Motorola Solutions: From Zero to Hero - [Business Breakdowns, EP.171]

0:03This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from. and we are here to bring them to you. To find more episodes of Breakdowns, check out joincolossus .com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers or affiliates may maintain positions in the securities discussed in this podcast.

0:45This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Welcome back to Business Breakdowns. Today, we have a fascinating story of brand versus business as we cover Motorola. Motorola was a mainstay on Interbrand's top 100 brand list. For most of the 2000s, I get nostalgia thinking about those old flip phones and the Razer model. But Apple and Samsung took over that market. It was not the end for Motorola, and they found their own way to thrive. For this episode, I'm joined by portfolio manager Joseph Shapochnik. And we get into how Motorola achieved this stealth success over the past 15 years.

1:32We get into how CEO Greg Brown worked with two and arguably three activist investors to focus on mission -critical communications, a very specific customer segment, and a more blended hardware software model. It's a truly great example of a business finding a niche and executing to a T. Please enjoy this episode on Motorola. All right, Joseph, it is great to have you back on Business Breakdowns and excited to get into Motorola with you. I have nostalgia thinking about Motorola in the early 2000s, flip phones, and that era. And I'll be honest, I haven't thought about Motorola too much since then.

2:18Yet I look at this name as you talk to me about it. It's got a $60 billion market cap. So clearly, there's a very interesting story here. And I just want to kick it off with, can you give us a snapshot of what Motorola is doing today? Well, Matt, I think to have a snapshot of what they're doing today, it's important to go back to the days that you remember so fondly, the days when they were producing the Razer flip phone and people were so excited about that. Those days came to an end, 2006, 2007, 2008. The handset market began to roll over. The iPhone began to take market share. And at the time, Motorola was really involved in three businesses, the cell phone business, which was a big part of their overall business, a networks business where they made cable set -top boxes, and a third business, which is the business that they're in today, the land mobile radio business, all of which are about a third of sales.

3:21As the business began to deteriorate because the Razor and their cell phone business was under pressure, Carl Icahn came in in 2007 and pushed for a breakup of the company and was pushing for a split off of the cell phone business. He had a CEO in mind and he succeeded in accomplishing that. So in January of 2011, Motorola Mobility, the cell phone business, was separated. And for all intents and purposes, Motorola Solutions was born and Greg Brown was made CEO. And that's really the Motorola Solutions of today. Can we just zoom in on what Greg Brown does as he takes over this newly split business, what he lays out and basically paved the path over the next 10 years?

4:16What happened in those early days to set the business up into what it is today? Greg has been at Motorola for 20 plus years and had run, I believe, two out of the three major divisions, the networks in the land mobile radio business prior to becoming chief operating officer and CEO of this new Motorola or what they call now Motorola Solutions. One of the keys to his success was focusing this business on this undiscovered crown jewel that most couldn't see because it was buried within a segment of a segment. Just as Carl Icahn was ramping down his pressure on the company, interestingly, a new activist emerged and Greg had a grapple with a second activist.

5:07The new activist, which came into the story in, I think, 2011 or 2012, they were focused on optimizing Motorola's cash -rich balance sheet. They had a ton of cash and very little debt at the time, improving the company's cost structure. So it was clear that they were probably 1 ,000 basis points or so bloated relative to where they should be. And so what Greg did was sell off the second business, which was the cable set top box networks business. That took place early on in the 2012 timeframe or so and managed to get Motorola focused in on this single business, the land mobile radio business, which is the most attractive of all of the assets that they had back then.

5:58And they repurchased about a third of the company's market cap over the first five -year period at a multiple that was very low because after the split, the story was pretty misunderstood. And I think the stock traded at kind of a low teens earnings multiple. They were buying back stock at very, very attractive valuations at the time. And they focused on optimizing the real estate footprint of the company and getting this business slimmed down. He was pretty successful in executing on either his ideas or the ideas that the investors brought to him. and I think that that really helped him gain a lot of confidence with investors and eventually the challenges from the investor base quieted down and the activists left the story in 2016 and sold their shares and he was left to continue to build this business and then the next leg of the story was the entrance of Silver Lake who came in in 2016, 2017 and helped them grow into adjacent areas.

7:08And those adjacent areas were video surveillance and command center software. I must say to have the back -to -back activist campaigns and just the amount of high -profile investors that you are dealing with, including Silver Lake, as kind of the third leg in that stool, is remarkable in many ways. And I I don't know how many management teams have survived that long to go through that many moments in time. So it is quite interesting. Just to zero in a bit on that initial spin and the second activist coming in, when you say the market maybe misunderstood Motorola, I'm picturing something where it was expected to have low growth, but maybe kind of a steady, stable business.

7:55and that's what they were going for with the recapitalization. You can add some leverage to this, but you're not expecting major growth in the future. Was that the perception at the time or to the extent that you kind of pine on what was happening in the moment? I think that's a good way to explain the way investors had understood the story. But I think that most investors couldn't find a comparable business to compare Motorola to because you have this hardware networks business, which is a one -time sale. And then you have this razor blade radio business, which has got some software, but a lot of hardware associated with it, but also tied to municipal markets, which tend to be very predictable.

8:45Yet the margins on this hardware business were unusually high. So investors were grappling with, what do we have here? Is this as high quality as it looks? Is this business bloated or is this the right kind of cost space for this company? Isn't quite clear what we have here and what this management team, which wasn't really known, what they could do with it. You have Icon making a lot of noise and then another activist coming in making a lot of noise, which kind of put a lot of dust in the air and create a lot of uncertainty as to what this business was all about. Can you just give us the sketch of the numbers of this business, however you would lay it out, revenue, buy segment, whatever you think is the best way to connect numbers into what Motorola is doing?

9:38So Motorola generates about $10 billion of annual sales, $2 billion of free cash flow, and generates a 30 % return on capital employed. So really a profitable business at scale here. About three quarters of total sales come from the land mobile radio business and the remainder come from their fast growing video surveillance and command center software businesses. The radio business is pretty sizable. So about 13 ,000 Motorola networks have been deployed across the US, Europe, and Australia. We think they have about 80 % market share of those deployments and perhaps an even higher percentage of the radio sales that come after that.

10:30So a huge market position that they've developed over many, many decades. Just to give you a sense as to how the transaction works for a typical customer, typically when a customer agrees to have a LMR network installed, it agrees to a long -term supply agreement with Motorola to have Motorola supply at radios for its first responders or commercial customers for a number of years. The business operates in that classic Razer, Razer Blade business model where they sell the Razer, which is the network at the start, and then they sell radios really perpetually for a long period of time to the customer.

11:16And Motorola tends to come out with a new radio model every five or six years, typically at a higher price point with new features. Just to give you a sense on the customer base, about three quarters of the business is tied to the government sector, typically tied to public safety, with the remainder being commercial customers in heavy industries. Municipalities and municipal budgets are really a key driver for the LMR business and to some extent, the software business as well. Well, understood. So if I think about what they're working with today, is it those two businesses that they had that weren't part of the basically cellular business that remain?

11:58Or what did Greg do with the business since then? Just a snapshot of what it looks like and what segments are included in Motorola? So many things. And I think that's one of the keys to the story. Greg, one of the keys to his success was focusing this business on this undiscovered crown jewel that most couldn't see because it was buried within a segment of a segment. And so what Greg did was sell off the second business, which was the cable set top box networks business. That took place early on in, I think, 2012 timeframe or so. And then he had the third business, which is the land mobile radio business, but with some other businesses associated with that as well.

12:48He proceeded to sell off the other businesses associated with scanning technology and managed to get Motorola focused in on this single business, the land mobile radio business, which is the most attractive of all of the assets that they had back then. Can you explain some of that in terms of it being a crown jewel? I can think of walkie -talkies, land mobile radio, but what is the business behind what's going on there? I know there's some security element, but can you capture it a little bit more just in terms of what's actually happening? The land mobile radio business is about three quarters of the company's total sales today.

13:32And the attractive part of this business is that you have 12 ,000 land mobile radio networks today that are predominantly used by municipalities for emergency service applications. The business model is essentially selling the network implementation, which is a profitable business, managing that network for the municipality, for the customer, but then gaining this perpetual stream of radio sales that tend to upgrade every five or six years for your first responders, for your security professionals, etc., etc. And so Motorola's business is maintaining the existing networks for their customers and investing in the creation of more innovative, more reliable radios for their customers, which tend to be sold every five or six years.

14:37And on that point, the radio sales make a lot of sense just in terms of being some type of hardware. When you talk about that network implementation and managing the network, what's going on there? Is there a software element? Are there boots on the ground for Motorola setting things up? If you could paint a picture just to bring that to life. It's a focus on maintaining the overall security and reliability of the network. So they provide cybersecurity services, software services to maintain the network, backup power services, emergency response for the customer in the event a natural disaster has occurred and they're having an issue maintaining the viability of that network.

15:25And so that service element is a nice business, but it's not really the growth part of their business. And the margins there are okay, but not quite as attractive as selling radios, which tend to be higher margin. Makes a lot of sense. And I can understand the overall offering is probably what makes it such a sticky business. And anytime you're dealing with governments or municipalities, anything in that area, that relationship can be so valuable over the long term. Just to harp a little bit more on the idea of the land mobile radio networks. If I just use the comparison of a Verizon or an AT &T, I can think about the quality of my network.

16:10And that's usually related to whether they have fiber optic cable in the area, cell phone towers. Are there assets in the ground that Motorola owns? Or is this just happening through the hardware itself of the radios? The Motorola network or the land mobile radio networks have several key advantages over the traditional cellular network. I think the first really important advantage is overall reliability and control of the network by the network owner. So if you think about a police department, their communications abilities are critical. In the event of an outage, a power outage, the LMR network typically has backup power that will last for a week versus a few hours for the commercial cellular network.

17:03The land mobile radio network has multiple levels of redundancy built into it. So as you think about the P25 standard, which is the standard that is used in the United States, if the core or the equivalent of it were to fail, the network would continue to operate on a site -by -site basis. If multiple sites fail for whatever reason, users could continue to communicate between each other on a device -to -device basis. With a traditional carrier network, if the core part of the network fails, the users on the network will lose connectivity completely. I think the other key aspect to it is the land mobile radio network has dedicated spectrum and capacity that isn't shared with the traditional consumer cellular networks.

17:59So during a disaster, you don't want to have an emergency worker having his communications throttled down because consumers are trying to make calls between each other. So you don't want event overload preventing your emergency responders from being able to communicate. And lastly, on the point of reliability and control, you want to be able, particularly in an emergency to prioritize the capacity of that network based on where the emergency is. So certain first responder communication can be prioritized over other communication that's taking place on that network during an emergency. And that can be very, very important and very useful to that police force.

18:46I think the second key differentiator of the LMR network versus the traditional cellular network is just the reliability and the ruggedization of the hardware. So if you think about a firefighter storming into a burning building, the firefighter needs a communications device in hand that can withstand very high temperatures, lots of water, dusty conditions, and be loud enough for him or her to hear the communication that is going back and forth and be rugged enough to withstand what can be a very, very difficult environment. Typically, these devices require a lot more power than the traditional consumer devices because of the configuration of the network.

19:35And so these devices need to have 10 to 12 hours of continuous operating capabilities, which wouldn't be able to be supported by a consumer device. So the device itself is very, very different and its requirements are very, very different. Of course, customers are looking for continuous improvement across all of these vectors. The acoustics, the battery life, the ruggedness of the product, and its ability to hold up across multiple types of difficult conditions is very, very important. And not surprisingly, because of the complexity of the devices, these devices are several thousand dollars as opposed to much less expensive devices that are sold to consumers.

20:23So very, very different. And can you get into a little bit more detail about video security, what that actually entails beyond some obvious things? Just detail a little bit more about what Motorola is offering those customers and how they use it in the field. Just for some context, Motorola entered the video market through its acquisition of Avigilon. And Avigilon gave the company the product suite that it essentially operates today. And that product suite is an end -to -end portfolio of cameras, analytics, video management, video storage, everything you might need to be able to deliver a complete offering to the customer.

21:06As you think about it, video surveillance has become much, much more important to our society. As an example, surveillance today can identify an individual or a weapon as they're walking into a school or a facility, notify security, notify the police, and indicate where that threat is in real time. And that's become more sophisticated and certainly much more important. Video surveillance is, I think, changing significantly and evolving with AI. Recently, Motorola acquired a company whose sole purpose is to eliminate the need for organizations to have teams of people sitting around looking at video monitors to monitor a facility.

21:59Today, software and AI is good enough to be able to identify most threats and relay that information to the authorities, which has made it much more efficient than what we had in the past. And then for command centers, what does that look like? What does that entail? How is that different from the other segments besides the obvious of it's happening inside of command center? What is Motorola providing there? Command centers for the longest time were stitched together using multiple systems and pen and paper. Motorola has done a great job of acquiring, developing, and integrating a suite of solutions that allows for a much more efficient, effective command center operation.

22:52They break down the command center into three separate phases, detection, response, and resolution. And so they provide software that allows for the detection of harmful situations, that allows for consumers to send or upload pictures or video, which appear to show some suspicious behavior to a command center. They provide response software that allows for a coordinated response from the command center into the field and resolution software, which allows for the categorization and centralization of records from the incident to be recorded and to be stored. That's really what they're providing.

23:40Interestingly, this is very close to LMR, similar customers. In some ways, they're providing some LMR technology into the command center. So very synergistic with the existing business. And if we just go up a level, I think you gave some context for them in terms of the various markets. It sounds like they're very much global. But how big is this market? Do you have any sense of what Motorola's market share is, how penetrated are they in this unique market segment? Within the land mobile radio business, we think they have about 80 % market share. They have, I would say, one and a half real competitors that remain.

24:28And that's Harris, who's in this business, and Airbus is also in this business. That's really the remainder of the competitive base. And they basically dominate the Western part of this business. In terms of the growth of that market, if they have that 80 % market share, you are very much reliant on some type of market expansion. Is that occurring? Are there drivers that would make this market expand more and more in the future? To an extent. So the business has historically been driven or been related to the growth in municipal tax receipts. And so that's a GDP -like growth rate. And so for them to grow more quickly than that, they have to see government safety budgets grow faster than municipal budgets.

25:26And that certainly has happened. And they also have been able to take pricing power to at least keep up with inflation. So the last couple of years, they've certainly benefited from the inflation that's occurred in their markets. And so it's a business that grows, I think, on a secular basis at a mid single digit rate, but probably not more quickly than that. And we've talked a bit about the top line story here. I want to get a bit more into what the financial model looks like. You mentioned the opportunity to expand margins 1 ,000 basis points, which is jaw -dropping. What did the margin profile look like?

26:09How does it look today? And is it a business with a ton of operating leverage? Is it something where you see that number stay steady? Any framing you have for that is useful. Just to give you a sense, when they came out of the split, you had a business that was operating at kind of a mid -teens EBITDA margin at the time. And through various activities, which included dramatically refashioning the real estate footprint, reducing the number of employees, optimizing the cost structure of the business. I can't help but remember Greg went through, I think, three CFOs in this process. So I think it was not an easy process for them.

26:57Margins have improved from mid -teens to now high 20s. So they've done an incredible job improving the profitability of the business. Through that period of time, they repurchased about 50 % of the shares outstanding at an average price that's about a third relative to where the stock is trading today. So they had a keen, keen eye on capital allocation, which is, I would argue, even more important for a business that is a relatively modest growth company. And so they had to pull a lot of different levers at the right time to make this story work out. But they've also enhanced the growth profile of the business dramatically over the years.

27:49As we've talked about, they entered the video surveillance business, which turned out to be a master stroke through an acquisition some years ago. And it's become increasingly important for video surveillance to be owned by an American company. And that, I believe, has helped them significantly. They've also added on to that video business. and today that's about 15 % of revenue, but growing at a double -digit rate. It's quite profitable, so they aren't sacrificing the margins of the company to enter a faster -growing space. And it's also so synergistic with the current customer base, which I think is one of the other very intelligent decisions that the company made.

28:42They entered two new spaces, but they're very adjacent to the existing business, which is obviously selling to first responders and security -related entities. And so video surveillance, the customer base is very, very similar. They've used very similar channels to sell, both indirect and direct. So they've really leveraged the relationships that they've had to grow that business. And I think that has helped to enhance the growth profile of the business. And certainly entering the software space, which they did as well, software is about 10 % or so of the business today where they sell software, control software to command centers and 911 facilities.

29:30again, leveraging the exact same channel, high margin business grows more quickly than the existing LMR business. And that combination of assets, I think along with very predictable growth and execution has been very enhancing to the multiple of this business. So when I started following the business in 2012, this was a eight, nine, 10 % free cashflow yielding business. today, the free cash flow yields at 3 .25%. And I think a lot of that has to do with the combination of all of those factors. Yeah, that's pretty incredible in terms of how the perception has changed and what they've been able to execute on.

30:12It sounds like the early days is very much cost optimization. And now you're likely getting some combination of whether it's operating leverage through having optimized costs, but also the pricing power that you mentioned. And I want to get into that a little bit more. If they were to go to some of these municipalities and say, we're going to push price 4%, 5 % on the next renewal rather than a 2 % or 3%, is there a natural substitute that they could lose business to? It just seems like with 80 % market share, the pricing power would be pretty significant here. What is your sense of that? I'll just step back for a second and just give you a little bit of context.

30:55When they sell a network to a customer, the customer typically gets preferential pricing on radios for an extended period of time. Think about it as five to six years. They get a discount off of the list price for Motorola. So for the first five or six years, they are probably relatively happy because they're getting an attractive price. Longer term, I believe that Motorola has very, very strong pricing power because while it's true that radios need to be interoperable with the standard, the customer is very reluctant based on our discussions with customers to mix and match different radios across their network.

31:48I think they fear complexity. They fear interoperability issues. And I think they're also very keenly aware of the amount of investment that Motorola puts into generating better, more reliable radios relative to the competitors. I think Motorola's brand is very, very powerful. So they certainly have pricing power. And I think that has shown itself in the last couple of years where the businesses generated solid pricing, at least at the rate of inflation, if not better. I think also Motorola is likely to be sensitive to the fact that they're very intent on growing in other areas with those customers.

32:34So they're very intent on growing their software business with the same customers. They're very intent on growing their overall video surveillance business with those customers. So it's a balance between getting appropriate price on the business, but also satisfying the customer needs and finding other ways of growing with those customers. So it is a balance, but I think unquestionably they have a very, very strong position and pricing could be used as a stronger lever but it is not evident that that has been one of their growth strategies over the last several years. You mentioned earlier in the conversation a bit about the breath power of that sales force that sits inside Motorola.