Research In Motion Shareholders Should Take Their Profits While They Still Can

| About: BlackBerry Ltd. (BB)
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Research in Motion's (RIMM) stakeholders can celebrate the fact that the company' Q3 FY2013 adjusted loss of $.22 per share ($114M) was less than the $142M incurred in Q2 2013 and the $192M incurred in Q1 2013. RIMM even had a GAAP profit of $9M ($.017/share), which was better than the $235M loss ($.45/share) in the prior quarter. The company benefited from a $226M recovery of income taxes accrued during the quarter. RIMM's stakeholders should not read too much in the $958M in operating cash flows and the $640M in free cash flows generated during the quarter because this primarily came from amortization ($523M) and reductions in working capital ($420M). We were surprised that RIMM's gross margin increased by 3.2% year-over-year and 4.4% on a linked-quarter basis.

Source: Morningstar Direct

We think RIMM's share price dropped by 16% largely because of the quarterly decline in the overall BlackBerry subscriber base. RIMM's overall BlackBerry subscriber base declined to 79M in Q3 2013 versus 80M in Q2 2013. At least the subscriber base in Q3 2013 was higher than the 78M in Q1 FY 2013 and 77M in Q4 FY 2012. However, RIMM saw a rapid decline in its BlackBerry smartphone shipment volumes from 14.1M in Q3 FY 2012 to 6.9M in Q3 FY 2013. One piece of "good news" for RIMM was that its BlackBerry Playbook tablet computer volumes actually saw growth from last year, from 150,000 in Q3 FY 2012 to 250,000 Q2 FY 2013. Of course RIMM's Playbook sales volumes pale in comparison to Apple Inc's iPad volumes (14M iPads sold for $7.5B). We think that Research in Motion's stakeholders should be embarrassed that Apple's most recent quarterly iPad revenues are more than 2.75X RIMM's most recent quarterly total consolidated revenues.

Sources: MRQ Reports for Apple and Research in Motion

These trends explain why RIMM saw a steep 47% decline in its revenue versus the comparable quarter last year. RIMM couldn't cut operating expenses fast enough to offset this rapid revenue reduction, resulting in RIMM's third straight quarterly loss from operations. Despite the fact that the BlackBerry has been in the market 8 years longer than Apple's (NASDAQ:AAPL) iPhone, the iPhone sold nearly 27M units in its most recent quarter, compared to 6.9M units for the BlackBerry smartphone. RIMM's Playbook sales performance in Q3 2013 was a mix of good news and bad news. The good news was that RIMM enjoyed a 67% year-over-year increase in its Playbook shipment volumes as well as a 92% linked-quarter increase in its most recent quarter. Another piece of good news was that RIMM's 67% year-over-year increase in its Playbook shipment volumes exceeded the 26% increase in Apple's iPad tablet sales volumes during this period. The bad news is that Apple's iPad still sold 14M units in its most recent quarter, compared to 130K units for the PlayBook, even though the "brand-new" Playbook is $100 less expensive than the old Apple iPad 2.

Sources: Apple's Q4 FY 2012 Earnings Supplement and RIMM's Q3 FY 2013 Financial Report

To the surprise of no one, RIMM previously announced that it had delayed the product launch date to the first quarter of calendar year 2013. Even though RIMM is expecting to launch BlackBerry 10 on January 30th, it will be faced with a 4-6 month disadvantage versus Apple's iPhone 5 smartphone device. The Apple iPhone 5 was released for sale on Friday September 21st and despite a few hitches, Apple has already sold 5 million iPhone 5 devices. Considering that RIMM only sold 7.8M BlackBerry devices in Q1 2013, 7.4M in Q2 2013 and 6.9M in Q3 2013, RIMM's stakeholders should be embarrassed with the sales volumes of the BlackBerry Devices. At least RIMM's stakeholders can hang their hats on the fact that the BlackBerry Playbook Tablet shipment volumes increased by 67% on a year-over-year basis and 92% on a linked quarter basis. The best part of RIMM's Q3 2013 Playbook shipment volumes was that it was 50% of its all-time quarterly high in Q1 2012 and Q4 2012.

Source: Research In Motion's last six earnings releases

We see continued operational challenges for RIMM going forward. We think that RIMM's stakeholders are too sanguine with regards to BlackBerry 10. RIMM's boosters have severely underestimated the negative impact on the BlackBerry 10 brand thanks in part to the delays of releasing the BlackBerry 10 product line as well as recent network outages on the BlackBerry 10 system. We were surprised that BlackBerry Playbook tablet volumes spiked up recently however we don't expect the Playbook to pose a significant competitive threat to the Apple iPad or the iPad Mini. Even after RIMM releases BlackBerry 10, we think it is going to take a while for the company to regain the sales momentum that it previously enjoyed in prior years. We not only see the company incurring losses in Q4 FY2013, we see losses extending into FY 2014.

Source: Research In Motion's last seven earnings releases

Prem Watsa's Fairfax Financial doubled its stake in RIMM in its most recent quarter and now owns 9.9% of RIMM (51.85M shares as of September 2012) through its Hamblin Watsa Investment Counsel subsidiary. Don Yacktman's Yacktman Asset Management Company also doubled its ownership stake in RIMM in its most recent quarter and now has 23.5M shares as of September 2012 (4.5% ownership stake). The notable hedge fund Viking Global Investors initiated a 4.6M share position in Q3 2012 and this represents almost 1% of RIMM's outstanding shares. Other notable shareholders in RIMM include PRIMECAP Management (26.4M shares, 5% ownership stake), Franklin Mutual Advisers (17.1M, 3.25%), Renaissance Technologies (16.9M, 3.23%) and Meditor Capital Management (4.8M, 0.92%).

Source: Morningstar Direct

We were surprised that RIMM's stock enjoyed a rapid run-up after its Q2 2013 results but we are not surprised that RIMM's shares have given up its gains in the wake of its Q3 2013 report. The good news for RIMM was that it was able to harvest $640M in free cash flows for its most recent quarter. The bad news was its BlackBerry service subscriber base declined by 1M on a linked quarter basis. The ugly news is that had to scrap service fees for certain users, which will cause headwinds to its most profitable revenue source. RIMM also has to make one-time and ongoing payments to Nokia (NYSE:NOK) as part of a patent-licensing deal that ended legal disputes between the two companies. We think RIMM's shareholders have been exhibiting irrational exuberance with regards to BlackBerry 10's prospects. For RIMM shareholders who had purchased RIMM at $6/share, our advice to you is "Quitting while you are ahead is not the same as quitting".

Source: Morningstar Direct

Based on these observations, we believe RIMM's stakeholders shouldn't be too jubilant with regards to this EPS beat because analysts still have RIMM losing $.50/share in FY 2014 even after BB10 is released according to FactSet. We still believe that investors should take a "show me" approach before even considering investing in RIMM. RIMM stakeholders can point to RIMM's $5.60 per share of cash and marketable investment securities and that the company is debt free. However we see the company is has no real chance to generate a significant level of sustainable free cash flows until BlackBerry 10 is released. Plus investors in BlackBerry should take note of the fact that of RIMM's $893M in free cash flows during YTD 2013, $903M was due to net changes in the company's working capital as it is liquidating its inventory and accounts receivable and $917M was due to reductions in capital investment spending. If RIMM maintained its capital investment spending at the same level as last year, it would have generated negative $24M in free cash flows. We don't see the company being able to repeat this trick next year due to the launch of its highly touted BlackBerry 10 product line.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.