Top Reasons Why Google Agreed to Buy Motorola Mobility

In a significant development for the mobile technology industry, Google (NASDAQ:GOOG) has agreed to buy Motorola Mobility (NYSE:MMI) for $12.5 billion, or $40 a share, in cash to defend its Android ecosystem.

The price tag of $40 a share represents a premium of 63 percent to the closing price of Motorola Mobility shares on Aug.12, 2011.

Motorola Mobility is a leading developer of communications systems used in the wireless and cable television markets. The company has undertaken a complete turnaround over the past 2 years with a focus on Android-based smartphones. Motorola represents about 11 percent of Android phones.

Meanwhile, Google did emphasize that Android will remain open and that Motorola Mobility will be run as a separate business. Google also stated that its top five OEM partners were all supportive of the deal.

The deal is expected to close at the end of 2011/early 2012, subject to customary closing conditions, including the receipt of regulatory approvals in the US, the European Union.

Excluding amortization of intangible assets, Google expects the acquisition to be mildly accretive to earnings.

Google is paying 15x 2011E EBITDA and 9x 2012E EBITDA, adjusted for the Motorola's cash balance of $3.3 billion and a net operating loss (NOL) balance of $2.5 billion.

Here are the top reasons why Google is buying Motorola and that too at a hefty price tag:

At first glance, the deal seems large and expensive, and Google likely could have opted to license rather than buy. But market analysts view an ownership of the 17,000-plus patents as a long-term offensive bet for the company in the wireless segment.

"On a pure deal multiple, we view the 8.6x multiple as slightly higher than average, especially as its current comp group trades at 6-9x NOPAT (net operating profit after taxes). However, on a per-patent value, Google paid $735K per patent, which is in line with the $750K paid per patent for the Nortel patents - much lower if we include cash and NOLs - at about $513K per patent," Susquehanna analyst Herman Leung wrote in a note to clients.

This price does not seem unreasonable, especially given about estimated $3 billion plus in annual hidden patent fee costs to the Android ecosystem and the $4.5 billion spent on the Nortel patents.

While Android is open and free from Google, there can be a hidden patent fee. According to media sources, HTC is currently paying Microsoft a $5 per handset royalty, and Microsoft is apparently seeking a $15 per handset royalty from Samsung for use of Android.

"Assuming 200 million annualized Android devices at a patent royalty of $5-15 per device, the patent fees could have potentially cost the Android ecosystem $1-3+ billion per year," Raymond James analyst Shyam Patil said in a note to clients.

"It is unclear what drove Google to purchase MMI versus solely MMI's patents. We believe there could have been complex cross-licensing agreements between MMI and other handset OEMs, making it legally complicated to only buy the MMI patents," Patil said.

* Motorola and Google have a strong working relationship as Motorola was one of the first companies to adopt Android and is using it as its sole operating system within its smartphone portfolio.

* Google's Nexus S handsets have not been big hits within the industry. By leveraging Motorola's handset expertise in design, manufacturing, distribution and supply chain management should benefit any future versions of devices.

"A closer collaboration between the software and hardware teams could lead to increased functionality on future Motorola/Google devices," Rodman & Renshaw analyst Blaine Carroll wrote in a note to clients.

* The key rationale of the deal is to defend the Android ecosystem from patent attacks from Microsoft, Apple and Oracle. The Motorola patents will aid Google in any potential litigation. Motorola Mobility has more than 17,000 issued patents and 7,500 pending patent applications. Though many of the patents are older, they are core fundamental wireless patents.

* With Motorola's portfolio of patents, Google should be in a better position to protect its handset partners that have invested heavily in the Android platform over the years and also deflect some competitive pressure from Microsoft (NASDAQ: MSFT) looking to expand its Windows Phone 7 ecosystem.

* A large part of the reasoning for this deal is not only to preserve its Android ecosystem but to go on the offense now with this portfolio of patents that covers technologies such as 2G, 3G, 4G, H.264, MPEG-4, 802.11, open mobile alliance (OMA), and near field communications (NFC), to name a few of the 17K+ patents.

"Its 39 OEMs should be more comfortable licensing Android and offer some additional protection from other companies seeking additional royalties. We believe a strong defense could be the best offense, especially if it is still early in the wireless game," said Leung, who expects the deal could add about $1.68 in EPS for 2012.

* Finally, the acquisition could boost Google's efforts to push in to the digital living room.

"We note that the addition of MMI's Home (set-top box) business could help to catalyze Google's push into the digital living room, where we see the company eventually facing a sizable market opportunity in targeted video advertising (we believe that much of Google's estimate of a $200 billion display advertising TAM relates to IP-addressable television/video advertising)," ThinkEquity analyst Aaron Kessler said.

By Manikandan Raman