A Big Mistake?

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

Google's (NASDAQ: GOOG) 2012 purchase of Motorola Mobility is looking increasingly like a mistake. Here's why it could have been a good long-term decision, but only if Google doesn't change its business model.

Motorola

Google paid over $12 billion to buy Motorola Mobility. Although that company has a storied history in the cell phone handset space, the logic for the acquisition was the more than 17,000 patents the company owns.

The idea was that these patents would allow Google to better defend its Android mobile operating system and, thus, the phones that use it, in patent infringement cases. To date, however, Bloomberg reports mixed results on this score. Indeed, Google hasn't won big bucks in any cases.

With such a large price tag, the market was clearly hoping that the purchase would lead to increased patent revenues. While that would be nice, Google might have had other ideas.

Downside Protection

What is notable, and perhaps being overlooked, is that Google hasn't lost any big patent cases. That the market is assigning a low value to Motorola's patent portfolio is understandable. No one values insurance highly until its needed. In fact, insurance can look like a waste of money all the way up to the point where a catastrophic loss takes place, and then it is the most important thing in the world.

Of course, in the case of Google and Motorola, the insurance policy might be best thought of as a vaccination. If the purchase stops companies from bringing patent cases in the first place, then it will always look like a mistake even though it has been an immensely valuable investment.

Where a Problem Could Lie

The big problem that Google faces with the Motorola purchase is more existential. Google's business has thrived because it uses an open model. It lets people use its products for free and collects small fees along the way, for things like advertising and application sales.

The company is seen as a partner, not a competitor. Samsung, for example, has used Google's Android OS as the heart of its Galaxy line of mobile products. The Galaxy is the iPhone's main competition.

In fact, so many companies have partnered with Google that its mobile OS has a massive market share relative to Apple (NASDAQ: AAPL). The two have an effective duopoly. This works so long as Google doesn't compete with the handset makers.

However, Motorola makes handsets. And Google increasingly looks like it wants to build hardware, from stripped down computers to tricked-out eyeglasses. It's even opening stores. That's a fine line to walk.

Margins

Google's long-term problem is that its margins are shrinking. For example, its profit margin fell over 10 percentage points between 2010 and 2012. Part of the problem is that Google doesn't earn as much from mobile advertising, which is more competitive than the online space. If the company tries to control its products from start to finish, it will start to look a lot more like Apple.

While that might sound like a good idea, it would risk destroying the company's other businesses. This could be a mistake with Microsoft (NASDAQ: MSFT)working hard to get a seat at the mobile OS table. Although Apple will never use Microsoft's OS, Samsung might welcome it as an insurance policy covering Google.

So, Google could actually create an opening for a very fierce competitor. Since mobile is such an important market, that could be a disastrous long term mistake.

Priced for Perfection

Although Google shares have come down some over the past few months, they are still trading near all-time highs. With margins already shrinking and Motorola looking as though it won't live up to the market's expectations, regardless of the true benefit, downside risk seems notable.

If the company starts to move aggressively into handsets, the downside could be even worse. Apple and Microsoft both look like better investment options right now. Each yields around 3%, which should provide a floor under each company's shares. Microsoft is more of a turnaround play with a still strong lineup of businesses. Apple is more of a fallen angel, though if it can break into emerging markets like China it might surprise to the upside.

The Other Options

Microsoft, despite a very public miss on the mobile front, has actually seen its top line increase in each of the last 10 years except 2009. Although the company's profit margin has contracted, too, its shares are trading at a more reasonable level. And, a lot of the company's spending has been in support of growth initiatives like a new Windows operating system (OS) and a mobile OS. So, there are clear opportunities for improvement if either takes hold. A share buyback and a growing dividend mean you get paid well to wait for this industry giant to get back into the game.

Apple, meanwhile, has also seen a solid upward trend in earnings, even through the deep recession. Moreover, as the company has sold more and more devices, its profit margins have expanded nicely. That said, it is likely that margin improvement will slow, or even pull back slightly, from here. The real issue now boils down to creating a new product that wows the market or finding a source of new customers.

China is the obvious source of new customers, but that isn't going as well as Apple might like. Still, that game isn't over and Chinese customers appear to want iPhones based on the sales success at the nation's third largest cell phone company (the only one that sells the device). There is also the option of a lower-end model, which would probably put downward pressure on margins but that would likely be more than offset by volume gains. A newly initiated dividend and plans for massive stock repurchases mean investors get paid to wait for this angel to regain its wings. 

No Easy Answers

There are no easy answers for Google, Apple, or Microsoft. However, of the three, only Google appears to be priced for perfection.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. 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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