Research in Motion, Ltd. (RIMM) has fallen significantly from its all-time high of around $150 per share. As of Tuesday's close it was valued at $68 per share or roughly 4x this year's revenue or $39 billion.
Hate to tell you folks, but I believe RIMM's stock price still has further to fall. Can't say when, can't say where…but can say it is not if, but when. Here are the reasons for this argument. There are five things I can promise you about RIMM's devices and those of their competitors in the future:
1) The average selling price will continue to fall for smartphones. Just like they have for cellphones, plasma TVs, Personal computers, digital cameras, and most other hardware devices that can be copied and mass produced for less and less money every year.
2) The average gross margin for these devices will also continue to collapse. How far will they fall? I took a look at Nokia's (NOK) gross margins as a reasonable proxy for where RIMM's margins are heading.Try 35% v. RIMM's recently reported 50%.
3) At some point, these devices will "commoditize" in terms of features and innovations. It seems logical to me that consumers will ultimately be offered a cross-section of "me too" devices, trustworthy brand names, and compelling pricing. RIMM's hardware and software will also get commoditized if not out-innovated in the future.
4) Enterprises will migrate to completely open e-mail architecture to allow their users to be "device agnostic". Many enterprise accounts that only support RIMM for their users today will ultimately open up the range of hardware options for their users and put pressure on RIMM's device share in this segment.
5) Carriers will increasingly apply pressure to handset vendors either by way of bargaining for better pricing or by continuing to produce their own private label handsets in order to capture more of the vertical value chain that exists in this space. As hardware continues to be innovated, carriers have been ceding bargaining power to hardware manufacturers. But as the innovation curve flattens, the bargaining power will tilt back towards the firm closest to the customer. eg. Verizon (VZ) v. Apple (AAPL).
If you think of RIMM's market capitalization as a giant pair of shoes that the company has to grow into, follow this set of assumptions to its conclusion and tell me what you think of the exercise.
A. Pricing pressure reduces RIMM's average selling price to $250 per unit
B. Gross margins fall to match Nokia at 35%
C. RIMM's Price to Sales Ratio (P/S) falls to 1.5x Sales or if you like 1.5x Nokia's P/S of close to 1x Sales
Q: How many handsets does RIMM have to sell in an annual cycle to support these assumptions?
A: $39 billion Cap @ 1.5x sales = Implied Revenues of $26 billion
B: $26 billion/ $250 = 104 million handsets sold per year (RIMM shipped 11 million in the first half of this year)
Now, pick a point in time in the future when you think RIMM will hit this set of business results/handset volumes and trade at these simple valuation metrics. Then take the current share price and discount it by 10% (reasonable return) for every year out you pick.
e.g. I think it might take RIMM 7 years to sell 100 million handsets per year and that average selling prices will have to fall to $250 for these volumes to materialize.
$69 per share (Tuesday's price)/ 1.10^7 = $35 Present Value for the Stock
Monkey around with some of the assumptions and see what you come up with. My approach to this exercise asks you to think about the following question. When a market reaches maturity, should the participants in that industry/market trade at similar valuation metrics?
Should the industry leader typically command the highest premium? When it all shakes out, is it reasonable to conclude that RIMM will trade at similar valuation metrics to Nokia which currently enjoys 40% share of the global handset market and trades at a Price/Sales ratio less than 1?
I happen to think so, which is why I think the stock will trade lower over time and remains decidedly overvalued. For fun, try to guess how many handsets RIMM will sell ten years from now, pick a price per unit, multiply it out at 1x sales and discount back ten years at 10% to see what share price you get for RIMM.
Here's an example. 150 million handsets x $150 - sounds like a hum-dinger of a business to me. At 1x sales the Present Value of the Stock is $15 per share. Not to worry – if you own RIMM @ $68, it would only have to sell 600 million plus handsets by 2018 for your investment to break even on this set of assumptions.