For many of you that are unfamiliar with the term "cigar butts," it's one of Warren Buffett's favorite ways of describing a company that's selling below their liquid assets on hand (current assets - all liabilities). Four months ago, Research in Motion (RIMM) (now known as BlackBerry) was trading for a few days below the net/net price of $6.57, and that was the prime opportunity for any bargain hunter.
But now the question is when to sell? As any value investor would do, the best time to sell is when the company reaches the calculated intrinsic value. Based on the balance sheet analysis I conducted, I arrived at a target price of $20.19 per share. The analysis did not include these three factors, which could potentially apply a premium to the underlying balance sheet values.
- The service revenue is moderately stable and profitable, which applies a significant margin of safety to the underlying hardware business.
- The intangible assets could be leveraged by other companies.
- Last but not least, RIMM could potentially divest its hardware division at a modest premium relative to the balance sheet values.
Long Term Tangible Assets:
RIMM currently has a net book value of 2.493 billion dollars in land and properties. Most of the land and properties include its proprietary security servers, R&D research facilities and its office buildings. If these were to be sold, it could be reasonably assumed that the equipment would be liquidated for 4 billion dollars. The liquidation of the servers and the manufacturing equipments will yield slightly lower resale values, but an asset is an asset.
Looking at the cash on hand, RIMM has a solid cash position of 1.910 billion dollars in cash and cash equivalents and short term investments of 821 million dollars. Long term investments are 169 million dollars, which gives RIMM a total of 2.9 billion dollars in cash and cash related securities.
Alongside the substantial amount of cash it has, accounts receivables and inventories would be liquidated at market value or fair value. The two of these would not result in zero because of accounting rules. The management must report these two items based on the fair value of the asset. If it happens to be lower than fair value, then a write-off is needed. Although this is upon the management's discretion, we can only give the benefit of the doubt. This is a risk that's always associated with investing.
If we add up the long term tangible asset valuation to the current assets, we result in roughly 10 billion dollars in assets (some deductions are included). Some of the items that aren't included are deferred income tax asset and income taxes receivable. These two items are accounting items which reflect the differences in the financial reporting of tax liabilities and the actual taxes paid.
RIMM is currently reporting zero goodwill, and the intangible assets are 3.113 billion dollars after amortization.
RIMM has no long term debt, and most of the liabilities are subjective. Deferred revenue is not really a liability, but a company has to recognize it as one if it received payments before it actually performed the service. Deferred income tax liability and income taxes payable are once again accounting items, and for the purpose of this analysis, the items will not be included in the fair value.
There are 10 billion dollars in tangible assets + 3.1 billion dollars in intangible assets - 2.5 billion dollars in liabilities. The ending valuation we get is 10.6 billion dollars, or $20.19 per share.
As you can see from this balance sheet analysis, RIMM's intrinsic value on the assets alone yield more than the market price. Of course, people will speculate and say that the market is currently applying a discount to the underlying assets in case of any future failures. But what we must be mindful of is that some of the tangible assets won't go away, and the value is still embedded in RIMM.
The Future of RIMM:
There are multitudes of analysts speculating if BB10 will either make or break RIMM. CNBC came out with an article titled, "Sink or Swim for RIMM as BlackBerry 10 Launch Looms." In general, people are very short term minded, and what they don't realize is that long term profitability in the smartphone market is unsustainable. The current leaders in the market Apple (AAPL) and Samsung (SSNLF.PK) are both experiencing margin compressions. It is only a matter of time before we realize just how bloody and messy this market truly is.
To form an opinion on the future of a company based on one product release is illogical and obscene. Did the playbook doom RIMM? I don't think so. To put this in perspective, RIMM's service revenue still generates around 3.1 billion dollars in gross profits per year. If the cost savings initiative is complete, overall costs will be reduced by a billion dollars, thus increasing overall margins. After this simple analysis, we must ask ourselves of the inherent possibility of a divestiture of the hardware side. This division alone soaks up most of the expenses. There was recent speculation that Lenovo was interested in RIMM, but what I see here is a hardware divestiture instead of a takeover.
After the initial divestiture, RIMM would find a way to license their security technology out to other platforms. The increased cash position from the divestiture coupled with the overall lower operating costs will allow the company to focus a significant amount of capital on their strengths (security). The company would most likely continue to focus on the BB10 operating system, and a possible licensing deal could enhance the intrinsic value of the company even more. They could either agree on a per-unit fee deal or a yearly fixed deal.
In the end, I predict that RIMM's vision is to shift away from the hardware side of the smartphone industry. We can start to see that with some of the recent initiatives they are taking such as mobile fusion, mobile payment security, and QNX integration in cars. While these ventures are still in their infancy, there is a high probability that Thorsten Heins, the CEO of RIMM, is shifting the company away from the hardware side due to the competitive nature of the industry. In the end, none of us are certain of where RIMM will be in 5 years, but one thing is quite certain, the hardware side will no longer exist in the ensuing future, which would turn RIMM from a cigar butt into a cigar.
Disclosure: I am long RIMM.