This Chart is Screaming “Takeover Targets”

Published Wed, Aug 17th, 2011   Louis Basenese, Chief Investment Strategist

Merger Mondays are back!

This week, four deals were announced. And there’s no arguing that Google’s (Nasdaq: GOOG) acquisition of Motorola Mobility (NYSE: MMI) and its 17,000-plus patents is the most significant one.

Consider: The $12.5 billion deal is the biggest in Google’s 13-year history. By a wide margin, too. Since going public in 2004, the company has made 136 acquisitions for a combined purchase price of just $9 billion.

So why is the king of the internet coughing up record cash for a single company… and for a struggling mobile phone manufacturer, no less?

I’ll let a simple chart do the explaining. It also reveals two other companies that could be the next takeover targets in the mobile space.

And given the 63% premium Google’s paying for Motorola, investing in advance of any future deals for these two companies could prove enormously profitable.

So let’s get to it.

Bring on the Patent Plays

For months now, I’ve been writing about the trillions of dollars of pent up value sitting on the balance sheets of corporate America in the form intellectual property (IP) or patents.

And make no mistake. Google’s interest in Motorola Mobility is first and foremost about the patents.

You see, the company’s Android operating platform boasts the top marketshare spot for smartphones in the United States at 40.1%, according to the latest figures out of comScore. Apple (Nasdaq: AAPL) ranks second with 26.6%, Research in Motion (Nasdaq: RIMM) is third with 23.4% and Microsoft (Nasdaq: MSFT) is fourth with 5.8%.

However, Google’s pulling up the rear in terms of the number of patents protecting its technology.

And in our idea-driven global economy, if you don’t have a solid patent portfolio protecting your products, it’s only a matter of time before the competition eats your lunch.

That’s particularly true in the mobile space because the financial incentives are so significant.

Consider: The mobile industry represents one of, if not the, fastest-growing segments of the technology sector. It also represents only the fourth industry in the history of the world to generate more than $1 trillion in annual sales.

So like I said, there’s a lot of money up for grabs. The result?

“This is an arms race,” as Christopher Marlett, CEO of investment bank, MDB Capital, recently told Bloomberg BusinessWeek.

More simply, the top players in the mobile space are jockeying to acquire the most patents to protect their current marketshare and ensure their future success.

By acquiring Motorola Mobility, Google leapfrogs from the back of the pack to the front in terms of its IP portfolio in the mobile space. Prior to the deal, Google’s mobile patent portfolio ranked No. 24. Now it will rank in the top 10, based on MDB’s data.

But here’s the rub – the competition isn’t going to sit on the sidelines as Google stockpiles patents. Heck no. They’ll likely consider acquisitions of their own. And if you look at that chart again, there are two companies ripe for the picking.

Motorola Won’t Be the Last Billion-Dollar Mobile Payday

In terms of patents, struggling phone manufacturers, Research in Motion and Nokia (NYSE: NOK), top the list. So they naturally represent the two most likely takeover targets in the mobile space.

However, most analysts are downplaying the potential for a deal for either company.

They contend the companies don’t represent a strategic fit for any potential suitors. They also believe the price tag for a potential deal is prohibitive. Using Motorola Mobility as a proxy, Research in Motion and Nokia would fetch about $20 billion and $35 billion, respectively, in a takeover.

Silly rabbits! Arms races aren’t about offense. They’re about defense. About being protected. And the patent arms race in the mobile industry is no different.

So ignore what the other analysts are saying. The reason a deal is likely for Nokia and Research in Motion is simple.

The biggest players in the mobile space must defend their marketshare. Even if it means scooping up companies that aren’t the best strategic fit, just so other competitors can’t get their hands on the patents.

Given the upside in the mobile market, price isn’t a concern, either. Not to mention, technology companies aren’t exactly cash poor. Microsoft and Apple alone are sitting on about $53 and $76 billion, respectively. So they could easily afford a deal for either company.

Bottom line: I’m convinced it’s just a matter of when, not if, a deal is announced for Nokia and Research in Motion.

Maybe it’s after the companies’ struggling operations land them on the courthouse steps, like we witnessed with Nortel Networks. But I doubt it. There are too many profits up for grabs in the mobile space for companies to sit back and wait to buy patents on the cheap.

Ahead of the tape,

Louis Basenese