Research in Motion (RIMM) turned out to be a stock to avoid prior to December 14, ahead of the quarterly earnings report on December 20, 2012. Positive sentiment that built starting at the end of October 2012 finally led to shares peaking at $14.12 by the time the company reported its quarterly earnings. The reasons to avoid RIM prior to earnings were:
(1) Expectation that subscriptions would not grow
(2) Rising competition and
(3) Risk of disappointing earnings.
RIM shares dropped a devastating 23% after reporting quarterly earnings, rewarding many short-sellers (the short float over 25%, or 119.6 million shares, as of December 14, 2012). Investors sold-off shares in RIM because they fret that a new service pricing fee structure will erode earnings when Blackberry 10 ("BB10") is released. Between now and January 30, 2013 when BB 10 is announced, what should investors be doing with RIM? There are five things to consider.
1) Balance Sheet
RIM increased its cash balance by $600 million in the quarter, to $2.9 billion. This was accomplished by managing working capital, and by completing cost reductions (headcount reductions) ahead of schedule. RIM will now save $1 billion this year in costs.
2) Decline in Subscriptions
RIM reported a decline in subscribers, to 79 million. Sales from the U.S. and Canada both declined as a percentage of revenue.
3) Service Pricing Fee Structure
Service revenue represents 36% of revenue, or $974 million. The amount of decline is not yet known. Assuming both BB7 service revenue will decline, it is certain that RIM will see a short-term decline in service revenue. This will add pressure to margins for one or more quarters.
4) Keyboard-Based Blackberry 10 Release Date Unknown
As other smartphones increase their emphasis on touch-screen, RIM's keyboard-based device continues to be a competitive advantage, Yet, delays in releasing this model could limit initial sales momentum when BB10 is launched.
When asked when a QUARTER-based BB10 device would be available, CEO Heins did not provide a date. Investors will not know until January 30th when this particular device will be launched.
RIM said to expect cash to remain above $2.1 billion even after marketing costs are factored in. This implies that RIM will spend at least $800 million on marketing. Assuming cash flow improved by the same amount in the next quarter ($600 million), RIM could spend around $1.4 billion to market the new device.
Analysis - Positives
Strong worldwide marketing initiatives to promote the BB10 platform will ensure RIM will have over 75,000 applications at launch. RIM reduced its inventories during the quarter, which will limit margin erosion for the legacy device. Selling the BB10 at prices similar to that of high-end Android devices or the Apple (AAPL) iPhone is possible. This would help limit margin erosion on the service side.
The Gadget Masters posted 10 reasons why Blackberry 10 is better than Apple's iOS6. The key featured mentioned in the article were:
- Blackberry Hub - operates at the operating system level which means it is always accessible regardless of task being performed
- Blackberry Flow - gesture-based user interface removes limits of "in-and-out" paradigm
- BBM - still runs through the world's largest secure data network
- Time-Shift Camera
- BB10 alpha device is as good or better than current Android or Apple devices
Analysis - Negatives
Investors have no idea how low the service revenue will drop. RIM is unlikely to be able to make-up lost revenue by selling Blackberry Fusion server software to the enterprise.
Competitive Analysis: Nokia
Nokia is most similar to RIM in terms of total smart phone market share. Nokia has a market cap of $15.3 billion, compared to $5.72 billion for RIM. When RIM reported earnings, it also helped pull down shares in Nokia (NOK) on December 21, 2012:
(Chart Source: Yahoo Finance)
For the year-to-date, shares are both down 20%:
(Chart Source: Yahoo Finance)
Sentiment for Nokia shares are being driven by sales in Windows Phone 8, but Nokia has a more diverse revenue base. Nokia generates revenue from phones, maps (Navteq), and networks. Nokia Siemens Networks recently made a deal to sell its optical networking division.
To resolve patent litigation between the two companies, Nokia entered into an agreement with RIM. This means Research in Motion will make a one-time payment to Nokia, along with ongoing payments. Terms of the agreement were not disclosed.
RIM shares could continue to drift lower, but could find buyers at the $10-level. Despite uncertainty in RIM's service revenue model, risk substantially declined for the launch of the Blackberry 10 device. In the next 3-12 months, there will be two things supporting shares of RIM. First, effective advertising will be crucial in convincing consumers to consider a Blackberry device. RIM will need to decide if it wants to increase advertising in the competitive landscape of the U.S., or strengthen its existing position in regions like the U.K. Finally, developer support must improve. RIM needs app-support from Netflix (NFLX) or Skype (MSFT). Until that happens, $10 will be a stock price level of resistance, instead of a support price.