Scotia Capital outlines continued case for upside in Research In Motion shares

Money, Money, Money, Money!
By Chris Umiastowski on 26 Nov 2012 02:42 pm EST

Scotia Capital analyst Gus Papageougiou published another research note today outlining the upside for investors over the next few months. I sounded off on his previous report in mid-October which outlined the potential upside in RIM if the launch of BlackBerry 10 goes well. As is always the case with reports like this, the report is an exploration of scenarios.

Papageougiou does a good job of tracking & analyzing the difference between shipment volumes on BlackBerry versus sell through rates. For those unfamiliar, Research In Motion recognizes revenue on product shipped to its distribution channels (carriers, retail stores, etc). But what really matters to the long term success of the business is sales to end customers, which is called "sell through".

Here's one of the interesting points he brings up in his report: RIM is selling 50% fewer handsets from its peak level 2 years ago. But that's when you measure it based on sell-in. RIM also reports sell-through numbers each quarter, and those sales - the ones that matter in my eyes, are only down 28% from their peak.

Of course, selling prices on handsets have also dropped, which is part of what has kept unit sales alive. RIM is using price as a weapon to ensure that it still has a large (and growing) subscriber base with which it can then market BlackBerry 10.

Over the last 5 quarters, RIM shipped substantially fewer phones than its end customers bought. Last quarter alone, RIM shipped about 3 million fewer units than were activated by buyers. What does this mean? It means carrier inventory has been bleeding dry. This is absolutely normal during product cycle transitions. So if BlackBerry 10 sees reasonable demand, carriers need to rebuild inventory. This means RIM will start shipping more phones than are activated, not less.

Scotia Capital estimates that RIM could ship 18.6 million devices in Q1 fiscal 2014, which is the quarter ending May 2013 (the first full quarter of BlackBerry 10 availability). Based on their model, that level of shipments could mean very significant earnings per share (EPS) of $0.42 for the quarter. It doesn't take a rocket scientist to realize that the market will extrapolate those kind of results and send the stock to even higher levels, should it materialize.

The US market is key to RIM's recovery, too. Looking at one of the charts in the Scotia Capital report, if my interpolation skills are of any use, it looks like Papageorgiou's estimates show that RIM still lost about 3 million subscribers in the US last quarter. Keep in mind these are just estimates, and RIM doesn't report a breakdown of subscribers by region. But if the Scotia estimates are even semi-accurate (and I have no reason to doubt them), all BlackBerry 10 needs to do is stop the bleeding in the USA and company's results will look dramatically different.

To keep things balanced, Scotia also points out that downward pressure on service fees is the single biggest risk facing the company. This is something I clearly agree with, and I've been saying it repeatedly here. So what's one more time, eh? It really is a big risk. There is no sugar coating it.

I realize that the company's COO, Kristian Tear, told Kevin in his interview that, "We will continue to have service revenues... We have discussions with the carriers on this and how we can evolve but right now as it stands, there have not been any changes there. When we have changes, we'll announce them". I'd love to find out that this means service revenues aren't going to change. But remember that RIM has publicly acknowledged the pressure facing these fees. Tear's comments shouldn't be prematurely treated as any kind of confirmation. It's pretty clear he was careful with what he said.

So there you have it. RIM might be facing a very strong Q1 (May quarter). Good news.

Reader comments

Scotia Capital outlines continued case for upside in Research In Motion shares


Chris great article. Just one quick question, if RIM's ships more inventory wouldn't the hardware costs cut in the revenue stream? Or will this cost be set off because of BB10 uptake?

I'm sorry if this sounds n00b.

Think of it this way.  Hardware has a manufacturing cost of $X and it is sold to the channel (carrier, etc) for a price of $Y.  So long as Y is greater than X, there is positive gross profit.  The more you sell, the more profit you make.

Revenue is recognized at the same time as COGS (cost of goods sold).  That moment is the moment when the product ships. 

No worries about noob questions.  They're all fine.  Accounting isn't exactly interesting. 

Good read. My question is: If RIM sells 10 million (just to pick a number) units in the North Americam market and 10 Million units in Africa and Asia would the proft margin be the same for all regions?

I would think it would be the same/almost the same since RIM will sell them to the carriers/retailers and so on at some price across all regions. It's the 'sell through' that should ideally matter imho. Don't quote me on this though.

In theory it could be but probably won't because Africa and Asia will be buying more of the BB7 phones while N.A. will be mostly BB10

Papageougiou is right that sell-through has been higher than sell-in. Should bode well for Q3, Q4 and Q1 sales numbers although it will not affect profits until Q1 '14 because currently phones are sold at cost.

However he is wrong here - if RIM ships 18.6 M phones Q1 '14, EPS will be much higher than .42 per share

Care to show me your math on that?  I know Gus pretty well.  He's' been modeling RIM financials for more than a decade.  He made certain assumptions obviously.  What assumptions are you making?  

Things that matter:


Mix of BB10 to BB10

Bill of materials (leading to margin) 

Sure. No offense to your friend, this is just what I am calculating.

If 18.6 M units are shipped, at least half will be BB10, probably more. Since current sell-through is 10M BB7, once BB10 ships and customers start to migrate that number will go down. In addition, channel stuffing (excess of shipments over sell-through) will occur more on the BB10 side than the BB7 side because carriers will want to stock up on the latest. Let's say given the 18.6M number 10M BB10, and 8.6M BB7, and that is being generous to the BB7 side. I don't see BB7 sales increasing after the release of BB10.

BB10 average selling price should be high - only the high-end phones are hitting the market in Q1, and the lower end phones should hit in Q2 and Q3 of FY 2014. So ASP should really be just slightly lower than iPhone's around $600. However, just for argument's sake let's give BB10 average selling price $450 which is much lower than iPhone and a little higher than Blackberry's $370 peak in 2009. I think this is still on the low end. In terms of bill of goods, this is not my forte, but I think gross margins will be at least 30% on the L-series and N-series devices. That is $150 per profit on 10M BB10 phones. $1.5 billion. You can see where this is going. Then they will lose a small amount on the BB7 phones. Hardware profits in the $1.4 billion range. Service rev's $1 billion which Gus seems to have modeled in there. So we're at $2.4 billion profit before the rest of the expenses. SG&A, R&D, Marketing, Amortization, Depreciation should be no more than $1.2 billion - this tracks historically, and it should decrease because of the CORE cost cutting program and increase because of BB10 marketing to be a wash.

So that's $1.2 billion before taxes. Income tax expense around $400 million. Net income $800 million, or about $1.60 per share.

That being said, I do not think RIM will ship 18.6 million phones Q1 2014. I would be very pleasantly surprised if that happens. I have penciled in 13-14M shipped, but that depends on the success of BB10.

By the way I would love to get in touch with Gus since you know him - I am just an independent investor who is interested in RIM but I'd like the opportunity to talk to some real analysts about the company to see their ideas.

Excellent analysis. I couldn't agree with you more. As an independent investor with a brain I wouldn't be looking to speak to anyone else. They seem to miss things that are so apparent.

@a1 - mind if I just call you that?  

Great reply, thank you for the detailed math.  Having not interacted with you I wasn't sure if you were just tossing aside the Scotia math without doing any yourself.  That's clearly not the case, and I think you captured all of the important line items in your answer.

I pulled up the report from Gus and here are some additional assumptions he lays out.  Plug these into your model and let me know what EPS you get now:

884k channel fill

$405 ASP

50% BB10 shipments

15% gross margin on devices (blended between BB10 and BB7)

Overall gross margin 23.3%

I guess we know where the big difference lies - it's ASP and margin assumptions.  So there is a HUGE range of possibilities.

So, this raises some good questions.  Can RIM generate $450 ASP on BB10?  It seems like something they should be able to do if customers want to buy it.  After all both the iPhone5 and Samsung GS3 sells for more.

BOM breakdowns of the iPhone 5 show a cost of about $200 depending on the model (iSuppli).  I'm not sure how accurate these are because I think they are based on "virual" teardowns.  Anyway, on top of this you have "conversion cost" (cost to turn parts into finished goods) and you have all the other costs associated with getting it into stores.  Say it's $230 to $250 finished.  Now let's say RIM takes another $50 hit because they aren't as big so they don't have the buying power or vertical integration of Apple / Samsung.  So $300 cost seems pretty reasonable, eh?

So, if they can sell at $450, I think you're making sense here.  $150 margin per device.  I'll take it.  Ramp up to 10 million units and we have VERY healthy profits coming in.

I'm also in agreement that we aren't going to see 10M unit sales of BB10 in the first full quarter.  It would be nice, but I doubt it. 

Two more small points to add here:

1) You forgot to account for COGS on the service revenues.  It should amount to about $160M per quarter between software & services.  

2) Gross margin on BB7 stuff was about -15% last quarter based on some quick math I just did tonight.  So I think that translates into a worse loss than $100M per quarter, which you assumed above.  

Anyway, plus or minus some tweaking on the model, I think the biggest factor is still ASP and shipment volume on BB10.  

Thanks Chris. You bring up good points. I had forgotten about the service COGS. You're also right that I also underestimated loss on BB7. I think I had gross margin last quarter at about -10% on those devices. BB10 will cannibalize Bold sales more than Curve sales, so those margins should slip even further once BB10 is released. I hope you keep up the articles on $RIMM stock because I enjoy reading them. Also I am looking forward to BB10 and Q1 2014 to see how this all plays out.

thanks for (timely) sharing the Scotia Nov 26 update.
Hopefully RIM can leverage their network asset vs service fee erosion

Question: when talking about service revenues, are you including licensing? If I read RIM'S strategy right, this seems like a growth area in automotive and medical sectors and who knows where else. I wonder if it could offset pressure from carriers.

Not really, I am talking about what the CEO has been talking about - a platform more than specific devices.

I wonder if Gus's assumptions are more conservative than some of the other analysts for ASP and margins on BB10. His shipment figures seem to be on the more optimistic side for the analyst community, so maybe the ASP and margin assumptions compensate for that.

Assuming everything else stays the same from Q2 FY13 or simplicity's sake, we'd have:

7.4 million non-BB10 shipments.
$747 million in gross margin from those shipments + service revenues.

Therefore 11.2 million in BB10 shipments.
Using the Raymond James figures of $375 ASP and 30% margins, this leads to $1.26 billion in gross margin from BB10 shipments.

Combined gross margin is $2.007 billion.

Operating expenses of $1.11 billion (although this doesn't account for increased marketing spend supporting the launch).

Leaving income from operations at $897 million.

Not sure what income tax would be, but say 25% = $224 million.

Leaving net income of $673 million.

524 million shares outstanding gives us an EPS of $1.28.

So the question is whether the difference in net income of $450 million ($0.86 EPS) is due to estimates of increased marketing spend, assuming a lower BB10 ASP / margins than the Raymond James analyst, or some other factor?

Totally off topic, but hands down the best image/background image of the US dollar sign I've ever seen or been attracted too....I would have that as an accent wall. I'm finishing my BA in Marketing and I'm broke as shit, but I'll still throw it on a wall.

Chris ; Do what a reporter is suppose to do. Report.
Don't bash RIM and it's future !
Why don't you talk about all of the CA$H that RIM will be making off of is part in NFC? You know that they control that for Canada. Android and MS need RIM to launch NFC.
And would you like to take a guess at how many other countries they will control?
And take a stab at how many credit card transactions are processed per year! Try close to 500 BILLION world wide.

( You do the math )

Does anyone's analysis factor in the scenario where carriers begin to accept preorders immediately following the 30-Jan event?

If so the device could launch with significant sales.

I don't know if the upside scenarios include preorders. It sure would allow them to get going with shipments quickly after the date of availability. RIM has never taken preorders before and they don't sell directly. They sell thru carriers. So it would be far more complex than Apple or Google doing it. 

Thanks Chris, insightful, again!

What I wonder is why no one even add some Kunits of PlayBooks under BB10 ... This babe will look like a Porsche under nitrogen ... Yet we have to know about the PB BB10 update date ... might be a very pleasant surprise if "immediately follows" Jan 30 ...

I think RIM will ship over 22M BlackBerry 10 devices another 1.5M BlackBerry 7 devices in Q1. Chris is right in suggesting that carriers will have to stock up on BB10 devices so there will be more shipped to carriers than activated.

Lots of folks have been waiting for this device, and lots more will switch back to RIM. Businesses who've been playing with the idea of BYOD won't come on board until the spring/summer as testing and BES upgrades are completed, so this growth of BB10 will continue strong through 2013... especially as RIM adds another 4 devices too :)

Joe - Q1 is the May quarter, so first full quarter of availability of BB10.  I think you need to re-evaluate your expectations.  A huge chunk of the subscriber base is in low cost markets where BB10 isn't going to be affordable.  You're expecting more than 25% of the entire BlackBerry subscriber base to jump on BB10 in a single quarter.  Ask yourself if that is realistic.


... not to mention working capital requirements.  

 If RIM wants to grow its quarterly shipments by 5 million units with a unit cost of (say) $300, they need $1.5 billion.

 Do the math of what it would take to ship 22M BB10 units.   


I am always looking for your posts. As a RIM investor, I try to read everything both ways with a little caution and you are refreshing. I have a couple of questions.

I do not see any mention of QNX in other markets in RIM's remarks. Is there not enough rev from that side of the business to be significant? I also thinking there is some level of revenue percentage gained from a business unit that requires reporting, am I wrong, or does it not meet the threshold?

Also the gross profit for RIM with the carriers depends on the "carrier buy down", based on the plan. I would think RIM in a weaker position than Apple, and that their margins could suffer a bit in that negotiation? As a comment, my wife has been in the Mobile phone business for 20 plus years, working for the two largest in the US. The internal chatter is that they hate Apple, as the profit margin for them suffers due to Apple's price demands. In the end this could help RIM on the distribution side, as they are tired of shipping all the profit to Apple.



Chris, like a few others have said, you've got to also look into the positive things too. But over all, great article.