Seeking Alpha
Long/short equity, contrarian, independent research, tech
Profile| Send Message|
( followers)  

The fundamentals of BlackBerry (RIMM) (although fair warning, I'm calling it RIM throughout the article) have been explored quite thoroughly by a number of very insightful authors here. However, what nobody has bothered to mention is that shares of the company, at least over the last several weeks, have exhibited the classic signs of a "bubble" (with a dash of penny-stock like "pumping" and "dumping"). I write this note as a way to educate investors, by way of using BlackBerry/RIM as an example, on how to identify and avoid losing money on such stocks.

Accumulation

The targets for these so called "bubbles" are companies that have been significantly beaten down, everyone's given up on it, and maybe even gotten a little overzealous in shorting it. Such an example is, of course, BlackBerry:

(click to enlarge)

Once everyone's out, and the stock is left for dead, then often times you have the folks with nerves of steel go in and buy shares of the company, especially if there is some catalyst (like a new phone launch) that is several months down the road. These investors are very patient.

Hype Begins, Bears Raid

Next, as the catalyst approaches, potential buyers become much more excited, and as a result start bidding up the stock in anticipation of the catalyst. Usually there will be a few "leaks" or perhaps some "news" events that keep the fire burning, but in general momentum begets momentum, hype begets hype, and fear leads to short covering. This usually leads to a pretty sustained move up.

In some cases, there may be a catalyst or two along the way (for example, RIM's earnings report in which the firm disclosed the new subscriber methodology) that could lead to what is known as a "bear raid". This is when the short sellers take advantage of the fear spread by this negative catalyst and drive the stock down in order to cover at lower prices. How does this work? Well, it's all about momentum. A stock that has been run up so high usually has a bunch of people who now have gigantic paper gains. To avoid seeing these gains evaporate, any whiff of a "downtrend" will send these guys packing -- and a lot of those kinds of traders are involved in a stock like BlackBerry.

But the catalyst isn't here yet, see? So the bear raid won't fool everybody, and it'll even bring aboard new investors who are lucky to have had a buying opportunity. This continues the upward momentum into the climax.

The Climax

Well, everybody's ready for the big catalyst, right? Everyone has bought in, everyone's ready for the big thing to happen so that they can unload their shares at a substantial profit to what they paid for them.

Now, just before catalyst hits, the guys who were savvy enough to buy at the low are probably also savvy enough to sell to the guys who were buying in at the last minute. Why? When the catalyst hits, who will be there to buy? Everybody who wanted to buy the excitement of the stock is already in, so these traders find themselves in a sticky situation -- is it time to get out?

Eventually, everyone starts to head for the exit in a desperate attempt to either keep their profits or to avoid taking heavy losses. In short, there's nobody left to sell to except each other!

Now, some traders try to "buy the dip", but what they're really doing is catching a falling knife. Unless this catalyst was something that was either:

  • Unexpected (everybody knew about the BB10 launch...)
  • Engenders a dramatic shift in the firm's fundamentals (big earnings beat, an acquisiton, a spin-off, etc.)

The euphoria will eventually wear off, and then experienced traders start to hit the stock with short sale orders, bringing the stock back to earth, usually very close to where it began before the hype.

What About RIM?

What about RIM? Well, as I've noted in previous articles, they have a tangible book value in the $11 range, so it has some very strong valuation support. The stock could overshoot this target in the near term, but it's a pretty good level of longer term support.

But what about BlackBerry 10? It's not a big deal, and quite frankly, betting on RIM reaching $50/share+ on the back of a commodity smartphone with a foreign OS is a little bit optimistic. Android phones come in all flavors, shapes, and sizes. You want a high end phone? There's a great LG, Samsung, HTC, or other phone that can fit your needs. Want a cheap beater? The Android guys have that too. Do you really like Apple (AAPL) products? Then an iPhone is available to you.

Microsoft (MSFT) is trying to get into the phone OS space with Windows Phone 8, and by sheer force and by having several very strong partners (Nokia (NOK) in particular), it will eventually grab a good amount of share. Android will probably still dominate because, well, it's a great OS and it's free, and Apple will always have its own group of fans, but it's uncertain as to how strongly RIM can compete in this area. Is there room for an OS platform that has only one hardware supporter? Sure, if you're Apple and have the insane amount of brand equity and marketing skills that is required to do so well. But I'm not counting on RIM being the next Apple.

Conclusion

Remember, take profits often on speculative plays like RIM. Sure, they could hit it out of the park, become the next Apple, yadda yadda, but the truth is, smartphones are becoming a commodity. Everything from the ARM (ARMH) processors to the Android OS is something that anybody can get. There's quite a bit of app/user interface customization going on at the different vendors, but even that has its limits.

Ultimately, though, the winners of the smartphone race will be those that can produce phones in sufficient quantity and at a good enough cost structure to actually profit from the razor thin margins that these devices will eventually have. I'd rather bet on Samsung than RIM, but sometimes lottery tickets pay off.

Source: Research In Motion's BlackBerry Bubble Trouble