Research in Motion (RIMM) is the company behind the popular Blackberry smart phones and new Playbook tablet. RIMM was a former Wall Street darling that has fallen upon hard times due to competition from Apple (AAPL) and Google (GOOG). As a consequence, RIMM has failed to outperform the S&P500 since 2009. In the last two years the S&P 500 has appreciated over 50% while RIMM has plunged almost 40%. Furthermore, the stock is currently down 25% year-to-date while the S&P 500 has appreciated approximately 7%. To make matters worse, RIMM’s market share is steadily declining and has fallen behind Android.
Click to enlarge
With this bleak information in mind, below I will present five reasons why you should not blindly follow the crowd and assume that RIMM will fail in the short-term. Make no mistake, I do not believe Research in Motion is a company with positive headwinds. However, I believe most of the bad news is priced into the stock and it will not decline substantially in the next year.
1. Attractive Valuation
RIMM currently has a P/E ratio below seven which is lower than any company I follow. Moreover, after adjusting for the approximate $5 per share cash the PE approaches six. I ran a screen using TD Ameritrade and there were only four stocks PEs in the S&P 500 lower than seven: AIG, Tenet (THC), Leucadia (LUK) and Gannett (GCI).
If RIMM declines to $36.70, it will be trading at only 5X current earnings (after adjusting for cash) and only have AIG and Tenet with lower PEs. At this valuation I believe that much of the selling is overdone. I believe that there will be resistance at that multiple; therefore, I advise avoiding trades that only profit on a decline below that level.
2. Large and Growing Market
There are four stages in the business lifecycle: introduction, growth, maturity and decline. Overall RIMM is in the maturity phase as described by QuickMBA in which “strong growth in sales diminishes, competition may appear with similar products, and the primary objective at this point is to defend market share while maximizing profit.” RIMM is certainly still growing but it is becoming clear that its tremendous high-growth days are in the rearview mirror. Despite its lackluster and disappointing recent products, the market is robust enough to support even lagging players for some time. Even if they flop like the Torch, the Playbook and other new QNX phones will likely keep the stock afloat for the remainder of the year.
3. Modest Switching Costs Provide Competitive Insulation
Porter’s Five Forces is an analytical framework created by Michael Porter of Harvard Business School. This methodology is extremely useful at identifying companies in profitable industries with strong business fundamentals. For RIMM I want to focus on the threat of substitute products as that is the most significant downbeat factor facing the company. Despite the growth of iOS and Android, buyer switching costs related to Blackberry Messenger (BBM) will keep the company protected for the near-term. For those unfamiliar with the product, it is a text messaging system similar to an instant messenger. In other words, if all of your friends have BBM, you have a strong incentive to stick with the platform.
Migrating from Blackberry to iOS still presents some obstacles and challenges, especially for the less technologically savvy. Most Blackberries sold are still using the outdated OS 5.X or 6.X. To be frank, if these consumers have not seen how far advanced touchscreen based OSs are by now, they will be hard to convince. This serves as evidence that RIMM will survive for quite some time, despite a product lineup that is generally inferior to the competition.
4. Canadian All-Star
As of last year RIMM was one of the top 20 largest Canadian companies and is certainly one of its high profile companies. As a result, it is not far-fetched to believe that other Canadian companies, investors and even the Canadian government will attempt to support RIMM in some form. If you find this theory hard to believe, simply look at how the U.S. government bent backwards to save the U.S. auto industry from collapse. Even prior to the Playbook’s release some Canadian companies were ordering the Playbook, despite its lack of a proven track record.
This point is epitomized by comparing the valuations of Canadian and U.S. equity analysts. In the past Canadian analysts covering RIMM believed that the company was worth over 40% more than U.S. analysts did. Currently the valuation gap has fallen to 10% but that is still a significant difference. To be clear, I do not consider this a grand conspiracy or potential manipulation. This is plainly Canadians having national pride and being optimistic about their country’s future prospects.
5. Attractive Takeover Target
Microsoft’s (MSFT) $8.5B acquisition of Skype may open the floodgates and reignite a technology M&A frenzy. Research in Motion currently has a market capitalization of $22.5 billion, which makes an outright cash acquisition unlikely at its current price. But if the price declines below $20B the takeover talks will heat up. Even if RIMM were to completely lose its share of the handset market it still has valuable assets that are attractive to competitors:
- Blackberry Brand
- Blackberry Messenger
- Encryption/Security network technology
- Patents, trademarks, copyrights, etc.
- Subscriber information
Therefore, even discounting RIMM’s “core” business, an acquirer could be willing to pay for its intangible assets. Another factor that makes an acquisition more palatable is the fact that RIMM is a Canadian company. Just as Microsoft did when acquiring Skype, structuring the deal to use foreign cash would significantly lower the effective cost of the acquisition.
- Shorting or betting against Research in Motion is not easy money anymore. There are profits to be made by taking advantage of those who believe RIMM will move precipitously in the short-term. Any investment involving RIMM should be classified as speculative at this point and should not be a portion of your core portfolio.
- Do not engage in strategies that depend on RIMM declining below $36.70 in the next eight to 10 months.
- If you are optimistic on RIMM, consider purchasing the Jan 2012 $37.50 Puts for $3 as protection.
- Avoid long-term (greater than two years) bullish positions in RIMM.
- If you are pessimistic on RIMM, purchasing at-the-money LEAP Puts is a safe way to profit from any RIMM decline without shorting the stock.
Disclosure: Author holds long positions in AAPL and GOOG.