BlackBerry 10 Will Flop. Then What?

| About: BlackBerry Ltd. (BBRY)

On September 25, 2012, Research in Motion (RIMM) stock descended to a 52-week low at $6.12. Over the course of the next four months, RIM investors pocketed 190% gains, as shares closed out the January 23 trading session at $17.35. Wall Street now values Research in Motion at $9 billion in market capitalization. Improved investor sentiment regarding Research in Motion stock arrives largely in anticipation of the BlackBerry 10 release, which is scheduled for January 30.

The recent surge in Research in Motion shares parallels that of Nokia (NYSE:NOK), as investors literally scour the trading floor for alternative options beyond the Google (NASDAQ:GOOG) Android and Apple (NASDAQ:AAPL) iOS ecosystems. Despite the recent run-up in shares, RIM shares still trade near fair value. If anything, a fundamental analysis of Research in Motion financials indicates that expectations for this company are abysmal. RIM shares have already discounted a disastrous BlackBerry 10 launch. Aggressive investors may take solace in the idea that Research in Motion executives can unlock shareholder value largely through financial engineering.

Short Interest in RIM

Throughout the past year, Research in Motion stock has remained within the crosshairs of aggressive short sellers. A trader initiates a short position after borrowing shares from a current investor and immediately selling those shares for cash. At a later date, the short seller will "buy to cover," or re-enter the market to purchase stock and replace the original loan. Traders going short turn profits amid stock market declines. By definition, a short position is always a risky proposition because share prices range between zero and infinity. Furthermore, short sellers effectively cosign modern portfolio theory, and a belief that financial markets are rational pricing mechanisms. Famed economist John Meynard Keynes would retort that, "markets can remain irrational longer than you can remain solvent."

Depressed stocks are often associated with short squeeze events, when bearish traders buy to cover en masse. Panic to close out short positions will exacerbate share price appreciation. RIM stock remains primed for a short squeeze, on top of its already torrid price gains over the past quarter. Stocks that carry relatively small market capitalizations and floats alongside heavy institutional ownership are notable for extreme volatility.

As of December 31, 2012, Yahoo Finance reports that 137 million out of the 515 million shares outstanding at RIM were short positions. The prior month, only 120 million shares were classified as short positions. Research in Motion features a short interest ratio slightly above 3, which means that it may take three days for short sellers to close out positions, if this stock maintains its average three-month volume of 42 million shares traded per day. An analysis of RIM financials may indicate that this company now trades for less than book value. A reversion back to the mean and book value would force bears to abandon short positions amid a squeeze and drive gains into next month.

RIM Financials and Book Value

On December 20, 2012, Research in Motion released its third quarterly report for fiscal 2013. This latest report calculates results for the quarterly period ended December 1, 2012. RIM executives now manage a business worth $9.4 billion in market capitalization that is effectively backed by a $12.6 billion balance sheet. Basic arithmetic indicates that Research in Motion executives can extract additional shareholder value largely through financial engineering irrespective of BlackBerry 10 sales performance. On January 22, Research in Motion shares surged by 13% to close out the session at $17.90, upon a report that all business divisions are being strategically reviewed. Investors aggressively bought stock upon speculation that RIM patents, handset technology, and software will be inevitably sold off to the highest bidder.

Broken down further, the Research in Motion balance sheet includes $12.6 billion in assets, on top of $3.3 billion in total liabilities. On paper, Research in Motion book value and market capitalization are now both roughly equal to $9.3 billion. Going forward, the $555 million in RIM deferred revenue will eventually come off the liability side of the ledger, as this company delivers goods and services in exchange for advance payments. Cash may decline by a net $300 million during this present Q4 2013 due to increased selling, marketing, and administration costs related to the BlackBerry 10 release. Improved cash management strategies will help offset BlackBerry 10 related costs at Research in Motion. Over the course of the past nine months, Research in Motion receivables and inventories have fallen by $1 billion and $570 million, respectively.

Before RIM closes any deal, investors must thoroughly analyze the value of this corporation's patent portfolio. Research in Motion financial officers posted $3.1 billion worth of intangible assets within the latest quarterly report. All recent evidence, however, indicates that smartphone patent valuations are trending sharply downward. Google's $12.5 billion acquisition of Motorola, alongside Apple versus Samsung legal wrangling mark the apex of a patent bubble that began to deteriorate last summer. Earlier this month, Research in Motion agreed to pay $65 million, plus ongoing $2-$5 per handset royalties to Nokia to settle a patent dispute. Roberto Baldwin and Wired ridiculed these series of events as "the saddest slap-fight of a patent war in memory."

Still, Research in Motion stock would be trading near fair value, even if intangible assets were written down to as little as $1 billion. In effect, any return on investment off BlackBerry 10 will be gravy for Research in Motion shareholders. Most likely, the BlackBerry 10 will be a non-event, and RIM executives can literally "float the note," while entertaining offers to break up this company. The timing of the BlackBerry 10 launch is quite awkward, as RIM engineers will bring new tablets and smartphones to market after the critical holiday season. Rival Nokia has already gone on the offensive.

Research in Motion Versus Nokia

On January 10, Nokia stock advanced sharply by 18% to $4.49, upon surprise news of accelerating Lumia phone sales. Nokia executives reported initial fourth quarter sales of 4.4 million Lumia units, which is a significant improvement above the 2.9 million units sold during the prior quarter. Nokia's turnaround largely parallels that of Research in Motion, as shares of stock in the Finnish company have surged from $1.63 to $4.76 over the past month. This latest run up in Nokia shares is juxtaposed against a backdrop of layoffs, aggressive cost cutting, real estate consolidation, and patent infringement lawsuits. Both Research in Motion and Nokia will become leaner operations, as each company vies to emerge as a legitimate third option to the Google Android - Apple iOS duopoly.

Google Android and Apple iOS operating systems power 89% of all smartphones, according to the latest smartphone market share data released by research firm comScore. The smartphone duopoly was actually consolidating strength during the quarterly period ending November 30, 2012. Google and Apple combined for a near 2% increase in market share above the prior quarter. On the handset side of the ledger, Samsung and Apple sit atop this list - with 27% and 19% of the smartphone original equipment market, respectively. At the bottom of the heap, Research in Motion - BlackBerry and Nokia - Windows operating systems are left to battle over the remaining, and paltry 11% market share.

For survival and growth, Research in Motion executives can pander towards their technocrat base, while effectively conceding the popular culture teenage girl segment to Nokia. BlackBerry 10 will be notable for its secure infrastructure and Hub program that assimilates social media, email, web browsing, and work files together. Earlier this month, Research in Motion closed a deal with Visa to transform BlackBerry 10 devices into virtual wallets. RIM, with its reputation for security, is an ideal fit for near field communication technology over the long term.

Beyond Nokia, Apple still looms large as the 800-pound gorilla still able to derail offensive maneuvers at Waterloo. Research in Motion shareholders should consider selling out positions, if Apple were to begin detailing plans to mass produce $200 smartphones, and undercut the BlackBerry at value conscious price points.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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