In Part I, I made the case for Research in Motion (RIMM) as an attractive asset play. Motivated by several very good comments to my post, I want to add some additional points about the risk and catalysts.
Two risk factors
Could the stock price drop to $5?
Barring a major surprise, that is very unlikely, but anything is possible. Most of the bad news is (over?)priced in the stock. I would expect the next major leg down would occur if, for example, Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG) surprised the market with a superb new product launch, at which time analysts would further downgrade earnings expectations. But, note that increased competition does not affect the analysis in my prior post. The tangible asset value is what RIM's assets are worth; frankly, it is a reasonable price that a competitor --such as Apple-- would willingly pay for RIM.
In the short-term, investors focused on RIM's earnings prospects may mark down the value of the assets. In the long-term, price and value will eventually converge. The price-value gap closes at a variety of rates, depending on the complexity of the issues and distance to news catalysts. As Warren Buffett famously said, "Price is what you pay; value is what you get. Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."
As long as earnings visibility remains low and investors focus on the income statement, the stock will continue to meander and even decline. While people focus on earnings, they will forget that there is large asset value per share on the balance sheets. This value would be unlocked through a corporate action asset sale or merger.
What if RIM's management spends the cash on its balance sheet?
First, there is a substantial amount of cash and receivables on the balance sheet: about half the company's market value. That's quite a bit of cash for them to spend.
But, this is a critical concern: I assume the management will preserve the capital for shareholders. As I stated in the first post, if management begins to spend heavily on new R&D projects, I would sell. I will be monitoring news flow for major new project announcements, but it does not appear RIM's management will bet the firm for now.
When will investors incorporate RIM's asset value in their estimates?
RIM is a buy, but the price is unlikely to start marching up today. First, it's the end of the year, so fund managers will not buy RIM. It's simply too close to bonus time to take such risks. Second, investors generally will not start buying it until the catalyst becomes clear and apparent: a CEO change or other management shakeup, a product launch earlier than expected, a buyout, and so on – these would be the triggers that would move the shares north.
Remember Newton's Laws of Motion from physics? There is an analogous law in investments: prices move in the direction of the most recent news event until acted upon by another major news event.
So what are the possible short-term news events? In the short-term, an influential analyst or investor could make positive comments about RIM's asset value that would send the shares higher. For instance, Sears (NASDAQ:SHLD) stock had a P/E of 3 in 2004 until Eddie Lampert announced he was acquiring shares. The stock soared once the market recognized Sear's real estate were valuable hidden assets on the balance sheet. On the short side, hedge fund manager David Einhorn recently noted balance sheet issues with Green Mountain Coffee Roasters (NASDAQ:GMCR). While these issues were apparent to anyone viewing the balance sheet, it often takes an influential person such as Einhorn or Lampert to shake the market from its collective groupthink.
So major news is likely 2-3 quarters out. In the interim, sellers will likely outnumber buyers, so my guess is the stock has limited upside in the near-term. This is not a short-term play. This is a longer-term value investment.
A value investment, such as this RIM buy, requires longer holding periods. Here's a very useful analysis of the investment process of value investor Walter Schloss:
Still, when asked to name the mistake he makes most frequently, Edwin Schloss confesses to buying too much of the stock on the initial purchase and not leaving himself enough room to buy more when the price goes down. If it doesn’t drop after his first purchase, then he has made the right decision. But the chances are against him. He often does get the opportunity to average down – that is, to buy additional shares at a lower price. The Schlosses have been in the business too long to think that the stock will now oblige them and only rise in price. Investing is a humbling profession, but when decades of positive results confirm the wisdom of the strategy, humility is tempered by confidence.
§ In the book, the paragraph about the one noted above read: ”The disappointments or reduced expectations that have made it cheap are not going away any time soon…”
Another quote from Bruce Greenwald, a professor at Columbia business school, is instructive:
We've got Walter Schloss's archives, and it looks like -- we haven't got the numbers yet -- a large percentage of Walter Schloss's returns have come also over time from knowing that you're buying something worth buying. And then when it goes down, not getting frightened and dumping it, but continuing to buy. And then selling on the way up. Looks like that does a lot better than just averaging down.
While you must be prepared to continue to buy when the price moves against you, one of the keys to value investing is to know when to throw in the towel on the investment. Again, in RIM's case, my thesis is that RIM is an attractive asset play. The two key premises of the thesis are that the firm will not have operating losses and that management will not engage in expensive R&D and/or marketing projects. If either of these assumptions proves to be invalid, I would turn bearish very quickly and sell RIM.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RIMM over the next 72 hours.