Seeking Alpha
Long/short equity, value, special situations, contrarian
Profile| Send Message|
( followers)  

Equity Research

Company Research In Motion (RIMM)

Rating Buy

Price $11.87

Target Price $17.40

Market Cap $6,182.75

52 Week High/Low$6.22 - $17.96

COMPANY OVERVIEW

As of the most recent quarter, Research in Motion has seventy-nine million users, which is a decrease from the previous quarter. They continue to lose market share in the North American markets which mostly has been offset by an increase in users in Emerging Markets. Many of the headwinds RIM faces are related to their consumer segment. I believe BB10 will be successful in the short term but in the long run BB10 by itself will not solve all of RIM's shortcomings. Therefore, in the long run I believe RIM will be acquired either for its enterprise segment or for its patent portfolio. This is the perspective taken for this report.

STRENGTHS

  • Research In Motion currently has the best data security of any smartphones in the industry. In a survey (source:CFO Magazine published in May 2012, author: Kate O'Sullivan), CFO's readers listed data security as their number one concern related to IT management.
  • Substantial enterprise smartphone market share which we have estimated at 20.6 million users. We believe Management's recent announcement regarding the new service fee structure is a strong positive for retaining enterprise users (announcement made on Q3FY13 conference call). The share price dropped after this announcement because margins related to service are expected to contract. However, much of this contraction will be driven by the consumer segment which for this report I assert drives no future value for RIM. Management stated on the last conference call that the fee structure will allow businesses that do not need the services to decline them and therefore not have to pay for them. We believe this will help maintain and build the current enterprise user base. Enterprise service margins will slightly compress but the value is in retaining the user base. A would be acquirer will be looking to leverage this user base with their existing products and services.
  • Research In Motion offers a wide variety of smartphones at various price points. The existence of lower cost phones has allowed them to compete in countries where the carriers do not offer subsidies. This is one of the main reasons for the company's growth in Emerging Markets. Although lower priced phones lead to declining revenue momentum and contracting margins, it has allowed RIM to maintain and expand their enterprise users which again helps increase value to a would be acquirer.

WEAKNESSES

  • BYOD (bring your own device to work). Companies have been switching to BYOD as they continue looking for ways of cutting costs. This puts the choice of which smartphone to use for business in the hands of employees (consumers). Consumers enjoy having products that have the ability to be integrated such as integration between smartphones, tablets, PCs, and laptops. The only other complementary product RIM offers is a tablet that had a poor launch with many flaws and continues to struggle. (Last quarter RIM sold 255,000 tablets versus 14 million Apple iPads.) We attribute the decline in RIM's consumer segment predominantly as a result of not having these other products to offer consumers.
  • Longer upgrade times: Carriers are looking at ways to enhance their returns so they have discontinued many incentive programs that influence customers to purchase phones more frequently. For example, Verizon (NYSE:VZ) no longer offers its new every two program. This will lead to customers holding off on new purchases which presents a headwind for RIM as well as other competitors in the industry. Current upgrade time for RIM is 2.4 years which is close to the industry average. This number is expected to increase in the future.
  • Lower ARPU: ARPU (average revenue per user) is expected to decline. As consumers and business continue to be price conscious they will continue to choose lower priced options. This especially holds true in Emerging Markets which is where RIM's user base is expected to grow in the future.

COMPETITORS

The competition within the mobile industry is extremely competitive. RIM's top three competitors are Apple (NASDAQ:AAPL), Samsung (OTC:SSNLF) and Microsoft (NASDAQ:MSFT). These companies share a similar advantage relative to RIM which is the capability of their products to interact with each other. For example, Apple has the iPad, iPhone, iTunes, Macbook, and Apple TV which can all access the same data. If you have a music playlist on iTunes you can retrieve it on any one of these devices instead of needing a separate playlist for each device. The glaring weakness relative to RIM which has led to their slow adoption in the enterprise segment is their deficiencies in regards to data security.

FINANCIAL OVERVIEW

The smartphone market is expected to see significant growth in the coming years. However, I expect RIM to face headwinds in regards to revenue as a result of ARPU continuing to decline in the long term. I also expect continued pressure on margins resulting from longer upgrade times and decreases in service revenue. These are the main reasons I believe BB10 will not save the company in the long run and the Company will eventually be acquired. RIM currently has $2.9 billion in cash and no debt on their balance sheet. They currently have operating leases that we have capitalized and added to debt (estimated value of capitalized leases is $300 million).

PROJECTED FINANCIAL METRICS

To derive the value of the enterprise segment of RIM, five potential acquirers were examined to determine what they may potentially pay for RIM. Metrics used to help determine value were: value estimate of the patent portfolio, multiples of EBITDA, Multiple of revenue, and dollar per user. Key assumptions are listed below:

  • Beginning number of enterprise users 20.6 million. Current enterprise smartphone market estimated to be 34.33 million current users and growing at 17% for FY14 and FY15. RIM's market share estimated to be 54% FY14 and 48% FY15.
  • Current ASP (average sales price) estimated at $225 calculated per RIM's third quarter earnings release. ASP growth in FY14 of 3% used (participating majority of phones sold will be BB10 and higher priced while being slightly offset by sales of lower priced phones in Emerging Markets). ASP declining in FY15 by five percent.
  • Service revenue per average user estimate at $49.28 calculated per third quarter earnings release. Decreases in service revenue per average user expected as enterprises opt not to pay for these services under the new plan. A decrease is assumed for FY14 and FY15 of 15% and 10% respectively.
  • Devices and development expense margin estimated currently to be 73%. RIM's 40-f for 2012 states the gross margin for hardware is less than consolidated amount. As of the third quarter earnings release, consolidated device and development expense was 71.9%. Expense margin expected to increase as more sales come from lower priced phones. Service and software expense margin currently at 40.2% and is expected to increase.
  • Assumption made that acquisition would be made at the time of RIM's fiscal calendar end 2014 and a majority of RIM's business would be integrated into the Acquirer's business by fiscal calendar end 2015.
  • Discount rate used, 12%.

The following are companies which have been identified as potential acquirers of RIM. Please note that Samsung is not included. Samsung's management has repeatedly said they are not interested in purchasing RIM. We believe this to be the case because Samsung would be interested in the consumer segment of the business, and we have previously stated the belief that the consumer segment has no value in the long term. Also, Samsung has recently announced its intentions of pursuing enterprise business. However, their focus will be in niche markets currently underserved which they will target through organic growth.

  • Lenovo (OTCPK:LNVGY): Lenovo is a Chinese based company with a strong international presence. They have recently shown dedication and expanded interest into the enterprise segment of the business through their partnership with EMC. The Company is currently focused on its "Four screens one cloud" project. This project integrates the use of PCs, tablets, smartphones and televisions. In June 2011, Lenovo purchased Medion AG for sixteen times EBITDA. Based on this previous purchase, the estimated purchase price Lenovo would be willing to offer RIM is $26.29.
  • IBM: Rumors have circulated regarding IBM's interest in RIM. IBM has maintained its focus on services, software, and integrated solutions. RIM's reputation as the leader in data security and enterprise services it offers (such as Blackberry Mail which currently has fifty-six million users) are the driving factors behind IBM's acquisition interests. IBM would be able to leverage these assets by integrating them with their current suite of existing services. In August 2012 IBM purchased Kenexa for 6.46 times EBITDA. Based on this purchase, the estimated purchase price IBM would be willing to offer RIM is $10.48.
  • Microsoft: Microsoft is a potential acquirer because this would allow them to compete and have a dominating enterprise presence in the smartphone market while focusing on the consumer market through its partnership with Nokia. Microsoft would be able to integrate Blackberry with its other business segments allowing them to leverage RIM's current strengths adding value for Microsoft shareholders (specifically BBM and data security). Microsoft purchased Yammer in June 2012 for $320 per user. Using the estimated enterprise user base of 22.4 million in FY15 produces a share price of $10.65.
  • Dell (NASDAQ:DELL): It is believed that PC sales will continue to fall (the death of the PC) and to survive PC makers will need to diversify. Dell falls into this category and we believe that their management has been actively taking steps to prevent the fall of their Company. Dell has been acquiring companies to help diversify their business and we believe they would benefit by purchasing RIM. The acquisition would provide Dell an entry point into the smartphone and tablet market which they would be able to integrate with their existing business. Many will point to HP's acquisition of Palm as a reason why Dell should not purchase RIM. However, RIM still has a large percentage of the enterprise smartphone market, whereas Palm had lost most of its market share and was quickly losing the portion it still controlled. Dell purchased Compellent Technologies in December 2010 for 5.6 times revenue. Using the estimated enterprise revenue for FY15 provides an estimated share price of $30.87.
  • Facebook (NASDAQ:FB): Facebook is a potential acquirer because of the patents that RIM currently owns. Buying these patents allows Facebook to have a secure messaging system (BBM). Currently, the book value of their patents is listed at $3.3 billion (source: RIM 2012 40-f). Lowest estimated market values used for this report are $400mn for the LTE/3G patents, $500mn for the wireless patents, and $770mn for the patents purchased from Nortel. The total portfolio is estimated at $1.67bn. Adding RIM's cash position to this provides an estimated purchase price of $8.71.

VALUATION CONCLUSION

Taking an average of the five estimated purchase prices above gives us a target price of $17.40 per share representing a premium of 46.59%. We view this return potential as having low risk relative to alternative investment choices.

INVESTMENT THESIS

Based on our analysis of low risk and high potential returns we view Research In Motion as a buy. We expect this value to be recognized by RIM's fiscal end 2015. We have established this view assuming the following two scenarios:

  • As previously stated, we believe BB10 will boost RIM in the short-term but believe that it will not be enough to save the Company in the long-run by itself. We believe RIM will remain a strong competitor in the enterprise market segment for smartphones and therefore be acquired for an estimated share price of $17.40.
  • We acknowledge that we may have misinterpreted BB10's long run effect on RIM. If this scenario happens then the share price of RIM will far exceed our target price. Our expected return will still be achievable on our long position in this scenario.

Provided below are our two suggested ways of establishing positions in RIM (all investors have unique circumstances. Before placing any trade, each investor must evaluate their personal circumstances and develop an appropriate investment strategy to accomplish their goals. The following recommendations may not be suitable for all investors):

  • Establish an initial position and add to it on days RIM's share price decreases allowing you to lower your average purchase price per share.
  • Establish an initial position and sell puts. If the price decreases allow the puts to be exercised allowing a lower entry price. For example; As of close 12/31/2012 RIM February puts with a strike price of $10 traded at $61 per contract. If the price of RIM declined below ten and the put is exercised the effective purchase price per share would be $9.39. As of close 12/31/2012 RIM March puts with a strike of $10 traded at $89 since per contract. If the price of RIM declined below ten and the put is exercised the effective purchase price per share would be $9.11.

FINANCIAL PROJECTIONS AND SUMMARY

Income Statement Enterprise Segment

($ in millions)

INCOME STATEMENT

2013P

2014P

2015P

Device and Other Revenue

$1,654

$3,586

$2,839

Service and Software Revenue

1,076

926

868

Total Revenue

$2,730

$4,512

$3,708

Device and Other Cost of Revenue

$1,207

$2,671

$2,158

Service and Software Revenue

433

417

434

Amortization

273

186

186

Total Cost of Revenue

$1,913

$3,273

$2,778

Gross Profit

$817

$1,238

$930

Research and Development

$366

$605

$0

Selling, General & Administrative

517

767

0

Depreciation

200

200

200

Total Operating Expense

$1,083

$1,572

$200

Operating Income / EBIT

($266)

($333)

$730

EBITDA Reconciliation

Amortization

$273

$186

$186

Depreciation

200

200

200

EBITDA

$207

$52

$1,116

NET OPERATING ASSETS

2013P

2014P

2015P

Net Operating Assets

$409

$677

$556

CAPITALIZED EXPENDITURES

2013P

2014P

2015P

Cap-Ex (PP&E)

$164

$271

$222

Cap-Ex (Intangibles)

$109

$180

$148

Total Cap-Ex

$273

$451

$371

RIM valuation based on LNVGY purchase of Medion AG

(in millions)

Fiscal Year Ending

3/1/2013

2/28/2014

2/28/2015

EBIT

-$266

-$333

$730

Less: Taxes

$93

$117

($256)

EBI

-$173

-$217

$475

Plus: Depreciation & Amortization

$473

$386

$386

EBIDA (EBI + DA)

$300

$169

$860

Less: Changes in NOA

($150)

($267)

$121

Less: Capitalized Investments

($273)

($451)

($371)

Free Cash Flow

-$123

-$550

$610

PV of Cash Flows through 2015

-$120

-$481

$476

DCF Assumptions LNVGY Purchase

Discount Rate

12.0%

Tax Rate

35.0%

Terminal Value Assumptions

EBITDA - 2015

$1,116

Valuation Multiple

16.0x

Terminal Value at 2015

$17,850

Discount Period

2.19

Discount Factor @ 12.0%

0.78

PV of Terminal Value

$13,929

Valuation of Enterprise Customers

PV of Cash Flows through 2015

($126)

PV of Terminal Value

$13,929

Total Valuation of Enterprise Customers

$13,803

RIM valuation based on IBM purchase of Kenexa

(in millions)

Fiscal Year Ending

3/1/2013

2/28/2014

2/28/2015

EBIT

-$266

-$333

$730

Less: Taxes

$93

$117

($256)

EBI

-$173

-$217

$475

Plus: Depreciation & Amortization

$473

$386

$386

EBIDA (EBI + DA)

$300

$169

$860

Less: Changes in NOA

($150)

($267)

$121

Less: Capitalized Investments

($273)

($451)

($371)

Free Cash Flow

-$123

-$550

$610

PV of Cash Flows through 2015

-$120

-$481

$476

DCF Assumptions IBM Purchase

Discount Rate

12.0%

Tax Rate

35.0%

Terminal Value Assumptions

EBITDA - 2015

$1,116

Valuation Multiple

6.5x

Terminal Value at 2015

$7,207

Discount Period

2.19

Discount Factor @ 12.0%

0.78

PV of Terminal Value

$5,624

Valuation of Enterprise Customers

PV of Cash Flows through 2015

($126)

PV of Terminal Value

$5,624

Total Valuation of Enterprise Customers

$5,498

Summary of Implied Share Price

Acquirer

Previous Acquisition

Target (Patent Portfolio/Enterprise Segment)

Valuation Metric

Lenovo (OTCPK:LNVGY)

Medion Ag

Enterprise Segment

16 x EBITDA

IBM

Kenexa

Enterprise Segment

6.46 x EBITDA

Microsoft

Yammer

Enterprise Segment

$320 per user

DELL

Compellent Tech.

Enterprise Segment

5.6 x revenue

Facebook

Patent Portfolio

Low estimate of patent port. + estimated cash

Summary of Implied Share Price Cont.

FY '15

FY '15

FY '15

Acquirer

EBITDA

Revenue

Users

Shares Outstanding

Implied Share Price

Lenovo (OTCPK:LNVGY)

$1,115.64

524.852

$26.29

IBM

$1,115.64

524.852

$10.48

Microsoft

22.4

524.852

$10.65

DELL

$3,708

524.852

$30.87

Facebook

524.852

$8.71

MEAN

$17.40

Source: Valuing RIM