 million smartphones in December 2013.
Implications for Apple
Broadly, we see the transaction impacting Apple Inc. (NASDAQ:AAPL) two ways. First, Lenovo Group Limited (OTCMKTS:LNVGY) (HKG:0992) has practically no presence in the US and European markets. Motorola on the other hand focuses mostly on the US and European markets. While Motorola has released very capable phones like the Moto X and Moto G at attractive price points recently, it has failed to gain market share in developed markets. With some additional marketing push by Lenovo, we could see Motorola/Lenovo gain some share in the US, European and Latin American markets at the expense of Apple and Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930). Additionally, in terms of market share, a combined Motorola/Lenovo move to the #3 spot (from Lenovo’s current #5 spot), ahead of Huawei, giving the company significantly more leverage in negotiating with carriers for higher visibility. Google Inc (NASDAQ:GOOG) CEO Larry Page stated that “Lenovo has the expertise and track record to make Motorola a major player within the Android ecosystem”
In emerging markets, particularly in China, Lenovo Group Limited (OTCMKTS:LNVGY) (HKG:0992) has a strong presence and a well-segmented product portfolio spanning from simple, affordable smartphones to full-featured 5” screen models. With the addition of Motorola, we believe that Lenovo will be able to offer higher-quality and customizable phones. However, we expect less of an impact on Apple Inc. (NASDAQ:AAPL) in emerging markets from this transaction, given that Lenovo already has a large presence there.
Purchase price analysis:
Lenovo Group Limited (OTCMKTS:LNVGY) (HKG:0992) will be paying $2.91 billion for Motorola, including $1.41 billion at close, comprised of $660 million in cash and $750 million in stock. The remaining $1.51 billion will be paid in the form of a three-year promissory note. As a reminder, Google Inc (NASDAQ:GOOG) paid $9.5 billion for Motorola – $12.5 billion minus the $3 billion in cash that Motorola had on its balance sheet. Google sold Motorola’s set top business for $2 billion, bringing the net price for the handset business to $7.5 billion. heT patent portfolio, which Google retains, was valued at $4 billion. Consequently, if we believe the patent value, then the value of the hardware business being sold to Lenovo is around $3.5 billion.
Apple’s target price methodology and risks
Our $650 target price for Apple Inc. (NASDAQ:AAPL) reflects a weighted valuation methodology using a 13x P/E, ~8x EV/EBITDA, and 12x EV/FCF multiples on our FY15 estimates, as well as a modest weighting to our 10-year discounted cash flow model, using a ~9% WACC and a low double-digit revenue growth rate over the next couple of years, followed by a low single-digit growth rate thereafter. Risks to our target price include: (1) Reinventing product momentum – can Apple sustain current level of product innovation?; (2) Emerging competition for iPad and MacBook Air; (3) Wireless carriers looking to push back on iPhone subsidies; (4) Slowdown in Chinese growth impacting expanding operations in the country; (5) Legal disputes (e.g. Samsung tablet litigation); and (6) Execution missteps.