How Google’s Costly Motorola Maneuver May Pay Off

How Google’s Costly Motorola Maneuver May Pay Off

ROLFE WINKLER

Updated Jan. 30, 2014 9:02 p.m. ET

Motorola will help Lenovo capitalize on its supply-chain and distribution strengths. Here, workers in a Motorola smartphone plant in Texas. Associated Press

Google Inc. GOOG +2.57% suffered some expensive bruises in its two-year foray into making smartphones. But the expense wasn’t as big as it appears, and Google may have achieved some strategic ends.

Google’s primary goal in smartphones is to undercut the competition and get them into as many hands as possible. This generates more traffic to its search engine and the ads that surround it.

By unloading its Motorola Mobility handset business to China’s Lenovo Group Ltd.0992.HK -8.21% , Google gains a partner that may inflict damage on rival Apple Inc.,AAPL -0.19% while balancing the dominant market power held by partner Samsung Electronics Co. 005930.SE -0.23% It could also resolve some nagging conflicts in its sprawling Android ecosystem.

In Lenovo, Google gains another partner with grand ambitions to penetrate the global smartphone market with low-cost phones, a segment Apple has ignored. This strategy helped Google’s Android software grow to power the majority of the world’s smartphones—four of every five smartphones shipped in 2013 ran Android, estimates Strategy Analytics.

By flooding the market with Android phones, Google wards off Apple’s threat to bypass Google services on its own phones. In 2012, Apple ditched Google Maps and stopped installing the YouTube app on iPhones.

Lenovo is already the fifth-largest handset seller, with the vast majority of its business in China. And with lean operating profit margin in handsets and tablets—less than 1%, according to Bernstein & Co. estimates—it is in position to expand the market for Android handsets by addressing value-conscious consumers.

Motorola will help Lenovo to capitalize on its supply-chain and distribution strengths, similar to how it has grown into the world’s largest seller of PCs after buying that arm of International Business Machines Corp. in 2005.

The deal also helps Google bring more balance to the Android ecosystem. Today, Samsung dominates the Android world, selling more than six times as many phones as its nearest rival. A combined Lenovo and Motorola can help offset Samsung’s strength, reducing the risk that the Android world is dominated by a single hardware maker.

At the same time, the deal resolves a big concern of Samsung and other Android-phone makers: That Google was both a supplier of their mobile software and, through Motorola, a competitor in hardware. As a sign of that frustration, Samsung in recent months had been de-emphasizing Google’s apps in its latest Android devices, while working on its own mobile operating system called Tizen.

Google’s exit from the business should strengthen Android, said Jefferies analyst Brian Pitz in a client note, “by reducing the risk that handset makers will deploy competitive operating systems.”

All of that could be worth the cost of Motorola. Google Wednesday agreed to sell most of its Motorola Mobility unit to China’s Lenovo for $2.9 billion, less than two years after buying it for $12.5 billion. Factoring in Motorola’s cash, some asset sales and Google’s operating losses while running the business, its final cost will likely be closer to $6 billion.

That is a lot of money, but not bank-breaking for Google. The company added more than $10 billion to its cash pile in 2013, leaving it with $58.7 billion at year-end.

It also acquired 17,000 patents that are proving less valuable than Google first thought; regulators told Google that some Motorola patents shouldn’t be used as weapons in litigation. But the patents—most of which Google is keeping—give Google more legal leverage than it had previously.

Rajeev Chand, managing director at investment bank Rutberg & Co., says buying Motorola was a way for Google to test whether the smartphone business requires a single vendor to create both the hardware and software, as Apple does with its devices.

Two years later, Mr. Chand says, it appears that phones can follow the personal-computer model, where the hardware is made by one company and the software by others. So Google can exit.

Controlling both the hardware and software “is not necessary” because smartphones and tablets have matured as products, Mr. Chand says.