In Defense of Research In Motion

Research in Motion (ticker: RIMM) announced that it expects second quarter earnings per share to by between $1.30 and $1.37, rather than between the range $1.47 of $1.55 that it just promised a month ago.  Stock analysts hate this kind of revision and many who follow RIMM have drastically cut their ratings on the maker of BlackBerry phones in the last day.

For me this is an illustration of just how stock analysts so often get it so wrong.

• First, let’s just look at the numbers of the situation.
  • RIMM has 521,120,000 common stock shares outstanding.
  • RIMM reduced its earnings outlook from a maximum of $1.55 per share to a minimum of $1.30 per share, or a potential maximum reduction of $1.55 – $1.30 = $0.25 per share.
  • That equates to an absolute drop in the value of the firm of 521,120,000 shares outstanding × $0.25 earnings per share reduction = $130,280,000.  Remember, this represents the worst case scenario for the firm, assuming that it can at least deliver on $1.30 per share for its first quarter earnings.
  • RIMM’s total firm value = market capitalization (i.e. value of all stock) + value of other sources of financing (i.e. debt, preferred stock, warrants, etc.).  Actually calculating the value we have: ($48.99 price of RIMM stock × 521,120,000 shares outstanding) + ($31,000,000 other liabilities + $276,000,000 deferred long-term liability charges) = $25,529,668,800 + $307,000,000 = $25,836,668,800.  RIMM actually has no long-term debt!  How many firms or individuals can say that?
  • So the maximum reduction in the earnings per share figure from RIMM represents $130,280,000 ÷ $25,836,668,800 = 0.5% reduction in firm value.  In absolute dollar terms the maximum reduction in earnings estimates has lowered the value of the RIMM by half a percentage point.
  • Yet, the stock is down to $48.99 (as of the time of this writing) from last night’s closing price of $56.59 yesterday.  This represents a reduction in firm value of $48.99 ÷ $56.59 – 1 = 13.4%!  In absolute dollar terms that reduction is worth ($56.59 – $48.99) × 521,120,000 share outstanding = $7.60 × 521,120,000 = $3,960,512,000!
  • In summary, a reduction in earnings per share of $130,280,000 has resulted in a $3,960,512,000 reduction in total firm value.
  • You could look at this on a P/E multiple basis, too.  The multiple assigned to these incremental earnings is: $3,960,512,000 ÷ $130,280,000 = 30.4×  This compares to RIMM’s previous day P/E multiple of: $56.59 price per share ÷ $7.50 expected annual earnings per share = 7.55×.  Note: $7.50 is the total year earnings per share, whereas the earnings per share range of $1.47 to $1.55 was just expected earnings per share for the second quarter alone.
  • In summary, the incremental earnings were being assigned a 30.4× multiple, but the entire firm itself was only being assigned a 7.55× multiple.  If the market sell off response today was rational then the sell off ought to have been closer to that 7.55× multiple, rather than the 30.4× multiple.  Why?  Analysts are clearly seeing the reduction in earnings expectations for the second quarter as being indicative of a greater problem at RIMM: competitiveness with Apple’s (ticker: AAPL) iPhone and Google’s (ticker: GOOG) Android phones.

• Second, it is certainly a legitimate concern whether or not BlackBerry can remain a competitive product relative to Apple and Google offerings.  That RIMM, even yesterday was valued at a 7.55× multiple as compared to Google’s 19.8× P/E multiple and Apple’s 16.8× P/E multiple is evidence that investors think of RIMM as having a less competitive offering.  But the real questions are:
  • Can RIMM stabilize sales of its products and maintain its market share going forward?  Consider Avian Securities LLC’s Matt Thornton who said, “The sales on their existing devices must have fallen off a cliff.”  Meanwhile, Cannacord Genuity Ltd’s Michael Walkley says, “Higher-end phones have not sold so well.”  Yet, RIMM’s revision to earnings per share still showed the company was strongly profitable and that revenues continue to grow.  When a company continues to grow revenues and remain profitable, but is losing market share it simply means that competitors are growing faster.  I would counter that BlackBerry has always been a specialized product for a specialized market: the traveling business executive.  In that niche, BlackBerry continues to grow, as indicated by growing revenues and profits.  Which brings me to the next question RIMM management and analysts ought to be asking?
  • For whom are we making our products?  If RIMM wants to stay apace with Apple and Google it has a long way to go.  Its phones have very small screens compared with Apple and Google.  Yet these small screens are why the battery life of a BlackBerry is excellent.  This does matter if you are out of the office for an entire day or two.  Apple and Google phones need constant recharging.  This is why if you walk midtown Manhattan – home to Wall Street these days – you will see BlackBerry phones everywhere.  If you walk Soho or the Village you see Apple and Google phones in droves.  Yet, maybe RIMM can re-focus itself on its core business market and carve out a permanent niche that Apple and Google cannot ever penetrate.
  • Over what kind of time frame are investors and analysts evaluating RIMM?  The analyst quotes in today’s news seem to indicate that RIMM is about to go bankrupt compared to Apple and Google.  Consider the Wall Street Journal’s Cody Willard’s blog headline of, “RIMM is Truly Dead.”  How can such an assessment be made while RIMM is still demonstrating high profit margins and revenue growth in the face of very strong competition.  Motorola very famously led the cell phone market back-in-the-day with its flip phones.  Then Motorola lost its edge.  Everyone thought that the company was dead.  Then something unexpected happened: two years ago, Motorola started making products that every user and evaluator thought were superior to those of its chief nemesis Apple.  My point: one quarter’s disappointment does not a bankruptcy make.
• Third, RIMM has no long-term debt, yet stable operating cash flows.  What this means is that RIMM can borrow money to purchase what it is lacking in internal research and development and accelerate the development of new product offerings.  Those steady cash flows can be used to make interest payments.  After all, Apple just designs phones and then outsources the manufacturing.  Same with Google.  So RIMM has the balance sheet fire power to make for a brighter future.
• Fourth, there is no getting around the fact that you can today buy RIMM for less money than you could yesterday.  In fact, as a company, RIMM is almost $4 billion cheaper today than it was yesterday.  And as I demonstrated earlier, this is with only slightly less profitability than was previously expected.  At current prices, RIMM is trading at a 7.7× P/E.  This low price is for a company that has profit margins in excess of 15% and operating margins in excess of 20%!  How can it be said that “RIMM is Truly Dead?”
• Fifth, some analysts are calling for a change to the executive structure of RIMM, which features two chief executives.  Huh?  On what basis can an analyst, truly removed from the day-to-day operations of any business, possibly know what makes sense for an executive structure?  In fairness, it isn’t as if boards of directors often make a good call on this either!
• Sixth, Mike Abramsky of RBC Capital Markets lowered his price target on RIMM from $90 to $55 and lowered his rating on the company from “top pick” to “sector perform.”  Frankly, this is an example of why when I was a portfolio manager I did all of my own proprietary research.  Your average financial analyst for a “sell-side” investment banker has his head up his butt.  Because of a reduction in value of 0.5% (as demonstrated earlier), Abramsky has lowered his enterprise value for RIMM by $18,239,200,000 (!), or by 38.9%!  Ridiculous.  I also love the “day late, dollar short” rating change from “top pick” to “sector perform.”  If analysts truly had insight into the goings on of a company – such that they could make a recommendation as to executive structure – then why is it that they can’t see that a “top pick” is truly just a “sector perform?”  That’s a huge change in the rating of the business based on what RIMM announced.

In conclusion, analysts are often blind harpies that eat upside and downside hype for dinner.  I do not own shares of Research In Motion, but I am now strongly considering such an investment.  If I do, you will be the first to know.  By contrast, I have owned Apple shares in the past and currently own shares in Google.

Jason