Monday, August 30, 2010

RIM As The Next Palm

There are no shortage of articles touting Research in Motion (RIMM) as the next Palm, which had to sell itself earlier this year as its current business model proved unsustainable. What all of these "analyses" seem to omit, however, is a comparison of the financial situation of the two companies. Instead, the comparisons appear to be made based on sentiment (which can change in a hurry - consider that RIMM stock traded about 70% higher just four months ago) and predictions several years out (which is almost impossible to do!), rather than on the financial data which could illustrate just how similar the two companies are. In this article, I attempt to make the financial comparison.

In the fifteen year record of Palm's existence, it generated an operating income in just 6 of those years. The best operating margin it could ever manage was 8.5% (1999) at the height of the tech bubble. In no single year did Palm ever generate a return on equity of over 10% (the closest was 7.8% in 1998), even though it was considered the leader in its industry during that period.

RIM, on the other hand, operates at very high margins and generates returns on equity that are extremely high. The following charts illustrate how RIM has been more profitable in each of the last five years than Palm was even in its best year:





When an industry grows at a 25% rate despite a recession, there is room for success for many companies. The success of one or two companies (e.g. Apple, Google) does not preclude the success of other companies. Investors who predict the demise of companies generating ROE's of 30% in growing industries are ignoring the most fundamental and basic aspect of whether a company is sustainable: its financials.

In a similar way, GameStop (GME) is often touted as the next Blockbuster. But an examination of the financials shows that these two companies are nothing alike, and never have been. While one barely snuck by, even in its "good years", the other continues to deal from a position of financial strength that the former never had. That again appears to be the case here with RIM and Palm. But investor sentiment is so low, that RIM trades at a P/E below 10 once its cash balance is factored in.

Disclosure: Author has a long position in shares of RIMM

9 comments:

Anonymous said...

hi saj,

past performance is no indication of future performance.. RIMM like NOKIA are both "cheap" because their product lines miss a real answer to iphone and android.. we all know how a disruptive technology can drastically change a wonderful high return business.. even apple will feel competitive pressure from android ..ever tried a samsung galaxy i9000s with android? ..honestly, im pretty sure competition will erode all excess returns in this business rather quickly! ..but hey its technology, you know ;-)

Best wishes,

nell

Saj Karsan said...

Hi Nell,

I agree past performance is no indication of future performance, but it's still better than our estimates of the future. High ROE and low P/E means the market is making a heavy bet, so I'm just playing the odds that the bet is too one-sided.

Anonymous said...

hi saj,

it sounds more like speculation than investing ;-)

may the odds be with you..

best wishes,

nell

Saj Karsan said...

Hi Nell,

I see what you are saying about there being risks, especially because this hi-tech, but the element of value in this type of investment is still present. Because we are poor predictors of future performance, a diversified portfolio of high ROE and low P/E stocks does outperform the market. (This is empirically demonstrated and thoroughly discussed in this book, which is also summarized here.)

Mike.Gayner said...

Nell, like so many others you consider Apple and Android to be significant competitors to RIM - RIM devices are used far more in commercial environments, unlike toys likt he iPhone. I don't see there beign a significant erosion of margin in this respect.

Anonymous said...

@saj:
yes, a reasonably diversified portfolio is always a plus ..high return businesses with "economic moats" at low valuations sounds too good to be true ;-) ..honestly, i believe in the no free lunch theorem (http://en.wikipedia.org/wiki/No_free_lunch_in_search_and_optimization) ;-)

@mike:
it is not easy to predict outcomes of a dynamic changing landscape ..maybe RIMM can be your envisioned niche player for business customers, but thats in my view speculation and not investing..

best wishes,

nell

Anonymous said...

RIMM just missed the metrics that matter (customer adds), and has failed to address the smartphone market to the point that corporate america is looking at iphopnes. Combine this with the fact that the smartphone market now has external factors (i.e. the application development market) which don't charge just because someone releases a shiny new handset, and you can see that RIM doesn't control its own fate anymore, since s wonderful handset doesn't insure application developments will invest in developing for their platform. Short term metrics are fine, but RIM is no longer in the smartphone market but instead a speciality IT market.

Anonymous said...

Anonymous, All you do is rant over and over again about doom and gloom. Past performance is no indication of future performance yada yada yada... Come up with some real data and stop trying to scare people away from RIMM. Saj did a very good job analyzing RIMM and made a good argument for it so unless you have anything productive to say, shut up and move on.

Anonymous said...

I think some are missing the financial strength argument here in regards to RIMM. Having this strength means the ability to adapt when times are tough. RIMM has a great capacity for innovation. To say it is exiting the smartphone market and entering a specialty niche market is not reasonable at all. Yes, I would keep a close eye on RIMM's technological developments, but at this price I would consider it a bargain. Just in terms of the growth of the cell phone market, RIMM is positioned to increase revenue. I think it will come down to what cell phone provider does a better job at capturing the emerging markets. Just b/c a phone has all the bells and whistles doesn't mean it will be a hit..., price is also a huge factor to consider.

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