Despite the impressive 16%+ rebound year-to-date, Research In Motion's (RIMM) battered shares are still down 76% from the 52-week high of $70.54.
Most investors following this company are well aware of all of the various reasons for the downfall. The decline of the smartphone's U.S. market share has been well chronicled, and the recent execution problems have all been covered to death. These are not the focus of this article.
What I intend to do is to come up with the absolute worst-case valuation for RIMM, based on the worst-case scenario of it closing down its business at any moment, liquidating all of its assets, and returning the proceeds to shareholders. I will then compare this scenario with the current market price.
Analyzing a company's liquidation value is a theoretical but useful part of fundamental analysis because it provides a solid floor for its valuation. As a company trades at or below liquidation value, it becomes more valuable broken up as scraps than as a going concern. It would become a hostile-takeover target for vultures who can profit from selling its assets and its patents, even against management's will. And most importantly, in this particular case, RIM is still cash flow positive (and will remain so for the foreseeable future according to even the most pessimistic analyst predictions), which means the longer we delay this eventuality, the stronger the cash balance becomes, which leads to even better liquidation value in the future. All of these reasons make this a good worst-case scenario analysis for RIM.
The calculation will be based on the most conservative assumptions:
- Wallstreet estimates Research In Motion's patent portfolio to be worth between $3-$10 billion. Let's assume the worst case of $3 billion for this exercise.
- Assign a value of $0 to the brand, factories, and all other long-term assets.
- Include all liabilities from the balance sheet.
- Assume the low-end of analyst estimates for this quarter's earnings.
|Worst Case Scenario|
|Q4 Complete shut-down and liquidation|
|Current Assets (Q3)||7,202,000,000|
|Long-term Assets (Q3)||0|
|All Liabilities (Q3)||(3,840,000,000)|
|Number of Shares Outstanding||524,160,000|
|Liquidation Value Per Share as of Q3||12.14|
|Current Quarter Earnings||0.73|
|Liquidation Value Per Share||12.87|
So if Research In Motion decides to call it a day and get rid of everything in a fire-sale this month, it can return $12.87 per share to investors at a minimum, based on these very pessimistic assumptions.
As of Monday February 6, the stock closed at $16.575. How does this compare with the worst-case liquidation value? (I will ignore CAD/USD conversion rates for now, given that they are currently very close to par and will not change the conclusion materially.)
Based on the lowest earning estimate from First Call analysts, RIM will earn about $3.28 per share in the next two years, which will put its liquidation value at 16.15. The average estimate is actually 5.85 in the next two years, and the high-end estimate is 9.21. These will produce liquidation values of 18.72 and 22.08 in two years, respectively.
Evidently, as illustrated by the pessimistic assumptions above, to bet against RIM at the current market price is to bet that it will definitely go out of business within the next two years. Obviously, this is a very unlikely scenario because no company would voluntarily liquidate when it is still cash-flow positive. But this goes to illustrate the irrational valuation that the market is currently assigning to RIM.
There is more to the long case - we are obviously not buying RIM in hopes to earn peanuts in the event of a liquidation - but this provides a very good floor of how much the company is fundamentally worth.
Any scenario beyond liquidation is pure gravy - if the company (a.) is bought out at a premium, or (b.) successfully licenses out its OS, or (c.) breaks-up the businesses into separate profitable units, or, heaven forbid, (d.) flawlessly executes a transition to the BB10 platform and re-conquers the U.S. market, then sky is the limit.
Regardless of which scenario pans out, it is indisputable that the current market price of RIMM provides a very favorable risk/reward profile for longs.
Disclosure: I am long RIMM.