It's been about a week and a half now since Research in Motion (RIMM) reported its fiscal second quarter results. The company beat on the top and bottom line, producing results that weren't as bad as everyone feared they might be. The companies cash and investment pile even increased in the quarter. This was definitely a positive surprise from Research in Motion, a company that has disappointed investors tremendously in recent years. Today, I'll examine how things have changed since the report (mostly analyst estimates), address some of the concerns over the recent quarter, and try to figure out where the stock will go from here. Is Research in Motion back from the dead? Let's try to figure that out.
Changes in Analyst Estimates:
For the second quarter, RIM reported revenue of $2.87 billion, handily beating estimates for $2.5 billion. Earnings per share came in at a loss of $0.45, compared to expectations for a loss of $0.46. However, when you exclude restructuring charges, the company only lost $0.27, an extremely large beat.
The beat on both the top and bottom line has influenced analysts to raise their expectations on RIM going forward.
For the fiscal third quarter, which ends in November, analysts were expecting $2.31 billion in revenue (a 55.7% drop from the prior year's $5.22 billion), and a net loss of $0.41 (compared to a prior year period profit of $1.27). Currently, analysts are expecting revenue of $2.6 billion (a drop of 50.2%), and a net loss of $0.35. That's a revenue increase of $290 million and an earnings per share increase of six cents.
For the current fiscal year, ending in February 2013, analysts had been at $10.14 billion in revenue (a drop of 45.2%) and a loss of $1.49 (compared to prior year profit of $4.20). Since then, estimates have really gone up. Revenue expectations are now for $11.05 billion (a drop of 40.3%) and a net loss of $1.26.
For the following fiscal year, ending in February 2014, analysts were expecting a further decline in revenues to $9.77 billion (a decline of 3.7% from the then estimate for fiscal 2013). Analysts also predicted another net loss of $0.71. However, analysts have now pulled a 360-degree turn, and are now expecting fiscal 2014 revenue to increase by 0.3% to $11.08 billion. That's an expectation increase of $1.3 billion. In terms of earnings per share, analysts are now forecasting just a $0.55 net loss.
Concerns Expressed By Bears:
There were a number of concerns expressed by bears regarding this quarter, so let me try to address some of them.
First, the drop in revenue and the fact that Research in Motion still lost $235 million (including restructuring chargers). That is true. However, a stock is priced for expectations. Expectations were for a much larger revenue drop and a bigger loss. RIM beat expectations, that is why the stock has risen, and expectations have risen. A net loss is a net loss, but when your stock is priced for a terrible quarter, and the quarter isn't that bad, the stock rises, and it did.
Second, the company's cash and investments pile increased, and bears stated that this was pure accounting games. The first issue relates to inventory. Bears laugh at the cash flow RIM received because its inventory balance dropped from $1.018 billion to $785 million in the period, a decline of $233 million. In RIM's case, the inventory decline is a good thing. This company is trying to get rid of old inventory as it approaches the BB10 launch. Take the following hypothetical example. Let's say the company sold an old phone during the quarter for $200. Next quarter, that phone might only sell for $190, and six months from now, after the expected BB10 launch, that phone might sell for just $150. Would you rather the company sold it for $200 in August or $150 in February, plus the cost of holding it on the balance sheet?
The second part has to do with working capital changes. RIM's cash flow from operations shows RIM adding back (to net income) $483 million from "working capital changes". That is true, but that is over a six month period. $395 million of those changes were in Q1. Q2 only saw an increase of $88 million.
The bears find this pure accounting garbage because Research in Motion's accounts receivables have dropped over the past two quarters. Again, of the $868 million decline in six months, only $357 million was in Q2. At the same time, bears fail to mention that while RIMM received $357 million in cash from the reduction in accounts receivable, the company also saw a decrease in current liabilities of $371 million. Just as RIM collected some bills, they also paid a fair amount of them too. I don't hear that being mentioned.
But just ask yourself this question when you challenge the company's accounting. Would you rather have $357 million in cash, or $357 million in accounts receivable on the balance sheet? A dollar in cash is worth a dollar to everyone else. A dollar in accounts receivable usually isn't worth a dollar to everyone else, and that's assuming they get all of those accounts to pay up.
One last point on the net income. When you look at the cash flow statement, you see that the net loss was $753 million. But if you add back in the goodwill impairment charge, the impact on cash was only a net decrease of $418 million. More importantly, RIM has no goodwill on the balance sheet anymore. There will be no more goodwill charges!
Trying to find a valuation that fits:
Since RIM is not profitable, price to earnings does not work. Another valuation that bulls like to use is the price to book. When you subtract out RIM's liabilities from its assets, RIM had $9.372 billion in equity at the end of the most recent quarter, or almost $18 a share. That was down $236 million in the quarter, which actually was basically equal to the $235 million drop in net income. Let's say the balance sheet continues to contract a bit, and equity falls to $8 billion in over the next year. Even if you apply a 20% discount to that equity value, you are still at $6.4 billion. That basically equals a book value of $12.20, or almost 50% above where we are currently.
The other thing to look at is expectations. Before this past quarterly report, analysts were expecting about $19.91 billion in revenue for both this fiscal year and next fiscal year. Expectations now call for about $22.13 billion. That's a nice rise. In terms of earnings per share, a net loss of $2.20 was expected. That's now expected to only be $1.81. Since the report, shares are up 15%. Is that too much, too little, or just right? Well, they are certainly above the $7.50 they closed at the day after earnings, but they still haven't found the roughly $8.81 high they saw in after-hours trading the afternoon they reported.
Trying to find a valuation for a company that is reporting a plunge in revenues and net losses can be difficult. It's especially true when a company is losing tons of market share and is throwing a hail Mary pass on a new product that opinions are mixed over. The fact that RIM shares did not rally back to $10 after this report means that investors are not 100% convinced that RIM is back yet. They will need another good quarter or two, plus a good BB10 launch to prove that. Expectations have come up significantly, so if they miss when they next report we could see shares drop back down to 52-week lows.
While I don't think RIM is completely back yet, and it may not ever be, things are certainly more positive than they were even a few weeks ago. The company didn't report as bad of a quarter as many had expected, and while some may question the accounting, the balance sheet improved in some respects. When you look at the three month numbers, not the six month cumulative ones, you can see the second quarter was pretty decent. I wouldn't make this stock the largest holding in my portfolio, but if you are looking for a nice speculative play, this company has plenty of upside should they be able to produce decent results going forward. This stock was priced for Armageddon. We haven't seen things that bad, not yet anyway.