Over two years have passed since Motorola (MOT) first announced its intentions to spin off the troubled handset unit amid mounting pressure from activist investor Carl Icahn. While the financial crisis certainly contributed to the long delay, management also needed time to turn around its cellphone operation and devise a separation strategy that it believes will unlock the most shareholder value. What it came up with is a plan for two independent companies grouped according to the end markets they serve.

The first entity will unite the two consumer businesses, i.e. cellphones and TV set-top boxes, to form what co-CEO Sanjay Jha is calling a “mobile Internet content management and delivery and services company”.
In theory, this new business will eventually allow people to download TV shows, movies, and user-generated videos using a set-top box or a mobile phone, and then transfer content back and forth between those devices. 

This is easier said than done, however. Cisco (CSCO) is Motorola’s primary competitor in the set-top box space with the Scientific Atlanta brand, and it has been pushing a similar concept called “the connected life” since 2006, but to no avail. 

In order for the free flow of video to occur, television content providers will need to be convinced that it will lead to incremental viewers and advertising dollars while not hurting the revenues they currently get through their various distribution deals. If consumers are allowed to transfer TV shows to their mobile devices, then will anyone still buy or rent them from Amazon (AMZN) or Apple’s (AAPL) iTunes store?

A new gadget that Motorola showcased at the 2010 Consumer Electronics Show should provide a gauge on content providers’ willingness to allow consumers to take content with them on the go.  The device, dubbed MOVER, is a set-top accessory that enables users to securely put DVR content on a mobile phone, personal media player, or PC. The company claims that it does not violate digital rights management rules, but we won’t know for sure until the technology is released in mid-2010.

MOVER appears to have support from one of the company’s major service provider partners, Comcast (CMCSK), whose senior vice president of digital TV, Mark Hass said, “(We) think this mobile media product is a terrific example of how Motorola’s innovations align with our vision to provide our customers with the entertainment they love anytime, anywhere.”

Mr. Hass may have sung a different tune if the device were able to transfer user generated content from a smartphone to a set-top box, due to the potential for that functionality to dissuade consumers from buying pricey on demand movies and pay-per-view events.

It’s going to be a while before service providers’ broadband networks are fast enough to transmit HD quality video over Internet Protocol. And even when that occurs, there is no guarantee that these quasi-monopolies will want to change to a system that is focused on social networking, personalization, and custom-tailored advertising when they can simply rest on their laurels. So there are clearly a number of hurdles that must be overcome if Motorola and Cisco’s visions are to become a reality.

Even before these businesses can combine and start focusing on the proposed synergies, the handset division will need to turn profitable. In order to do so, sales of its flagship DROID phone will need to remain strong. In the December period of 2009, Motorola sold the third most smartphone devices in North America out of any phone maker and only had two models on the market. It plans on having 20 smartphone models released by yearend.

If Mobile Devices’ recent performance can be maintained, it should be able to meet its profitability deadline of the fourth quarter of 2010. After which, it intends to break off the two consumer businesses sometime in the first quarter of 2011 through a tax-free distribution of shares of the new company to MOT shareholders. 

What will be left is a two-way radio and bar code scanner division that caters to enterprise, government, and public safety agencies as well as a wireless infrastructure unit that sells mostly 2G cellular base stations to service providers.

Due to municipalities’ use of long-term contracts and the relatively predictable (albeit declining) demand environment for 2G cellular infrastructure, these businesses are considerably less volatile than both the handset unit and the set-top box divisions (which is influenced by the housing market). This will likely create a stock with less downside and upside price potential.   

The opposite may hold true for the handset and set-top box company. Without the steady cash flows provided by government radios, the new entity could be even more volatile than before the separation. Still, a more focused management team that has no cushion to fall back on might find new motivation to deliver a more consistent and appealing product lineup.

As far as the details of the separation, management seems to have quelled most of the fears investors have voiced. All of the debt will be assumed by the stable infrastructure business, and nothing new will be taken on by either entity. The intellectual property portfolio will be split up, and the consumer company will give away branding rights to the enterprise business free of charge.

All in all, the two companies should be worth more separated than they are together, since the poor performance of the handset unit has discounted the healthier enterprise radio and networks business for years now. Unless Mobile Devices experiences a sharp fall in demand for its phones, it looks as though Mr. Icahn -with his 6.7% stake in Motorola- will finally get what he has been seeking.