Google’s Short Sale to Arris a Signal of Things to Come

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Google (NASDAQ: GOOG) sold the lucrative Motorola Home division to Arris (NASDAQ: ARRS) for $2.35 billion in a cash and stock, offloading what was a redundant part of their acquisition of Motorola Mobility earlier in the year.  Google wanted MMI for its ability to make compelling smartphones to grab the Android market share from Samsung, not to build more set-top boxes. According to the terms of the deal, Google will end up with $2.05 billion cash and 15.7% of Arris.  Arris’s own market cap is just around $1.74 billion, so this deal will be financed through debt.

For Arris, the acquisition will more than double the size of its operations with an additional 2,000 patents, and its sales will triple while its customer portfolio will become much more diversified. Arris currently gets 50% of its revenues from Time Warner Cable and Comcast, but following the acquisition it will be getting the same percentage of revenues from five different customers.    

MMI’s Home unit was a profitable venture that generated quarterly revenues and profits of $880 million and $60 million respectively by selling television set-top boxes. Google rids itself of a low-margin business unit whose growth prospects are limited at best and strips MMI down to focus on Google’s future: smartphones and Android. It did so at about a 22% discount to MMI Home’s annual revenues, not a good return on investment, but set-top boxes are a dying industry, so the deal is a good one for Arris, and Google sheds the manufacturing hassle.

Google and Motorola have been working on developing a new “X Phone” which will rival Apple’s (NASDAQ: AAPL) iconic iPhone or Samsung’s Galaxy series. The phone is rumored to have innovative features such as a bendable/flexible screen, but nothing is confirmed because the entire project is shrouded in secrecy.

A couple of months ago, Motorola acquired the face recognition with augmented reality specialist company Viewdle in an estimated $40 million deal. Viewdle started out in the Ukraine but has its head office in Silicon Valley now. It had been in discussions with both Motorola and Google for the past couple of years. Viewdle is obviously going to be integrated into all of Google’s location services (and forced into Google+) and Project Glass as well as playing a big part in Project “X Phone.”

The X Phone is going to be launched sometime in 2013 and will likely be followed by an ‘X tablet.’ Through the new smartphone and tablets, Google will continue to push against dominant Android player Samsung. X Phone's rumored flexible screen will likely use Corning’s Willow Glass.  Samsung Display, a subsidiary of Samsung, will put its unbreakable plastic HD 5.5” screen for public viewing at CES 2013.  To take things to another level, 55-inch panels will also be available for demo on the next generation of smart TVs.

The Google/Motorola mash-up has its work cut out for it, but it is necessary if Google wants to get control of Android.  In some ways, Samsung has become the standard Android platform, and its ability to supply global demand at all levels of the market is unparalleled.  According to Canalys, Samsung and Apple hold about half of the global smartphone market share in Q3-2012. Everyone else, like Sony and former industry leader HTC, is struggling.  If anything, HTC knows it can’t compete in Android anymore and has shifted to stronger Windows Phone support fighting in a smaller field of opponents.

Samsung has its work cut out for itself as it sees strong competition coming from Lenovo and other Chinese manufacturers like Xiaomi and Hauwei.  And if a dominant player like Samsung cannot stave off this charge, what is Google/Motorola going to do to blunt the mix of razor-thin margins and ‘Made in China’ loyalty in a place where Google’s services are effectively banned? 

Moreover, according to research firm IDC, Android’s market share has likely peaked and is going to drop from 68.3% in 2012 to 63.8% in 2016 while that of Apple will rise from 18.8% to 19.1% in the same period and Microsoft’s Windows Phone (WP) will rise.  I’m not sure I agree with IDC’s numbers, but the initial response to the first round of WP8 handsets is impressive, especially that of the Nokia Lumia 920. 

Android’s success has come on the back of Samsung’s ability to produce excellent value at all price points, build the first true iPhone competitors in the Android space and continue building on their massive in-house design and production advantage.  Google’s phones will have to be fundamentally superior in every way to reliably grab market share from Samsung and force Samsung to play catch up.  Google has made good strides since introducing the Nexus 7 this summer, and the current backlog of orders for the LG-produced Nexus 4 is impressive.  But the next phone will have to be not only a hit in terms of technology but be available in quantity without exceptions. 

This is an arena where brand loyalty means very little; it is one of the problems with an open architecture OS like Android. IPhone users are not going to switch to Android because they have to wait a week for their iPhone 5.  But, they will be happy to give Samsung their money if Google can’t deliver them a phone when their contract is up.  Because Samsung is adept at adapting to what the market wants quickly; any ‘gee-whiz’ factor produced by the latest ‘X Phone’ will be gobbled up and commoditized quickly. 

Google is facing the same problems now that Microsoft is with its Surface line of tablets and soon-to-be phones.  How does a software cum private equity firm handle the rigors of bringing serious volume to the market and compete with streamlined, vertically integrated production powerhouses?  Even outsourcing the production to a competent supplier of smartphones (and good Android soldier), LG has not worked to match supply with demand.  Now, one can argue that these are good problems to have, but as I just said Google’s not competing to create platform awareness like Nokia is with WP8.  Google is attempting to beat Samsung at their own game, and that just seems like a bad idea. 

PeterPham8 has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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