Research In Motion: Profit From the Fear

| About: BlackBerry Ltd. (BBRY)

As one of the most hated equities in the marketplace, Research In Motion (RIMM) has reached a point of undervaluation, which implies little downside. With solid fundamentals, a loyal customer base, unique enterprise-oriented services and a portfolio of hardware, which is slowly but surely undergoing revision, bullish RIMM option plays are likely to reward investors with strong stomachs.

Profile: Research In Motion is synonymous with its BlackBerry brand, which has established a broad following in the enterprise world, especially large corporations and government institutions. RIMM provides secure and reliable connectivity services through its proprietary instant messaging service.

BlackBerry handheld units accounted for 81% of total revenue in FY11 Q4. Service contributed 16%, up from 15% in Q3, and other software, OEM, accessories and other revenues accounted for 3%.

As numbers clearly show, hardware sales are the key driver. RIMM launched its PlayBook tablet to mixed reviews (Endgadget, ArsTechnica, C-Net) and nominal sales (PC-Mag.) Most critically, it's been working to redesign core phone and recent tablet offerings around a more robust operating system (TechRadar UK, Endgadget) to counteract encroachment from increasingly popular Android handhelds and the iPhone juggernaut. (Source: Standard & Poor's Compustat Company Report.)

Fundamentals: RIMM is now trading for an astonishing 6.1x P/E TTM and a projected 5.6x forward P/E. 52 week range is $70.54 - $37.69.

Forward PEG comes in at slightly less than .50, although there's a great deal of fear that the company will be unable to sustain revenue growth and historical margin levels. The most immediate challenge appears to be downward pricing pressure on BlackBerry devices as entry-level Android phones are now available in the $50-0 range with carrier-subsidized 2-year contracts.

RIMM revised current quarter guidance on April 29:

Revenue estimates were cut to $5.2B from $5.6B.
EPS estimates were cut from $1.47-$1.55 to $1.30-$1.37.

RIMM has outpaced consensus EPS estimates for 10/10 of the last quarters, a remarkable stretch of performance. Analysts expect below-guidance EPS around $1.33 for QTD performance--results are due June 16. (Source: Yahoo! Finance, Fidelity Investments.)

Downside Protection: P/Book is at 2.56 vs. industry average of 3.27.

P/Sales hovers around a remarkable 1 vs. industry average of 3.7.

As flatly stated in the introduction, RIMM has the dubious distinction of being one of the most hated equites currently trading, if not the most hated. While valuation metrics imply a good amount of downside protection, adages about catching falling knives apply.

The company holds $2.12B in cash and, remarkably enough, no debt. It does not pay a dividend. The stock has 65% institutional ownership, with 1.9% short ratio. (Source: Yahoo! Finance.)

Technicals: No way to dress up this kind of price action: the charts look terrifying. RIMM has been spiraling downward and is about 38% in the red over 6 months. It's trading near 52-week lows and is way below 50 and 200 day SMAs.

The bleeding started in late March and got worse on April 29--revised guidance sent the stock tumbling 14%. On May 12, a strong sell signal was generated by the 50-day SMA plummeting below the 200-day SMA.

MACD has been flashing sell signals since late February and currently sits at a dismal -2.77, with a negative divergence of -0.08.

RSI and Williams %R confirm RIMM to be severely undersold--the latter in particular has stayed above the critical 90 mark just about every day since RIMM released revised guidance on April 29.

General Sentiment: The ongoing sell-off tells a story of fear building to near-panic level as investors appear to have lost faith in RIMM's ability to execute and refresh product lines that are competitive against Android and iOS devices.

Analysts diverge widely. Ativo Research, Standard & Poor's and Channel Trend have all recently upgraded RIMM from Neutral to Buy based on valuation. Others, like Market Edge, Deutsche Bank and Thomas White International have downgraded RIMM to sell due to the strength of the fear sentiment in the investor community and strong doubts about shrinking handheld marketshare.

The mean 12-month price target from 44 analysts covering the stock sits at about $57, implying about a 42% upside. (Source: Fidelity Investments.)

Analysis: RIMM is shaping up to be a clear case of money to be made when there's blood in the water. Although recent price action and technicals are formidably negative, the stock has been priced as if Research in Motion is the second coming of Palm, a mobility company which faded into irrelevance within the span of a couple of years.

2 brief bullet points as to why current fears about RIMM are widely overblown:

  • Bears underestimate the strength and unique set of value propositions the BlackBerry brand built over the years. While Android and iOS devices are as of right now more appealing to retail customers, the security and enterprise integration options of the BlackBerry platform favor RIMM in the highly profitable institutional segment of the mobility market. Apple (NASDAQ:AAPL) recognizes iPhone's competitive disadvantage and is moving to address it through the just-released iMessage feature (C-Net.)

    Another fundamental mistake is to lump RIMM with Nokia (NYSE:NOK) -- the latter is retail-consumer oriented whereas the former has always focused on business and government clients. The respective futures of the two companies are, simply put, not entangled -- a recent RIMM plunge (Reuters) following Nokia's profit warning, for example, was patently absurd.
  • The explosion in smartphone growth means that even in worst case scenarios with continually shrinking marketshare, RIMM still has room to grow.

Even more compellingly, bears fixated on erosion in the domestic space ignore the enormous amount of potential in BRICs. As private companies overseas mature into larger, potentially multinational enterprises, RIMM's BlackBerry offerings remain the default choice.

Based on valuation, the history of positive surprises vs. consensus estimates and the strength of its value propositions in the mobility space, I expect RIMM's decline to bottom out with strong support around in the $35 range. The announcements of quarterly results on June 16, may serve as a turning point.

A relatively conservative Jan 21st $32.50 cash covered put for a $2.57 premium yields an annualized return of about 26.5% (for comparative purposes only.) This implies a break-even price of $29.93 -- a price RIMM hasn't touched since mid-September of 2006, meaning you'd be establishing a position in a top-tier mobility company with large downside protection compared with industry average at a forward estimated P/E of less than 4.7.

A riskier approach involves purchasing Jan 21st $37.50 calls for a $6.15 premium. Assuming a conservative $50 price target (compared with analyst mean target of $57 and historical P/E range) this strategy yields $6.35 per contract, which amounts to an approximate 175% year over year (for comparative purposes only.)

As always, hedged plays are advisable when deploying a large amount of capital.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RIMM over the next 72 hours.