Motorola Valuation Analysis Valued as of April 1, 2007

Transcription

1 Motorola Valuation Analysis Valued as of April 1, 2007 Analysts: Christy Alanis: Sara Kutscher: Lesley Radicke: Lauren Slater: Zach Tubb: 1

2 Table of Contents: Executive Summary.. 3 Company and Industry Analysis... 8 Accounting Analysis Ratio Analysis and Forecasted Financials Valuation Analysis 66 Appendix 1- Screening Ratios. 77 Appendix 2- Financial Ratios 78 Appendix 3- Forecasted Financials 79 Appendix 4- Valuation Models. 81 Appendix 5- Cost of Debt 85 Appendix 6- Regression.. 86 References

3 Executive Summary Investment Recommendation: Overvalued, Sell 04//1/07 MOT NYSE $17.57 EPS Forecast 52 week range $ $26.30 FYE 2006(A) 2007(E) 2008(E) 2009(E) Revenue (2006) $42,879,000 EPS $1.46 $1.65 $1.77 $1.90 Market Capitalization $42.00 Bil Shares Outstanding 2.39 Bil Ratio Comparison MOT NOK ERIC Dividend Yield 1.10% Trailing P/E $23.51 $21.09 $ mth Avg. Daily Trading Volume 32,798,600 Forward P/E $23.37 $20.97 $26.42 Percent Institutional Ownership 74.10% M/B $23.55 $16.24 $42.78 Book Value Per Share (mrq) $6.164 ROE 15.22% Valuation Estimates ROA 5.54% Actual Price (04/01/07) $17.57 Est. 5 year EPS Growth Rate N/A Ratio Based Valuation Cost of Capital Est. R2 Beta Ke Trailing P/E $15.47 Ke Estimated 11.3 Forward P/E $ month % M/B $ year % 5-year % Intrinsic Valuations Estimated 7-year % 10-year % Discounted Dividends $1.25 Published 1.35 Free Cash Flow $35.62 Kd MOT: Residual Income $8.72 WACC MOT: Abnormal Earnings Growth $12.90 Altman Z-score: MOT:

4 Recommendation: Overvalued Firm Company and Industry Overview, and Analysis Motorola is the second largest manufacturer of headsets in the telecommunications industry, second only to Nokia. Motorola operates under the idea of seamless mobility that was developed in This idea is centered on wirelessly connecting the world through their customer s mobile devices, homes, and businesses. Motorola has received several awards in recent years for their advances in technology and continuous customer service. Motorola has facilities located all over the world from the United States to India to China. They provide products for large companies such as Comcast and Sprint Nextel. Motorola is a company that continues to improve on the technologies of today to improve the future of tomorrow s world. The telecommunication industry as a whole is competitive and as the demand for high tech products increases, the industry continues to grow as well. The major players in the telecommunication industry are Nokia, Motorola, Ericsson, LG, and Samsung. The entire industry is composed of 2000 companies with combined revenue of over $65 billion dollars, with the largest of companies holding 75% of the total market. The industry as a whole is hard to enter and hard to leave because the industry requires highly specialized products and requires high amounts of manufacturing facilities. It is best for a company to be one of the first in this industry because it can help set standards. Many companies within the industry lease out their facilities which includes office space, equipment, and land. In order to survive in the industry, Motorola along with the other companies must sell mass amounts of their products before the products become obsolete. In the telecommunications industry, customers have a high bargaining power because of the low switching costs. Switching costs among suppliers is also low because suppliers can produce mass quantities of products at a low cost. Accounting Analysis Motorola releases a 10-K after every fiscal year. This 10-K is a document that contains all financial information about a company that is used to value them. It is also 4

5 helpful for investors in determining if they would want to invest in the company or not. Motorola s 10-K disclosure was poor and we were unable to find rates and terms needed for further analysis. The main problems in the 10-K were that we were unable to find the discount rate and the length of the leases, making investors unsure of their actual lease obligation values. Despite these faults in their 10-K Motorola did a good job of disclosing information about their different segments. The management discussion was efficient in explaining the business and their goals. The only red flag that was found with Motorola was the missing lease terms and discount rate, making it difficult to accurately determine lease values. With an assumed discount rate, it was found that if Motorola capitalized their leases instead of considering them to be current operating leases, there would room for concern; we therefore believe that they are not hiding liabilities behind their leases. Motorola has 3 main key accounting policies which include research and development, customer service, and goodwill. Since the company is defined as competing on differentiation these key accounting policies are factors that take Motorola above the competitors which is why there is so much money and time put into them. Another factor to consider in the accounting analysis is Motorola s flexibility. They specifically utilize their flexibility to promote their most important assets as a company. Research and development is one aspect Motorola attempts to keep flexible because it is important for the development of the company, and managers have no accounting discretion over it. Another factor of their flexibility is the deprecation method of straight-line, declining balance, and inventory method of FIFO. In Motorola s accounting analysis, the company is defined as aggressive in the fact that they are FIFO inventory based. Also, Motorola reserves $501 million for their warranties, which goes hand in hand with the customer service key accounting policy. Motorola acquired a lot of goodwill in the five year analysis, leading us to believe that they are aggressive since it increases their assets and gives them more room to grow. Screening ratios were run to see if Motorola was hiding expenses or overstating their revenue. By overstating revenue or understating expenses, Motorola would be 5

6 boosting their net income, operating income, and their retained earnings. It would cause investors to make decisions with incorrect information. Although Motorola s 10K is audited, a company can still provide false information. Unless Motorola properly states why certain ratios jumped or dropped, it is a red flag for analysts. Overall, Motorola does not overstate or understate their revenue or expenses. Financial Ratio Analysis When analyzing financial ratios for a company, they are divided into three divisions: liquidity, profitability, and capital structure ratios. All of these ratios are very helpful when it comes to comparing the company in different areas to its competitors. The liquidity ratios contain seven ratios that are used to relate how well a firm can maintain its cash resources to cover its current obligations. These ratios also tell how strong the cash to cash cycle is by using inventory turnover, days of supply in inventory, accounts receivable turnover, and days until collection of accounts receivable. Profitability ratios look at a company from another prospective. A company s operating efficiency, asset productivity, and rate of return on assets and equity is explained by using profitability ratios. If these ratios are calculated correctly, they can give information about how profitable the company has been in prior years through information from the balance sheet and income statement. Capital structure ratios deal with how the company is financed. The first capital structure ratio that is calculated is the debt-to-equity ratio, to see if the company generates enough assets to pay back its interest and debt obligations. For a telecommunications company, forecasting of financial statements is very important. Forecasted financials give managers an idea of where the company is going, where it needs to improve, and sets goals. By analyzing how well Motorola did in the previous five years, forecasting for the next ten years was possible. Since every year is different, a smooth growth rate was used for all aspects of the income statement, balance sheet, and statement of cash flows. 6

7 Intrinsic Valuation There are four key models to run when valuing a company. These models include the dividends discounted, free cash flows, residual income, and abnormal earnings growth. In each model, the cost of capital or the weighted average cost of capital (WACC) was used to compute the intrinsic value per share for Motorola. The cost of capital was found after running a regression of the market risk premium and the risk free rate of return. The WACC was found by inputting the cost of debt and cost of capital into the CAPM model. The dividend discount model yielded a $1.25 per share using the cost of capital. This model has a low degree of explanatory power for the stock price in general. The free cash flow model yielded a $35.62 per share value using the WACC, while the residual income returned a value of $8.72 per share using the cost of capital. The residual income model has the highest degree of explanatory power because it takes into account more of the firm s variables, such as, beginning book value of equity, net income, and return on equity. The AEG model was run last using the cost of capital and returned a value of $12.90 per share. After finding intrinsic values per share from each model, the ratios were compared to the stock price of Motorola at April 1, Lastly, an Altman s Z-score was found for Motorola. Banks use this number when firms try to take out Loans. The number is used to determine the risk of a firm, or in other words, to see how likely the firm is going to go bankrupt. The higher this number is, the more stable it is and the less likely it is going to file for bankruptcy. 7

8 Company and Industry Overview Overview: Motorola was established in 1928 under the laws of the State of Delaware and has its corporate offices located in Illinois. It also has development centers within the United States in Texas, Illinois, Florida, and Arizona, as well as in Germany, Argentina, China, South Korea, and Russia, to name a few. The company is a leading, global manufacturer in telecommunication products ranging from two way radios to electronics within vehicles to emergency equipment. Motorola operates on the idea of seamless mobility (Motorola.com). Its vision is that the newest technologies better connect their customers with satisfaction and style. This company is ranked 54 in the Fortune 500 and 108 in the FT Global 500 (hoovers.com). In 2004, Edward Zander was named Chairman and CEO of the company. His vision was to help turn Motorola around and back into the profitable company it once was. Since that time, Motorola has received the National Medal of Technology, the United States highest honor for technological innovation (Motorola.com). Then, in 2007, the company received the Best Corporate Citizen Award and was ranked fourth in America s 100 Best Corporate Citizens (Motorola.com). Motorola is the number two manufacturer of wireless headsets in the world behind Nokia (hoovers.com). This company is composed of four segments: mobile devices, government and enterprise solutions, networks, and connected home solutions (Motorola 10K 2005). The company grew substantially in 2005 due to the 40% increase in the sales of the company s leading product, the RAZR. Motorola developed the SLVR and the Q, the cousins to the RAZR, to keep the sales increasing. Also, Motorola has partnered with Apple and Kodak to increase the features on their mobile devices and to increase its overall sales Sales 26,568 23,422 23,155 31,323 36,843 Assets 33,398 31,233 26,809 30,922 35,649 in millions 8

9 The Motorola products have evolved over the years. In 2000, Motorola teamed up with to Cisco to come out with the first GPRS cellular system, which is a radio package service in the United Kingdom (Motorola.com). In 2003, Motorola was the first to put the lunix and java technology into their cell phone along with full PDA functionality (Motorola.com). To further enhance the cellular devices, Motorola developed the RAZR in 2005 with internet and photography capabilities accompanied with Bluetooth technology. Also in 2005, Motorola combined licensed broadband and unlicensed Wi-Fi radios into a single point to provide better efficiency for public safety agencies. In the past year, Motorola unveiled the Motorola MING smart phone in the Asian market. This phone can recognize over 10,000 Chinese symbols (Motorola.com). Motorola has a market capitalization of 42 billion as of April 2007 with over 2.4 billion shares outstanding (finance.yahoo.com). Recently, Motorola s stock lost 19% of its value in 2006 due to underperforming business, an inefficient balance sheet, and management under the gun. (hoovers.com) Motorola s loss was Nokia s gain and decreased Motorola s profit margin by 7.2% in one year. In January 2007, Carl Icahn tried to attain a seat on Motorola s board of directors by buying $2.3 billion in Motorola shares (wikipedia.com). Sprint Nextel is Motorola s largest customer, accounting for the majority of its mobile devices segment sales and for more than 25% of the network segment sales. Comcast is the largest customer for Motorola s connected home solutions segment by accounting for 31% of this segment s net sales. Needless to say, that any disruption between Sprint Nextel and Comcast would cause serious consequences to Motorola s business. Nokia is Motorola s largest competitor with 34% of the market. Samsung and LG fall behind Motorola with 12.8% and 6.9%, respectively. Ericsson falls at the end with 5.9% of the telecommunications market. Two years ago, Motorola faced the threat of being bought out by Samsung and was forced to create a new product to stay within the top five. Motorola developed and sold 50 million RAZR phones that incorporated the newest technology and sleekest design. 9

10 Five Forces Model: The telecommunications industry consists of several firms that define new century technology. Motorola is among many giants that strive for success in a competitive environment. It has proven its strength in market development, trade shows, domestic and international advocacy, and standard developments that have enabled e-business. The five forces model for the telecommunications industry outlines the environment that Motorola intends to dominate in the near future. Rivalry Among Existing Firms Industry growth At the beginning of the late 1990 s the telecommunication industry experienced substantial growth. The industry experienced a $1.2 trillion growth at the end of 2006 and is foreseen to have continued strong growth in wireless communications, ( The company is expected to grow at a rate of 11.6 percent from previous years' sales, according to the Telecommunication Industry Association. The high demand for high tech products and services continues to steadily increase. Motorola will therefore experience growth and have a strong competitive advantage in selling mobile devices. Such devices include the MOTOKRZR and the MOTORIZR Z3. Concentration Concentration refers to the size of a company in a specific industry, as well as its pull in determining pricing, as well as competitive moves. The telecommunication industry is comprised of about 2000 companies with combined annual revenue of $65 billion. The industry is highly concentrated with the largest companies holding 75% of the total market. For example, Motorola, Nokia, and Ericsson are the top three leading telecommunication companies in the telecommunication industry. Motorola has to therefore compete on a competitive innovative level. Customers will only purchase products and services produced with the most recent technology. In order to gain market loyalty, Motorola has provided customers with 24 hour support services, as well 10

11 as repair or replacement services for damaged products. Nokia has become a strong competitor, producing similar products and services such as the Nokia E62, and Bluetooth capable devices. We therefore have come to the conclusion that the industry s concentration is relatively high. Differentiation and Switching Costs Differentiation is important to consider when analyzing the telecommunication industry. Differentiation refers to the degree in which a company provides differentiated products and services. If a company s products and services are similar to others in the same industry, then customers have an incentive switch to another company solely based on price. Motorola, for example states that they create differentiation through, compelling and rich experiences, what they call the mobile me campaign ( Switching costs are however low for customers who are provided with several products through intermediaries. Such intermediaries, such as Sprint Nextel, may carry up to six different brands in their store. Fixed- Variable Costs Many companies in the telecommunications industry lease out facilities, office spaces, factory and warehouse space, land, and other equipment under non-cancelable agreements. Motorola leased out 295 facilities in 2004, which has since increased. Rental expenses are considered a variable expanse, an expanse that many telecommunication companies have due to numerous large facilities. It is important to note that in order to survive, Motorola, as well as its competitors, must sell a vast amount of its products before the products become obsolete. Motorola is a leader when it comes to turning over its inventory before introducing new products to the market. The company s inventory turned at 8.9 percent in 2004 compared to 7.6 percent in 2003, and has continually stayed competitive in this area. 11

12 Exit Barriers and Excess Capacity There continues to be a high demand for products and services in the telecommunication industry. In Motorola s k, they state that the company has increased its demand for its products by 25% due to new innovations. Therefore, there seems to be little incentive for companies to cut prices in order to fill capacity. It is then reasonable to assume that since the telecommunications industry focuses on producing specialized products, the exit barriers are high, punishing companies that may choose to leave the industry. Threats of New Entrants Economies of Scale Economies of scale refer to companies facing the dilemma of whether to invest in a large capacity that may not be utilized right away, or have less than desired capacity. The telecommunication industry requires large investments be made toward physical plant and equipment. This therefore makes it difficult for new entrants to compete with Motorola or Nokia. Brand name recognition is also a hard characteristic to compete against. Known brands often prevent new companies from starting off ahead. The telecommunication industry also provides services, such as establishing land lines, which in turn allows new entrants to create a competitive pricing framework. After such analysis, the industry s economy of scale is considered to be at a moderate to high level. First Mover Advantage First mover advantage is often the first in the industry that has the ability to set standards for new entrants. According to Motorola, component parts are kept in stock for products that are no longer produced in order to satisfy customer needs. Certain licenses have also been granted in order to maintain operation at a maximum capacity. It is also important to consider that many of Motorola s products are distributed through retailers. The relationship that the industry has created with retailers such as Sprint 12

13 Nextel, has further allowed for the ease of distribution. Such examples allude to the idea that companies such as Motorola have a first mover advantage. Access to Channels of Distribution and Relationships The access channels of distribution refer to the developed relationships between preexisting companies in the industry and suppliers or buyers. New entrants often have a hard time entering into an industry due to these relationships. In an industry that consists of high tech products and services, it is essential to have strong relationships with both suppliers and buyers. For instance, Motorola has contracts with electronic manufacturing suppliers to lower costs and meet customer demands. Also many of the top telecommunication industries hold strong ties to buyers, such as Sprint Nextel, that provided customers with a variety of Motorola, Nokia, and Ericsson products. Legal Barriers Legal barriers are for example patents, contracts, and copyrights that give existing companies an advantage over novice. These industry barriers are seen as obstacles to new entrants and are often granted to companies that have created and sustained relationships with other major industry factors. Patents or legal barriers allocate rights to Motorola that potential entrants cannot receive so easily. In the telecommunications industry, such barriers have a strong effect of the entrance of interested companies. During 2005, Motorola was granted 548 utility and designed patents in the U.S. alone. Threat Substitutes Products Telecommunication companies compete to maintain a spot in a highly competitive technological arena. Relative to Motorola s leading position in the telecommunication s industry, several companies have achieved similar product design and innovation. Among such companies is for instance, Nokia. A company such as Nokia provides a wide variety of technological devices and similar services. Therefore, competition arises based on available services. In order for Motorola to maintain its 13

14 position it must provide a variety of services that entice customers. For example, on Motorola s website, (Motorola.com), customers can find an easy to navigate support system that can help quickly solve a wide range of problems concerning cordless phones, home monitoring, and digital audio players among many others. Buyers willingness to switch to a different product brand is relatively high and is not only based on the most novel products available, but also on service. Bargaining Power of Buyers Retailers, such as Sprint Nextel, provide consumers with a large selection of products from which to choose from. The relative bargaining power that customers carry in the telecommunication industry is ultimately strong because of significantly low switching costs. Product cost and quality are also evidently important characteristics to customers. Although costly, the quality that Motorola has provided has won the approval of several critics, receiving awards for its consistent improvements. Within the last year the telecommunications industry has provided thousands of different products and services to millions of customers around the world. Bargaining Power of Suppliers Several suppliers contribute to the telecommunications industry. Imported component parts create the products and systems that the companies in the telecommunications industry produce. Differentiation, as well as switching costs among suppliers is low due to mass productions of component parts that it contributes to the telecommunications industry. Numerous suppliers send products in bulk to companies like Motorola and Nokia, among others, to create innovative product lines for the public. Due to the long-term relationships established between suppliers and telecommunication companies, suppliers have a strong pull with the companies. Value Chain Analysis: In the mobile communications industry companies are constantly trying to differentiate themselves. Companies such as Nokia, Motorola, and Ericsson are all 14

15 coming out with Innovative products, which keep raising the bar. For each to differentiate itself, the industry must have some key success factors to have a completive advantage. Superior Product Quality One key success factor of the industry is superior product quality. The telecommunications industry must create products that last and not wear out during normal use. To differentiate oneself from the rest of the industry, products need to have quality at both ends, from supplies to the craftsmanship of the product. Without a quality product things will wear out faster and cause customers to associate low quality with your brand, and people tend to talk more about negative things than positive. Superior Product Variety The industry also must develop a variety of quality products with a relatively low price. The industry must produce a variety of products that will form to the needs of different customers. For example, Nokia and Motorola have developed wireless mobility products that allow networks to customize their packages. To illustration, a customer can have internet access as well as PDA functionality on their telephones. This is a key success factory that differentiates them within the industry, and will allow customers to choose which product is right for them. Superior Customer Service In addition to having a plethora of different products, the industry must exert to above average customer service. For example, customers will be unwilling to buy a company s products if they can never get a hold of a customer service representative. This is a big key success factor, and without superior customer service companies will find it hard to excel in today telecommunications industry. 15

16 More Flexible Delivery Companies in the market must embody flexibility while delivering products to consumers. If a company takes too long delivering a product, or if a consumer can only get it during allotted hours, the company will be doomed to failure. Companies need to have their delivery systems set up so that it arrives quickly and to almost anywhere. That is why flexible delivery is a key success factor in differentiating yourself from the industry. Investment in Brand Image One key success factor that helps companies differentiate themselves in this industry is brand image. Companies need to let consumers know about their products and what new innovations they have through extensive advertising. In 2005, Nokia spent 1.25 million on advertising and their net sales in 2005 were substantially higher than Motorola and Ericsson s sales. This helps establish your brand and makes people pay a price premium for your product. Investment in Research and Development To be a good competitor in this industry, companies need to invest a significant amount of time and effort into research and development. That is why R&D is another huge key success factor in the telecommunications industry. The following graph indicates how much capital the industry spends annually, specifically over the past three years. 16

17 Research and Development Expeditures in millions of dollars MOT Nokia Ericsson In the graph above shows that Motorola spent an average of 11.26% of their sales on research and development. Nokia spent an average of 12.3%of their sales on R&D, and Ericsson spent an average of 17.93% of their sales on R&D. Ericsson is trying to compete with the other two industry leaders that is why they are putting so much into R&D. All of these are key success factors of the industry. If a company does not perform well in these certain areas, then it will need to make adjustments and try harder. These factors will help a company gain competitive advantage and profits over the industry. Competitive Advantage: The Motorola Corp. is broken up into four segments which include: the mobile devices, Government and Enterprise Solutions, Networks, and Connected Home Solutions. Each segment entails specific characteristics that categorize them as competing on differentiation. In the mobile device segment, Motorola competes on differentiating itself from the industry standard with key success factors. They do this by providing superior products with a variety of options. For example, Motorola offers mobile devices that can gain access instantaneously to the internet, to devices with cameras, or devices that play music, all at a price within the consumer s budget. 17

18 In the government and enterprise solutions segment, Motorola has developed seamless mobility, which is connecting all parts of digital components. Our car, our mobile phone, our home security system, our office, all the systems that surrounds us, will communicate with each other automatically to fill our environment with our preferences, our desires, our music collections, everything we need or want to feel connected anywhere, anytime (Motorola 10-k 2005). In government and enterprise solutions segment, Motorola engages in a high a variety of high quality products backed by extensive R&D. Motorola s third segment: connected home solutions, bases its key success factors on quality and delivery. A focus on relationships with communication operators, as well as cable television equipment, allows Motorola to excel in the technological world. New product development is a consistent goal for Motorola, attempting to differentiate in digital set-top boxes, as well as staying involved in the growing HD and DVR markets. A development of digital video products compliant with a region s requirements is a step that Motorola has recently taken to reach larger markets. However, they are really trying to set themselves apart by focusing on providing networks with broadband wireless internet. Motorola introduced its MotoWi4 Canopy product, which has provided customers with the capability of a having innovative low cost internet access (Motorola.com). Motorola is developing fixed and mobile broadband standards, which allows them to provide superior customer service and product quality. Competing so aggressive in every segment of the telecommunications industry, Motorola attempts to maintain a competitive advantage. Motorola differentiates itself from its competitors through key success factors like: superior customer service, wide product variety, and high investment in research and development. Motorola created their Seamless Mobility campaign in 2004 and continues to use this idea in their daily operations (Motorola k). This campaign aims to connect all aspects of consumers lives with a touch of a button. Motorola incorporates this idea into all of their products and services through innovative technologies. Motorola relies heavily on their research and development program in all four segments 18

19 to help innovate new products and improve existing products. In 2005, this company had 10% of their sales devoted in research and development expenditures, which is about $300 million more than Motorola expensed in (Motorola 10-k 2005) Motorola has unlimited access to creativity and innovation through its 25,000 employees working in its research and development department. With the ever changing technology that the industry requires from Motorola, this key success factor is will benefit them in the future, and constantly funding the research and development department in order to stay ahead of its competitors. The research and development teams at Motorola design the wide array of products that are available to customers around the world. After the RAZR s huge success in 2004, Motorola was forced into creating something even better to maintain its high profits. In the past year, Motorola unveiled the QWERTY, also known as the Q. This new product offers its customers internet access, Microsoft office, and PDA features at the tips of their fingers. The Q joins Motorola s wide variety of sleek and fashionable mobile devices available to customers such as the RAZR, CRAZR, RAZR v31, and the SLVR. (Motorola 10-k 2005) In addition to product variety, Motorola offers a great customer service as well. You can walk-in, send them your mobile device directly or upgrade to a new one. You can them 24 hours a day or call them from 7a.m. 10 p.m. If a customer is not completely satisfied with there product, for any reason, he or she can return it within 30 day of purchase. Customers are reimbursed for the shipping cost after Motorola receives the product. You can go to any of your service providers, almost any retail consumer electronics store, and call and order it 24/7, or buy it from the company directly, with express shipping, online. Motorola believes that a strong and knowledgeable customer service department is vitally important to satisfying its current and potential customers. These three qualities have allowed Motorola to compete effectively with competitors, because they are key success factors. They have also helped Motorola achieve its number two position in the global market. In the past, Motorola has managed a portfolio of more than 3 billion dollars in order to take advantage of new 19

20 and innovative technology and product design.(motorola 10-k 2005) This Fortune 100 Company has had flexible delivery and timely service not only for retailers, but also customers that have access to products and services from Motorola s online website. Motorola has won several awards for its quality products and won the acclaim of millions. Accounting Analysis Key Accounting Policies: In order to have an affective accounting analysis an analyst must take into consideration several key accounting policies. The key accounting policies determine the accuracy and quality of the firm s accounting policies. When looking at key accounting policies it is important to take notice of the firm s keys success factors, and in turn determine the reliability firms accounting policies. Motorola has classified itself as a company focusing on differentiation, innovative design, as well as providing rich experiences to customers and carriers. Motorola, therefore, continues to spend a large amount of time and money on research and development, customer service, and advertising/marketing. Motorola s research and development department is a primary key success factor. The R&D department helps Motorola stay at the top of the industry, although it is sometimes hard to estimate the total effect of R&D. In 2004 Motorola was nearly bought out by Ericsson. However, with continuous research and development, Motorola created the Moto Razr, a product that essentially saved the company. Motorola spent approximately $3.7 billion dollars last year in R&D expenditures, or 10% of their net sales. This is consistent with the industry, in which Nokia s R&D expenditures were 11.2% of net sales (2005 Motorola 10-k) Another key accounting policy for Motorola is customer service and warranty expense. Motorola is offering exceptional warranty and customer service. There are currently three different ways to make a claim on a warranty item. Customers have the convenience of calling a representative, filling for a repair online, or by simply walking into any of Motorola s carriers. The company expensed a total of $500 million for warranties and doubtful inventory. This is a consistent trend with what Motorola 20

21 accumulated in the previous year. Nokia, however, the biggest firm in the mobile communications industry only allowed approximately $141 million (2005 Motorola 10-K; Nokia 2005 form 20-F). The reason for such a large gap results from two reasons. One, Nokia has a better quality product and two; Motorola has a better customer service. Goodwill Motorola preformed in 2005 was $1.3 billion as stated in K, while Nokia only spend approximately $856 million in 2005 (Nokia Form 20-F). This shows that Motorola is consistent with the industry for The goodwill impairment test is performed at the reporting unit level and is a two-step analysis. First, the fair value (FV) of each reporting unit is compared to its book value. If the FV of the reporting unit is less than its book value, the company performs a hypothetical purchase price allocation based on the reporting unit's fair value to determine the fair value of the reporting unit's goodwill (2005 Motorola 10-K). Motorola has partnered up with external company that performs this calculation, making this method a more accurate. Accounting Flexibility: Motorola has continually strived to stay within SEC s regulations. The company does so by continuously following the practices set by the SEC and maintained by Motorola s board. Motorola specifically utilizes its flexibility to promote its most important assets as a company. In the future, keeping a constant state of flexibility will increase Motorola s success, and therefore reduce the risk that shareholders may face. Research and development, as well as customer service are critical factors to take into account. The first aspect that is important to consider is the fact that managers have no accounting discretion when it comes to research and development. The $34 million allocated to R&D is a number that is reported on the financial statements as an estimate. Motorola, therefore, has the flexibility to report which research and development events and actions led to specific numbers on their financial statements. Motorola believes that it is critical to invest in R&D of leading technology and services to remain competitive (Motorola 10-K 2005). Customer service is as well a key success 21

22 factor that cannot be adequately measured in numerical terms. For disclosure purposes managers report this number under the long-term intangible assets. The flexibility that Motorola maintains in preparing values for specific assets allows for flexible information disclosure. The second aspect to consider is a factor that all firms have a policy such as the depreciation policy. Motorola records depreciation using declining balance and straightline method based upon the useful lives of its assets. An estimation method, which allows Motorola the flexibility to determine the ultimate useful life of its assets, results in an estimated inventory value on the Statement of Cash Flows. Along with the depreciation policy is the inventory policy that Motorola utilizes. Motorola uses the FIFO inventory policy and has done so for a number of years. The company is able to release useful information and the costs associated with inventory to company owners. This method of inventory provides customers with products before becoming obsolete. In addition, this leads to a constant level of the most technologically innovative products to remain in stock. Taking this into account, Motorola therefore has less flexibility when accounting for specific entries. We came to the conclusion that a strict FIFO policy results in an accurate use of the FIFO method, but restricts flexibility. In turn, it is important to note that the SFAS requires that, abnormal amounts of idle facility expanse, freight, handling costs, and spoilage are charged as expenses in the period that they incurred rather than be capitalized as a component as inventory costs (Motorola 10-K 2005). Motorola also uses a future cash flow analysis in order to determine the amount the assets should be impaired, another factor that allows for increased flexibility. Lastly, it is essential to consider the policy used for writing off goodwill. Goodwill has been reported on the balance sheet and is a number that can change due to managers discretionary decisions. Motorola does not amortize goodwill; instead it is tested for impairment at a minimum of once a year (Motorola 10-K 2004). The impairment of long-term intangible assets is, as well, reviewed for impairment when changes occur in the company. The company can be viewed as having the flexibility to determine which fluctuations in events cause certain asset impairments according to 22

23 disclosures in Motorola s 2003, 2004, and Ks. Motorola s ability to ultimately decide the impairment of intangible assets has concluded to augmented flexibility because of ultimately things such as negative economic trends, and declining stock prices. It is then clear that Motorola has been able to gauge key policies that have allowed them to maintain a strong flexible stance. This in turn helps investors and shareholders determine Motorola s future performance. Disclosing crucial information, that is based on past sales and expenses will be beneficial for owners who will be able to more easily determine the future prosperity of Motorola. Accounting Strategy: When determining weather a company is aggressive or conservative in their accounting strategy there are many things that need to be analyzed. These include their inventory method, investments in research and development, lease obligations either capitalized or operating, and accounting for goodwill. When looking at Motorola s inventory method they approximate it on a first in, first-out basis (FIFO). This would be considered aggressive since they want to send their old production costs which are lower to cost of goods sold in the income statement and their newer production costs which are higher to the balance sheet in inventory. This would make sense because in the industry Motorola is in they would want to get rid of the older inventory before they become obsolete with the new technology that will be coming in. If they were to use the LIFO method you would have a lot of inventory just building up of obsolete items and you would have to consume those older product costs. FIFO method is also aggressive in the sense that if you have a consistent selling price and you use the FIFO method your costs will be lower since you are getting rid of the old costs first thus making profit higher. Motorola also has to maintain a competitive inventory system to keep up with the competition on delivery performance while exercising this method. Management estimates inventory reserves of 18% of total inventory, 549 million, in order to protect themselves from obsolesce and new technology. This can be enlarged by writing down more reserves or lessened by being 23

24 reversed into income. (Motorola 10-K 2005) Nokia a close competitor also uses the same inventory method and has an allowance for the same reasons. FIFO and reserves for inventory are not unheard of in this industry. Another quality of Motorola that makes them aggressive is how they reserve $501 million for warranties (Motorola K). This makes them aggressive in that they are okay with allowing for more warranties expenses than their larger competitor Nokia. You can look at this in different ways either they are dedicated to customer service and will replace products easily for customers or it is that they have a poorer quality product and have to replace them more than there competitors because of default. Motorola does this to enhance their customer service because they are known for excellent service, it can t be because of quality since they are competing on differentiation and superior quality is followed. Since this number is relatively small compared to total liabilities they are not acquiring a huge debt on returns and defaults therefore proving that it is for their service and not due to poor products. Goodwill and Research and Development are also a factor to determine when analyzing a company s accounting strategy. Motorola acquired goodwill in the acquisition of companies while also capitalizing research and development facilities. This explains the high investment of research and development for Motorola s key success factor. The specific acquisition in research and development will help their differentiation competitive strategy because with having more R&D it will help them be more likely to create the most innovated product in the industry. In 2004 Motorola acquired MeshNetworks, Inc. and Force Computers and in 2003 they acquired Winphoria Networks, Inc. These acquisitions show that Motorola capitalized Research and Development through them. They acquired $18 million from the companies in 2004 and $32 million from the company in 2003 on in-process research and development. The allocation of value to in-process research and development was determined using expected future cash flows discounted at average risk adjusted rates reflecting both technological and market risk as well as the time value of money. (Motorola 10-K 2005) 24

25 Motorola also acquired $178 million in 2004 of goodwill from the companies which was 61% of the total acquisitions in that year and $93 million in 2003 which was 52% of the total acquisitions in that year. There were no recorded acquisitions in There were goodwill impairment charges of $125 million in 2004 and $73 million in 2003, but there was no goodwill impairment in 2005 due to not acquiring any in this year. These impairment charges would then decrease the total goodwill for the years making the balance in goodwill $53 million in 2004 and $20 million in Since there was not any goodwill impaired in 2005 this is an aggressive accounting strategy for 2005 but, in 2004 and 2003 Motorola was exercising conservative accounting in having impairment charges since this would make intangible assets decrease. Therefore, the acquisition of the companies in the previous years demonstrate conservative accounting since Motorola acquired research and development facilities that will greatly benefit the company and make net income decrease with more R&D expenditures due to these acquisitions. The acquirement of more goodwill is an aggressive technique since it will increase assets while holding liabilities constant. (Data found from Motorola s K) Motorola has various pension plans such as noncontributory pension plans and defined benefit plans. They contributed a total of $370 million total to their pension plans in This will make expenses go up and liabilities to increase. Therefore this is making net income lower so this is a conservative accounting strategy. Since they are declining in their contributions compared to their $652 million in 2004 and expected $275 million in 2006 they are becoming less conservative but still conservative since net income is being decreased by this activity. Motorola also discusses that the funding of their pension plans is based on the performance of the equity markets and interest rates. If they are performing poorly and do not bring as much long-term returns that are expected then they could be forced to pay higher contributions. Also, if the interest rates increase they can pay higher contributions. So if there is a huge change in the financial market their expectation for 2006 will be too low because they will pay a higher contribution due to the market making them more conservative. (Data found from Motorola s K) 25

26 When looking at all of these things together Motorola is mainly aggressive in their accounting strategy. This is good for them in the sense that they are acquiring new companies and with that more R&D and goodwill. This is also good in that they are allowing for good customer service since they have high warranties reserved compared to their competitors. Being conservative in their pension plans is a good thing because they do not want their employees taking advantage of a lenient pension plan. Motorola s accounting strategy is efficient and works for them quiet well therefore making them smart in their accounting choices. Qualitative and Quantitative Analysis: These revenue and expense diagnostics help to further analysis accounting numbers created and generated by the telecommunications industry. Revenue diagnostic ratios are a way to see if a company is overstating their revenue while expense diagnostic ratios see if a company is understating their expenses. Overstating revenue or understating expenses is not only illegal, but it also gives shareholders a false idea of the company s performance. Large jumps, within these ratios without disclosed explanations would be an indicator of a company misrepresenting their earnings. It should be noted that Ericsson is a competitor to Motorola s mobile device segment only. Therefore, Ericsson has lower ratios because it is not as large a company as Motorola or Nokia. Nokia is the closest competitor to Motorola because it competes in the same four segments as Motorola. Revenue Diagnostics These ratios include Net Sales/Cash from Sales, Net Sales/Accounts Receivable, Net Sales/Inventory, and Net Sales/Warranty Liability. Each ratio involves sales in the numerator while the denominator has an item that is related to sales. If one of these ratios suddenly jumps upward, the component of sales (like cash or accounts receivable) might be understated to make the company look better. The ratios help show how well Motorola stacks up with the rest of the industry. 26

27 Net Sales/Cash from Sales This ratio represents how much of Motorola s sales are done with cash. The idle ratio would be one so the accounts receivable would be reduced and would reduce the liability for doubtful collection of accounts. Net Sales/Cash From Sales Motorola Nokia N/A N/A N/A N/A N/A Ericsson Net Sales/ Cash From Sales Motorola Ericsson These ratios shows how much cash is received compared to sales made during the year. Motorola is decreasing their cash collected from customers because the increase to accounts receivable is greater than the collection rate. Ericsson is experiencing a loss in sales for the past 5 years and therefore collects less cash. Nokia was excluded from this list because they do not list their trade accounts receivable separately from their operating activities. 27

28 Net Sales/Net Accounts Receivable The lower this ratio, the more sales that are explained by accounts receivable. This coincides with the sales/cash from sales ratio because the sales/cash from sales ratio decreased, which means more sales are done on credit. The more sales that are done on account will reduce the sales/accounts receivable ratio. These two ratios move inversely of each other, like they should be, so Motorola is not overbooking its cash from sales or under-booking its accounts receivable. Net sales/ Net A/R Motorola Nokia Ericsson Net Sales/Net Accounts Receivable Motorola Nokia Ericsson Motorola has higher accounts receivables along with sales, but they are having trouble collecting on these receivables. For Motorola, the sales and accounts receivable have leveled off in the past few years after a surge in sales in 2004 due to the release 28