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15 February 2012 By Robert Cyran

Congratulations Google, you’re now a conglomerate. U.S. and EU antitrust authorities have cleared the search firm’s $12.5 billion purchase of Motorola. Its foray into manufacturing phones and tablets might open new markets – or simply amount to a vital means of defending its core advertising business. Whatever the case, on Wall Street, diversification like this usually merits a valuation discount.

Sure, the purchase of Motorola helps protect Google’s intellectual property. The cellphone maker’s several thousand patents shore up the walls protecting Google’s Android operating system from software and hardware rivals alike. But the company has made it clear from the start that its purchase wasn’t only about intellectual property – it was also about making gadgets.

This is partially defensive. If Motorola’s devices work well with Google’s own efforts in social networking, payment systems or games, it could blunt the threat of Facebook. Moreover, while Google’s attempts at creating phones of its own have been largely underwhelming, there’s potentially a big financial carrot if it can turn around loss-making Motorola. Apple has shown that hardware can generate 35 percent margins when partnered with the right software, design, marketing and content.

Yet Google’s hardware push smacks of diversification. Some on Wall Street are even starting to view the company as something of a conglomerate. The best way to figure out the worth of a company with multiple operations is to use a sum-of-the-parts analysis. To wit, in a recent research report, Barclays Capital figures Google’s search and hardware operations will be worth about 15 percent more than Google’s current $197 billion market value based on expected cash flows.

While Barclays uses the analysis to show why it thinks the shares are undervalued, it suggests investors are already attaching a “conglomerate discount” to Google. That’s typical, and very often justified, at companies like General Electric that embrace diversification. The worry is they poorly allocate capital among their diverse operations, are difficult to manage and are hard to understand. It’s also why breakups of companies from Kraft Foods to McGraw Hill and Fortune Brands have been welcomed by investors.

It will be a long time before anyone suggests Google needs to break up. But until the group run by Larry Page convincingly shows how combining Internet search and gadgets under one roof creates a better business, investors can be forgiven their skepticism.


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