"I have confirmed that the Company has substantial strengths that can be further leveraged to improve our financial performance, including RIM's global network infrastructure, a strong enterprise offering and a large and growing base of more than 77 million subscribers." Thorsten Heins, President & CEO of Research In Motion (RIMM), announcing Q4 2012 results.
Research in Motion's earnings for the fourth quarter ending March 3, 2012 disappointed investors, even those expecting to be disappointed. Revenues came in at $4.19 billion, down 19% from Q3, even lower than already dismal projections. Adjusted earnings per share were also a miss at 80c versus the 81c consensus. On the other hand RIMM boasts a large cash hoard and remains a cash generation machine. Net cash and cash equivalents held by the company are $2.1 billion and the company generated $1.1 billion in cash flow from operations in the recent quarter, up 22% from Q3. Is the company as good as dead or is it time to be greedy when others are fearful?
Let us first take a look at the numbers, particularly noting was how the revenue mix changed for this quarter versus previous years.
Hardware and other revenue
Not broken out
Service and software revenue
Not broken out
Dollars in Millions. Source: SEC Filings and 2012 Q4 earnings release.
RIMM is still a cash machine
Some aspects are worth noting. Firstly, this is a business that is still generating loads of cash with a positive change in cash of $600 million in the last quarter. So, it is not in danger of running out of money for operations any time soon. Secondly, the mix of revenue has been steadily changing towards service and software and, as far as we can tell, the service component of the business is still growing. In all of 2009, RIMM made $1.65 billion for the entire year in revenue from service and software and this number has increased to $1.34 billion in the last quarter alone, at annualized $5+ billion run-rate. (RIMM provided the breakup of revenue for 4Q 2012 but I did not find the breakup for the entire fiscal year 2012). So the mix has grown from 18% of total revenue in FY 2009 to 32% in 4Q 2012.
Note that RIMM's service revenue is increasing both on a percent basis and in absolute terms. The relative growth is magnified because of the problems with RIMM's hardware business and its missteps in this area. However, the service revenue is largely recurring revenue and even if RIMM were a company in terminal decline, it would take a long time for that revenue to go away. As of the last quarter, this revenue is still increasing.
Note that the service business is also the high-margin component of the business. For FY 2011, service and software enjoyed 84% gross margins versus only 36% for hardware and other revenue. So RIMM has a recurring and growing high margin business that is increasingly showing up as a larger portion of the overall revenue mix.
The picture is not so sanguine though. Unless RIMM fundamentally alters its business model towards a services only direction or can turnaround the hardware business, the hardware missteps will eventually catch up to the services side of the business. People will eventually switch away from using RIMM services if they no longer have attractive cutting edge devices. However, this revenue is still fairly sticky and generates gobs of cash.
Worst Case Scenario
Let us model the worst case scenario where RIMM completely fails to turn around its business and operating cash flows decline 20% every year in perpetuity. Putting this into a DCF calculator starting with the base of FY2012 (which was plagued with a service outage and massive inventory write-downs) with a $5.5 cash per share and 12% WACC and a terminal value of $0, we get the value of future cash flows as $13.75. Add to this about $4 in net cash/share that RIMM has and assigning value to no other assets such as patents or hard assets and we reach a worst case price for $17.75.
Even worse is certainly possible. Management could make silly moves to destroy shareholder value rather than milking the cash cow that they have. However RIMM is currently priced for terminal decline or worse. The enormous recurring cash flows gives management flexibility in righting the ship and the Blackberry brand still has millions of loyal followers though they are smarting from the company's missteps and Apple's (AAPL) gains. Major consumer brands do not just disappear. Apple itself is a great example climbing from under $10/share in 2003 to over $600 a share in less than a decade. RIMM is no Apple. But it is priced at worse than dead. Do you like the odds or have you had enough? Let's hear from you in the comments section.