RIM's Short Interest And The Microsoft Strategic Alternative

| About: BlackBerry Ltd. (BBRY)

The sell off in Research In Motion (RIMM) stock that started after hours on December 20th and continued through the Christmas Eve short session, is clearly due to a combination of aggressive short selling and long investor confusion and frustration.

Short Selling Metrics
The short interest in RIMM on 11/30 was 113,693,228, up from 104,202,426 on 11/15/2012 according to NASDAQ. The days to cover ratio went from 4.507144 to 1.978142 in the same corresponding period due to the rise in the RIMM's average trading volume in this period from 23,119,389 to 57,474,757, a result of news surrounding the BB10 product development and launch. A key component in short selling a stock is the rebate or negative rebate available on a particular name. In an "easy to borrow" stock, a brokerage house lending the stock will often give a short-seller a rebate for selling the stock and depositing the proceeds in an account in their institution. This rebate rate is normally in-line with money market rates, which today are inconsequential. Negative rebates are charged on "hard to borrow" stocks and are priced on availability of shares to borrow.

Our checks show a RIMM has a negative rebate. In fact, the cost to borrow RIMM stock is rising due to high demand of borrowing RIMM in order to sell shares short. In the beginning of December, negative rebate was 1.5% which is equivalent to an annual interest rate charge. The negative rebate rate now, depending on the institution offering it, is in a range of 1.5% to 5% annually. This shows continued demand for borrowing RIMM stock with supply diminishing. We attribute a portion of the drop in RIMM shares to an increase in short sales.

Investor Confusion/Frustration

Short-selling cannot be the only cause of the drop in RIMM. A very well written article by fellow SA contributor Vince Martin clearly lays out the case for apprehension in RIMM stock. Martin makes the case that with the BB10 launch, RIMM is really in a critical situation. Martin also points out the shortcomings of RIMM's previous management and some of the missteps of the new management. He makes the case for CEO Thorsten Heins inexperienced handling in the public dissemination of the news that RIMM is changing its pricing model. Our previous article points to the after-hours chart illustrating this point. Seasoned management is vital to a successful launch of the new BB10 product line which is vital to RIMM's future.

We put forth a different perspective on why the events since the earnings report may accelerate a new chapter in RIMM's history.

The lower share price yields a higher cash/market cap ratio {C/MC}. At the $10.60 a share 12/24 closing price, the market cap of RIMM is $5.56 billion with no long-term debt and $2.731 billion in cash. The C/MC ratio at $10.60 per share stands at 49% up from 31 % from last Thursday's closing price. The higher this ratio goes, the more compelling an acquisition becomes to a potential strategic buyer.

The reason is pure and simple: you are paying less for the RIMM enterprise when a high C/MC ratio is in place. In essence, the lower short sales take the stock price, the more likely a purchase of the company becomes attractive, which actually could put the most recent short-sale positions under water. The short-sellers should be mindful of the old adage "be careful what you wish for". Traders who are betting on RIMM's demise are hoping for RIMM to die a slow death by mishandling the BB10 launch and butchering its current enterprise business plan. The lower they drive the price of RIMM stock, the quicker they will force RIMM management to seek a strategic alternative to resurrecting the company back to its perch on top of the smartphone arena on its own. RIMM shorts should be careful what they wish for at the $10-$14 price levels, where cash is a high ratio to market cap.

We believe the strategic alternative is much clearer to us than ever. The natural buyer of RIMM is Microsoft (NASDAQ:MSFT). The proof here is evidence that Microsoft is scouring the landscape in search of mobile centric platforms. And it is "paying up" for companies that have a cult-like following such as Skype. We think RIMM is a likely candidate in Microsoft's plans.

In February 2011, Nokia and Microsoft entered into a broad partnership which has resulted in the Lumia product line. Microsoft publicly-embarks on an ambitious plan to focus on mobile platforms which has proved elusive for the software giant.

In May of 2011, MSFT paid $8.5 billion for Skype. A great article outlining the deal in Wired highlights the following deal points:

  1. Microsoft paid nearly 10 times gross revenue for Skype.

  2. Skype was barely profitable at the time of the purchase and historically was always struggling for profits under eBay (NASDAQ:EBAY).

  3. They estimate that the price reflected a $1000 per active user price tag. We think this seems very high.

  4. Microsoft ultimately wants to build its own phone.

With the backdrop of the BB10 phone using the QNX operating system in the next 35 days, we believe RIMM shares will be range-bound from the recent $10.60 low on December 24th and the after-hours high on December 21st of $15.50.

Goldman Sachs has recently upped its target for RIMM to $17 from $16 and attributed the recent selloff to investor confusion we described above. We also think the Goldman confidence is based on its IT and Risk officer's interview with CreditSights and its focus on information platforms and the need for high level security. We quote from a recent CreditSights article:

The overwhelming message from Creditsights' encounter is the importance of information: Goldman Sachs is in the business of information gathering and of information distribution internally.

There is no doubt in our mind Goldman is one of the companies testing the BB10 and will be a new customer once the launch goes live.

Disclosure: I am long RIMM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.