Tuesday, June 28, 2011

RIM: The Analysts Were Right

Analysts have been chided quite a bit on this site for their poor predictions and focus on the short-term. So when they get it right, they deserve some credit.

As recently as two months ago, management of Research In Motion (RIMM) re-iterated that it expected earnings per share for the company's fiscal year of $7.50/share. Analyst estimates, on the other hand, clocked in significantly below this level. The difference in expectations between analysts and company executives is even larger in light of the fact that we were already 1/4 through the fiscal year in which these estimates were based!

Two weeks ago, we found out which of these groups would be correct in their assertions; it was not management. RIM shares tanked on the news; the stock now trades almost 60% lower than it did four months ago.

In high-tech industries where product life-cycles are short and disruptive technologies are the norm rather than the exception, company fortunes can turn very quickly. In this case, the sluggish pace at which RIM is bringing new products to market is causing it big problems. But the company's position doesn't appear as dire as market sentiment would suggest.

First, management appears to finally recognize that there is a problem. As of two weeks ago, the company is aiming to streamline its operations to become more nimble and efficient. Headcount reductions (in areas management believes to be non-vital to the company's strategy) have already taken place, and the company's acquisition and capex spree is likely to slow significantly. This should allow the company to generate more free cash flow, and focus management resources on existing assets.

It is also worth examining the main reason for the recent lull in new devices: the company is transitioning to a new platform. As RIM moves its new devices to Blackberry 7, it has been slowed up by delays in the certification process with carriers. The new devices carry more functionality (e.g. HD video) in a smaller package (e.g. the Bold 9900 will be only 0.4 inches thick). Problems have been experienced at the certification stage which have delayed all the new products; but as certification for the initial Blackberry 7 products is now almost complete, the rest of the products under the new platform should experience quicker carrier acceptance.

Despite the fact that the company has been slow to market and has an aged product portfolio which is arguably inferior to that of competitors, RIM is still very profitable as a result of some competitive advantages that have kept it in the game. First, it remains the preference of corporate customers where security is the number one priority. Second, its enormously popular messaging application likely has network effects. The company's commitment to an open platform (for example, RIM's playbook can run Flash, connect via USB and HDMI, and will soon support Android apps, none of which the iPad can do) could also become an advantage in the long-term.

Lost in the competitive shuffle, however, is the fact that this is a growth industry. The market for tablets, smart-phones and other devices and services these companies are working on is relatively nascent. As such, each of these companies will experience tailwinds just from being in an industry that is growing at incredible rates.

Finally, from a price vs fundamental point of view, RIM's stock price appears extremely cheap. Based on the midpoint of the new earnings estimate for the year, RIM trades at a P/E of just 5. After subtracting out the company's $3 billion in cash equivalents (against no debt) from the company's market cap, RIM's P/E becomes just 4.

Nevertheless, risks remain. Management may not be able to execute on its plan to speed up the pace at which it is able to bring new products to market. On this point, once again management appears to sound overly confident that it is doing everything right, as on the latest call both co-CEOs seem to think they have done nothing wrong despite the fact that the company is no longer the market leader. Considering these guys have built the company from scratch and continue to generate very strong returns on capital despite the lowered estimates, however, perhaps they deserve a little more credit than they have been receiving.

Furthermore, even if management does execute and deliver much-improved products to the market, the competition is not standing still either. Both Apple and Android-based competitors are constantly innovating, with Microsoft also looming as Nokia will soon enter the market with Windows phones. This industry is characterized by fast changes, which remains the biggest risk to this company for value investors.

With the lowered share price, profit potential for shareholders is remarkably high. But downside risks remain if the company's competitive situation continues to deteriorate.

Disclosure: Author has a long position in shares of RIMM


Unknown said...

Slashdot, the nerd website, ran the headline yesterday "Developers Defecting From BlackBerry". http://bit.ly/mAajU6 Ouch.

RIM may exhibit value characteristics, but it operates in a fast-changing marketplace where you can never tell what's going to happen next. This could be a huge value trap, and it's probably for the best to put this one in the "too difficult" pile.

Anonymous said...

Don't you think its better just to buy the better businesses in the sector? buying the low multiple biz is not necessarily the best option. apple has always been more expensive than rim but always the better investment. the same for whole foods vs. supervalu. Going long companies with deteriorating fundamentals rarely works, regardless of valuation. Rim may finally be truly cheap, but most longs have lost a fortune on it already and have to climb back. Costco vs. Radioshack etc. Better businesses tend to outperform in the public markets.

Anonymous said...

I dont understand why you think that you can ever understand RIMM better than people immersed in the industry... it is not a "value investment" using the definition you repeatedly use on the site.

Saj Karsan said...

Hi, Anon1. Value investing is about price vs value. Even the best companies can trade at a price that is too high, and even poor companies can trade at attractive prices, is the way I look at it.

Hi, Anon2. I agree there are risks with this company, but I wouldn't characterize them as inconsistent with the site's definition of value. High ROE and low PE companies are often brought up on the site. Microsoft and Cisco would be similar examples.

Anonymous said...

For some reason you're anchoring to the midpoint of the new earnings estimate for the year and projecting that level 4 years into the future. How do you know what it's next year's earnings will be or the year after? If you're taking a calculated gamble, fine, but don't call it value.

Anonymous said...

Has your opinion on RIM changed at all? Are you down around 50% on your investment or have you averaged down?

Saj Karsan said...

Hi Anon,

I still believe the valuation is absurd, yes. I did average down, but I am still down big!

Anonymous said...

Any updates on your RIMM analysis?

Saj Karsan said...

Not really. Plenty of hiccups with the tablet and with the network, but hopefully the blackberry 7s are selling well. The valuation still looks compelling to me.

Anonymous said...

Thanks for the reply. Much appreciated Saj.

Ankit Gupta said...


Few questions on the points that you discussed or I saw discussed elsewhere:

1. BBM's Network Effects - how valid is this? Doesn't this require a significant mass to matter, because I don't see it occurring in the United States. That said... could it be occurring abroad? US sales are down year over year, while internationally, they're growing 100%+

2. Corporate/Enterprise Security - Applications like Good on the iPhone are bridging the gap and allowing corporations to use this instead of the blackberry solutions. Just how valuable is it? I did see that they have a government product line that requires an ID badge to be in proximity to use... great idea, but will it spread beyond government?

3. If the overall revenue picture falls, isn't it more likely that RIMM's revenue will fall faster than they can adjust staff? If revenues fell 20% year over year, their ability to be profitable may be questionable. Do we just count on management to do the right thing here? The Co-CEO's have a lot of stock ownership, so maybe that's what should help us believe they will do what is right? How will we measure them if the right choice is to not decrease staff, because they are doing R&D on items that will pay off in the next year or two, but produce a bad income statement for 1 single year?


Saj Karsan said...

Hi Ankit,

1) I thought this was a bigger moat than it turned out to be.

2) I agree the gap is being bridged here

3) Yes, the managers appears to be aligned with shareholders. Also, the fact that RIM is in a fast-growing industry will provide some tailwinds. Hopefully they can execute