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Standard & Poor's gives Google the U.S. debt treatment

itworld.com

47 pointsabennett44 comments

If Google really bought Motorola for the patents alone, we should expect massive layoffs as they wind down the phone manufacturing business.

If, as many have speculated, Google actually wants to follow Apple into the integrated software/hardware market, then this is a bet-the-company decision that will either see Google mired in a failed merger on the scale of AOL/Time Warner, or if successful it will provide a growth engine for the next decade and badly-needed diversification.

I think it's pretty hard to look at this deal purely from a technical analysis perspective, since no one except a handful of senior staff at Google really know what the plan is.

This is true. The CEO of Motorola Mobility came on a conference call with us (here at Motorola in Beijing) and told us that they didn't really know much more than we did, and to stay tuned. They have told us to "refrain from gossip or speculation", as the deal is still very fresh and far from closed.

It wouldn't surprise me at all to see them spin Motorola right back out into a separate entity. It would actually make a lot of sense. Google gets their patents and a very cooperative manufacturer, without the worry of managing Motorola day-to-day.

That $12B will be quickly absorbed.

If this new Motorola entity is separate from Google and without patents (since Google would have them), this new Motorola Mobility would no longer have any leverage for itself and could easily fall prey to future patent lawsuits.

Scott Kessler, the S&P equity analyst, gave an interview about the downgrade to Bloomberg West today:

http://www.bloomberg.com/video/74044556/

His justification was as follows:

  1) Google will not be able to close the deal by early 2012.

  2) Current related litigation is not helped.

  3) No one knows how much protection the patents will add.

  4) Moto will have an adverse impact on financials going forward.

At the end of the interview, Kessler comments that Google is making this move with a long-term view, while S&P is "obviously" looking at this transaction on a "micro-basis".

2) I don't understand. Just the threat of Google launching that missile at Apple and friends has to severely curtail patent litigation. If Apple knows that Google will soon have the ability to deliver a haymaker of their own, they are MUCH more likely to negotiate a cease-fire.

#2 is probably in reference to the Oracle claims since the Moto patents are more focused on wireless technologies, at least that would be my guess.

Your last sentence, made me think. We must not forget that this is short term investment advice. They are not saying that no one should ever buy Google stock again.

GOOG's market cap is $174B. A $12B cash purchase for Motorola Mobility Holdings Inc is not consequential to GOOG's balance sheet. (But it does seem like a big premium given that that price is above their 10 year high.)

There is obviously integration risk, but I believe the integration risk is low compared with the potential upside.

The reality of our world now is that almost everyone in every country living above poverty will own a smart phone.

Buying Motorola gives GOOG the ability to capitalize in a different way than just search and whatever value they get from the patent acquisition is bonus.

5 years from now, this will be viewed as an intelligent acquisition which provided a lot of value to GOOG, but most likely not the way most people are looking at it today.

*Scott's micro-basis is not a good way to look at this acquisition and by not looking at the big picture (mobile growth) he may have made a serious error.

12/174 =~ 7%, which is a significant amount of any company's market cap, and very consequential to the balance sheet.

I've never heard of such a large integration that has ever worked in the tech field; what percentage of Motorola's employees would be hired by Google through their normal rigorous procedure?

Large integrations have always been failures; this is definitely a bold move, but based on the history of these types of purchases elsewhere in the tech field, and the difference in corporate cultures, the best possible course would be to not integrate at all.

This is true, as well. In my short time (< 2 months) at Motorola in Beijing, I can tell you that very few of the "engineers" here would be hired at Google.

Is that a bad thing or a good thing?

It doesn't have to be either. Culture shock is one of the biggest risks in this deal, and having vastly different hiring strategies will make that risk higher.

Also, the culture here is much different. In fact, two different people on two separate occasions on the three monotonous conference calls we've had on the acquisition have asked how it could "possibly work." We don't have slides or teeter-totters or 20% time or any of that nonsense. Everyone here is about a massive amount of procedural discipline, huge timeframes for projects, and that's all they know.

Large integrations have worked at times in the past mostly when one company bought a competitor (or semi-competitor) for its market share. Generally they haven't been great for employees of the company that was taken over, though.

Some examples include: DEC/Digital (bought by Compaq), Netscape Server business (bought by Sun at the same time AOL bought the rest of the company), Compaq (bought by HP), Lotus (bought by IBM in a hostile takeover), Peoplesoft (hostile takeover by Oracle), BEA System (bought by Oracle), Sun (bought by Oracle).

There are also numerous examples in the telecommunications market.

The Oracle/Sun deal is the most interesting in this context, because it is a software company taking over a hardware company (yes, Sun has software, but one of the reasons Oracle bought it was to compete with HP & IBM on complete system integration all the way down to hardware).

It's clear there are plenty of examples where this didn't work. Google has a huge challenge, but there are some precedents for this working.

May be we have different ideas of what constitutes working out well, I wouldn't have considered the subsequent failure and acquisition of Compaq and Sun to be good outcomes.

subsequent failure and acquisition of Compaq and Sun to be good outcomes

I don't understand what you mean. Compaq and Sun were struggling prior to being taken over, not afterwards.

I'm more familiar with the case of Sun, but in that case some kind of take over was what all the shareholders were hoping for. The employees and many in the tech industry might have preferred a different buyer.

Compaq bought DEC, got into trouble and got bought by HP. It was a fairly short time line between rescuing DEC and needing their own rescue. How is that a good out come? I am not saying buying DEC brought them down but it certainly didn't save them from impending doom.

As far as Sun goes there is a much longer time line between the Netscape purchase and there own, but the way Sun fell apart until its eventual purchase isn't what I would call a paragon of success.

epistasis, It depends on your definition of consequential. To me, having $40B in marketable securities & cash is a huge burden. Investing it in Motorola allows them to get a return on that cash which is fairly safe, but not without risk.

While $12B off the balance sheet is a big number, it is not consequential to their operations or anything else they are thinking of doing. Unless they are going to acquire someone even larger.

A return would imply that this bit of Motorola made a profit wouldn't it?

Which it doesn't really.

These price targets are ridiculous. If S&P actually knows where prices are going, why aren't they running the world's largest hedge fund?

You must ask this question of every single piece of stock advice ever given freely or sold. If you knew about future price movements with some degree of accuracy, the least profitable thing you could do would be to tell others.

That is not entirely correct. If you have already acquired credibility (somehow, doesn't matter how for the purposes of this exercise), your estimate or advice can (and frequently does) become a self-fulfilling prophecy. Knowing that a significant number of investors will follow your advice gives you information which can be used in the market. It then stands to reason that the most profitable thing you could do would be to give this advice to the maximum possible number of people.

No particular reason the advice has to be accurate.

accurate advice is more likely to come true, thus bolstering your credibility.

But the advice comes true because you gave it. This is the inherent flaw with the market at issue here -- it selects for consistency, but not accuracy per se.

I have a theory about how a lot of Wall Street secretly works: the best way to predict the future is to make it happen the way you want.

I don't think that's much of a secret. It's written into the maths as far as I can see.

Well that's not much different from how we play right? Make the future happen, literally. But they ultimately have to face what we will face. The markets may not buy. All that real estate stock for example.

I think these moves are S&P's aattempt to come back from the massive hit their credibility took from rating toxic MBS as AAA. They're trying to prove they still have some market utility by making some predictions.

I'm not convinced that Google doesn't know the manufactoring nor device game. For one, they have designed and provisioned their own servers, racks, and data centers for "ever." As well, they have had their hands in building out both Nexus devices.

Servers in a data center are a very different beast than portable devices. They also have far fewer regulatory restrictions than cell phones; you don't need to register your custom server with the FCC, after all.

The unfortunate thing is that it's all too easy to imagine a scenario where you do have to get approval from a .gov regulator to put a server on the internet.

Or worse, several of them. Your copyright license, your permit for attaching to the internet, your Homeland Security Virus Scanning permit, etc.

Man, it's the internet. Just put your servers in another country.

Didn't work for Google in China all that well, did it now?

Let's say Microsoft and Apple can only go after the handset makers for whatever reason, and they win. Thst means handset makes will drop Android for WP7 or MeeGo.

Now that Google has is own cell phone manufacturer, it will still be able to produce an Android phone.

Patents I'm sure are important too, but being able to control manufacturing is crucial if the handset makers bail.

I'm not sure how this works, but the Rockstar Consortium, or whatever nonsense, that bought up the Novell patents, provides legal cover against any entity outside of that consortium right? Google could conceivably provide something similar to Android partners.

Why would Google necessarily care about their S&P rating? They have enough cash that they don't have to issue bonds, similarly with equity - I doubt it changes the dilution constraints to issuing new equities much. Short term debt? Nope, that cash again. Financial easing of big purchase deals? What banker is going to pass up working with Google?

This isn't about Google's bond-worthyness or financing corporate debt, but instead about their stock's perceived value. (The article talks about GOOG being rated "buy" versus "sell", not AAA or B which are bond terms.)

S&P ratings do affect how Google will run the business: If Google's stock takes a hit, employees get restless and are more likely to look elsewhere for employment. Employees aren't always long term focused in stock prices. Google could use this as an excuse to buy back their own shares to drive up value.

Actually, Google did issue bonds earlier this year[1]. The interest they were paying was so cheap it was better than spending cash. They pay 1.25% for a 3 year bond, up to 3.625% for a 10 year bond.

Theoretically I guess Google could care about their S&P credit rating (as opposed to this stock rating) if it made it harder for them to sell them in the future. Judging from how low the rate they had to pay on those bonds I suspect they wouldn't have any trouble selling them anyway.

Their credit rating is very unlikely to drop while they are highly profitable and sitting on a pile of cash though.

[1] http://www.reuters.com/article/2011/05/20/us-markets-credit-...

The point about margins is perceptive. Hardware is a very different business.

Margin differences between industries are obvious to a Sell-side/buy-side analysts. The analyst in this case talks about the difference in margins like a lower overall margin for google would be bad.

It won't be bad because Google will now have additional revenue (&profit) at that low margin and will be operating 2 different businesses. If anything is scary about this transaction it is the integration risk. Lower overall margins are not an issue for valuation.

This particular sell-side analyst may be using a model which does not value the company in 2 pieces which will give him a lower valuation than it should.

Google's new valuation should look like this:

Google's business prior to acquisition + Motorola's valuation + additional gains or losses from integration/synergies = Google's new valuation.

*also note that in finance valuations, the lower standard deviation of returns, the lower the risk premium so having Motorola may actually increase the valuation. On the other hand those buyers of google who wanted pure play search/cloud exposure may sell off google's shares.

I read the whole thing buy out as extremely ominous. The size of motorola mobility (if I read it correctly) was larger than Google. It has the potential to destroy Google from a logistical stand point, tie it up in so much red tape that it can't survive... or worse becomes a lame duck like Microsoft is now.

Profit margins aside its extremely hard to join to companies together. Infact one of my friends from childhood is an HR consultant who specialises is assisting business merge.

You wouldn't believe the crap he's told me, lets say fraud is generally everyones first order of business. If its like at any other company the people at motorola aren't going to be very happy with this new position and will try and take its parent company for all its worth before moving to a better position.

I assume Google is going to start issuing commands and maybe merging or forcing joint teams with the R&D departments, thats going to make things very difficult at motorolas end. Productivity is going to decrease as communication issues arise. People at motorola will probably get annoyed at being dictated to, always being wrong for misunderstanding directives, and want to move on (like I said above will take Google for all they can while they do it). Theres a serious chance they will view Google as an ivory tower issuing commands whilst being out of touch of reality. Loyalty will plummet.

Google is in for pain. Serious HR pain. A company that hasn't got a good record of dealing with things like that. Thats going to cost A LOT of money to work through.

Motorola Mobility is estimated at around 20,000 people. Google is at 29,000 people. So just a little bit smaller.

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