Can Research In Motion Turn It Around?

| About: BlackBerry Ltd. (BB)
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In the first part of my "Can they turn it around" series, I focused on how Sprint's (NYSE:S) weakening financials make it unlikely that the company can turn things around very soon. In the second part of my series, I'm going to focus on Research in Motion (RIMM). Now, we all know the quarter was bad. Very bad. There's a million articles out there on how bad it was. So I'm not going to focus on this quarter. Or just this quarter anyway. I'm going to show you how things have gotten worse at RIMM over time, and if there is any chance that they can turn it around.

So let's break down RIMM's financials over the past 5 years, looking at how they've done in their fiscal 2nd quarter (RIMM's fiscal year is not a standard one). If you want to do some of your own analysis, here's the link to the company's financial reports. We'll look at liquidity first.

Liquidity 2Q 2008 2Q 2009 2Q 2010 2Q 2011 2Q 2012
Current Ratio 3.29 2.28 2.41 1.98 1.94
Quick Ratio 2.60 1.80 1.86 1.57 1.25
Working Capital $1,926 $2,365 $3,049 $2,961 $3,542
As % of Current Assets 2Q 2008 2Q 2009 2Q 2010 2Q 2011 2Q 2012
Cash 30.62% 26.84% 20.77% 19.27% 11.63%
Short Term Investments 17.84% 10.02% 11.14% 6.35% 4.07%
Accounts Receivable 30.79% 41.92% 45.35% 53.80% 48.78%
Inventory 10.89% 12.17% 10.98% 10.79% 18.74%

As you can see from the tables, the current ratio and quick ratio have declined substantially over the past 5 years. However, working capital has increased, but that's only because RIMM's current assets have grown on a larger dollar scale than it's current liabilities. On a percentage scale you can tell from the ratios that current liabilities are growing much faster. The second worrisome part is that cash and short term investments as a percentage of current assets have declined greatly, while the accounts receivable balance has risen quickly. Accounts receivable have grown by 4.2 times over the past 5 years while current assets have only risen by a factor of 2.6. The recent inventory spike is a caution flag, but that might have just been due to the terrible quarter. We'll keep watching that. Next up are some coverage ratios.

Coverage 2Q 2008 2Q 2009 2Q 2010 2Q 2011 2Q 2012
Debt Ratio 23.07% 28.21% 24.26% 30.90% 29.04%
Cash Debt Coverage 26.78% 35.10% 52.16% 68.76% 23.36%

I'm not quite worried about RIMM's long term solvency, yet. Although liabilities are growing faster than assets, a 6 percentage point jump over 5 years is not worrisome. Especially since the ratio improved over the past year. The cash debt coverage ratio has bounced around a bit, but that's because RIMM's operating cash flow has been quite volatile. These ratios are fine for now. We'll look at some activity ratios next.

Activity 2Q 2008 2Q 2009 2Q 2010 2Q 2011 2Q 2012
Receivables Turnover 1.75 1.61 1.50 1.58 1.14
Inventory Turnover 2.38 2.61 3.27 4.27 2.21
Asset Turnover 0.37 0.40 0.39 0.44 0.30

Again, red flags abound. Receivables are growing fast, and RIMM isn't plowing through it's inventory as well as it used to. Again, this quarter was especially bad, so that might account for the huge dropoff. But the trend is not your friend here. The last section is profitability. And it's not pretty. This might make for a pretty good horror movie.

Profitability 2Q 2008 2Q 2009 2Q 2010 2Q 2011 2Q 2012
Gross Margin 51.33% 50.71% 44.09% 44.48% 38.68%
Operating Margin 28.64% 27.25% 18.49% 23.41% 9.76%
Profit Margin 20.98% 19.23% 13.49% 17.24% 7.89%
Return on Assets 7.67% 7.77% 5.27% 7.54% 2.37%
Return on Equity 9.91% 10.56% 7.06% 10.47% 3.37%

Now we all know that over time margins probably will decrease some, and RIMM is in a very competitive business. But these numbers take ugly to a whole new level. Again, it was a terrible quarter, so these numbers might improve a bit next quarter. However, there is a trend, and it's going the wrong way. The one good piece of news is that RIMM is profitable, something that Sprint was not.

RIMM needs to turn things around, and quickly. And they need to translate revenue growth to the bottom line. But right now, they can't. Apple (NASDAQ:AAPL) and Android (NASDAQ:GOOG) and everyone else out there is just beating them to a pulp. Current estimates for this year (ending Feb. 2012) are for just 2% in revenue growth, but a nearly 20% drop in EPS. And I'm sure those numbers will come down even more as more analysts get their analysis in. The good news is that there's expectations for 8% revenue growth next year. The bad news is only 2% in EPS growth.

I'm not going to try to make a valuation argument, because I simply don't have one. While RIMM trades at a 4.5 forward P/E, estimates are likely to come down further if the company continues to struggle on its execution. This stock could easily drop into the teens, or could be back above $30 if they figure something out. I'm a little skeptical. I think there's just too much competition. I'll also make one point on a possible buyout. Not likely until this stock falls further. Right now, you're probably talking about a $15 to $20 billion deal, and I don't think that price tag is very appetizing to any possible suitors.

Can RIMM turn it around? Right now I say no. While revenue guidance for the current quarter seemed decent, EPS guidance was weak. They are losing market share in the phone business and forays into tables and other products have not gone well, at the initial stages anyway. I don't think this company is dead, but it does not impress me either right now. I'd stay away from the stock for at least another quarter or two. Or until they start to figure things out.

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