By David Sterman
Whenever a stock takes a major hit, I like to wait a few days before assessing the wreckage. It gives time to let the issues clarify and provides a chance to see where shares end up once investors have finished selling.
After plunging from $64 to $57 -- more than 10% -- on March 25, shares of Research in Motion (RIMM) stabilized as the new week began, and the issues driving the sell-off can be more clearly assessed. My takeaway: the company faces real challenges, but has laid out a clear rebound strategy. And the stock's valuations are stunningly low. The path to a rebound will be bumpy, but significant upside can be had for patient investors.
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No Growth in the Spring
Investors were reacting to a dismal first-quarter outlook as RIM is caught in the midst of major product transitions. Fresh products are key for this phone handset maker, as it is very dependent on the promotional support of major service providers such as Verizon Wireless (NYSE:VZ). In recent quarters, Verizon has thrown much of its weight (in the form of $100 million in marketing) behind phones running on Google's (NASDAQ:GOOG) Android software. It also didn't help that Apple (NASDAQ:AAPL) has garnered a huge amount of consumer buzz in the past two years with its iPhone and iPad.
As a U.S. consumer, it's easy to conclude that RIM and its Blackberry have become irrelevant. U.S.-based quarterly sales have fallen by double digits (on a year-over-year basis) in three of the past five quarters. But that metric obscures several factors that paint a different picture. RIM's declining U.S. market share has been more than offset by explosive international growth. In its fourth quarter ended February, RIM boosted sales 36% from a year earlier, led by a 97% spike in non-U.S. sales (52% of users are now outside the United States).
And though RIM has lost resonance with U.S. consumers, the company is still the dominant provider of corporate-focused phone service and handsets. The concern for some investors is that RIM will start to lose market share in both fast-rising international markets and the corporate base of users. But might those concerns be overblown? RIM's near-term results -- especially the tepid fiscal first-quarter (ending May) guidance -- appear to be largely due to the company's lagging product lines. Starting next month, the company should begin a major product upgrade cycle.
It all starts with RIM's Playbook, a much-needed tablet computer that can capture much of the buzz the iPad has garnered. Investors have little sense of what to expect from the Playbook, as management has provided only a glimpse of its capabilities. We'll have to wait until April 19 to find out more, but management hints that the Playbook will be optimized for corporate users. On the conference call, management said many potential corporate users playing with early release models have been quite enthusiastic, and RIM expects orders to be quite strong right out of the gate.
The Playbook doesn't have to overtake the iPad or the crop of Android-based tablets that is coming; it simply needs to hold its own among corporate clientele. Lucky for RIM, much of that clientele is locked-in. Roughly half of the installed base of 50 million customers uses the Blackberry Messaging Service (BBM). And messaging services can be quite sticky in terms of retaining customers.
Those customers have been awaiting more compelling products to help support the BBM service. The wait is near the end. Not only will RIM soon have a tablet computer offering, but in subsequent weeks, look for a steady product upgrade cycle where all of RIM's phone handsets are upgraded with sleek new packaging and a far more robust operating system.
To be sure, RIM has lost some real momentum by taking so long to come up with an iPad rival. Some customers who have defected won't be coming back. But a look at the stock price tells you that investors have almost completely thrown in the towel, anticipating the company is about to enter a long-term decline. Not so, says management. First-quarter results will indeed be challenging, but later this year, the upgraded product lines should help reverse the recent negative trends.
Management now sees RIM earning roughly $7.50 a share this year, roughly 10% more than what (mostly bearish) analysts are forecasting. (That would be up from $6.34 in fiscal 2011.) Even if analysts are right and management is being too optimistic, this would still be a stunningly cheap stock -- it trades for about eight times this year's consensus profit estimate, and less than five times EBITDA, on an enterprise value basis. Those are metrics you only see for dying companies. (If management's guidance is accurate, then shares are really, really cheap.)
Remember, many investors dump a stock if it is likely to be dead money in the near-term. Even RIM's bulls would prefer to sell now and buy back in a few months once the weak first-quarter results have been digested. But what if RIM's April 19 release of the Playbook is met by very strong reviews? What if the company uses the opportunity to announce a significant amount of corporate orders?
If that's the case, then shares will start moving back up before first-quarter results are out in June. If that's not the case, then shares have likely found a floor at current levels anyway. Sounds like a positive risk/reward scenario. If the second half rebound unfolds as management expects (and it's been through these product cycle flat spots before), then shares could move past the $80 mark, representing 30% upside -- or more.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.