It feels like the right time to revisit Research In Motion's stock price and have a frank discussion about the upside opportunity and the risks. Usually when I write these kinds of posts we get a lot of readership and comments, and I love the interaction.
Let's start by looking back over the last few months. In September, RIM hit lows that we haven't seen since back in 2003. Of course, RIM stock was also below September 2012 levels throughout most of 1999 through 2003.
See the long term stock chart below and you'll understand exactly how dramatic the rise and fall of RIM has been so far.
Looking at this chart, here's an important investing lesson: Don't plunk down all of your money in one shot. In my case, I first bought shares in 1999. Sadly, the stock had already rallied significantly by late 1999 and I'm about even on that investment over a 13-year holding period. Yuck.
In 2000 I started working as a technology analyst on Bay Street in Toronto. I initiated formal coverage of RIM, and as a result, resisted buying more stock because it never looks good to trade in stocks you cover. So, for over a decade, I didn't add to my RIM holdings.
If I had been an outsider to the investment banking industry, I could have bought more stock during the big dips. For example, back in 2002 RIM was showing very strong growth in device sales, subscriber additions, and revenue. Yet the stock was an absolute bargain. If you were dollar cost averaging (buying in chunks, over time), you'd have done better than I did. So when you want to invest in a technology company it makes sense to do so in chunks, over time, in order to smooth out the natural volatility. Besides, this encourages you to save and invest regularly.
So now let's look at the chart for the last 6 months. RIM has started to climb again. Nobody picks the absolute bottom, but if you had been slowly picking up stock over the summer, your average price would be about $7. So RIM is already up about 25% from there.
Source: Yahoo Finance
Many portfolio managers won't touch RIM yet. The common view among professional analysts and investors is that you don't go near the stock until BlackBerry 10 launches. Why? Because we all know the financial results will be horrible (and worsening) until that launch.
Yet the stock HAS shown a good recovery despite posting ugly results. Investors were surprised to see the subscriber base still moderately growing. And to a lesser extent, I think people are starting to notice that BlackBerry 10 actually looks pretty good, and might do OK in the marketplace. I'm not kidding when I say that this is the secondary reason for the stock's recent climb. The financial markets are still telling us that RIM will never make the kind of money they used to make.
Let's go through the math. Currently RIM is not profitable. But in the past, RIM has done very well. Analysts often look at EPS (earnings per share) to evaluate a stock. EPS in fiscal 2011, the year of peak earnings, was $6.34 according to data from S&P Capital IQ (note: Thanks to the folks at S&P for giving me access to this awesome tool!)
The average company in the Telecom Services industry trades at just over 14x last year's earnings. So if RIM was to get back to $6.00 in EPS, we should be looking at a stock price over $80. Even if the market believed RIM could get back to half of its historical earnings (say about $3), we should be looking at a $40 stock price.
The fact that RIM trades under $10 tells you, beyond the shadow of a doubt, that the market casts a huge amount of doubt on the inevitable success of RIM in its current form. Remember that the market is a voting machine. Dollars cast votes, and the weighted average result is the stock price.
But stock prices change based on actual outcomes. Last night, for example, if you'd placed a bet on Obama winning the Presidential election, your payout would have been based on the odds. Today, knowing that he's the winner, the price of the bet would have adjusted to reflect this knowledge. In market terms, Obama's stock price just shot up.
And with RIM, we're essentially looking at some version of a binary outcome. It's not quite binary because there are so many variations of a "Plan B" that RIM could execute on. But in terms of BlackBerry 10 and the smartphone market, it pretty much comes down to RIM either returning to reasonable profitability or failing to do so.
With 80 million subscribers, even without accounting for growth, RIM should be able to ship 40 million phones per year. This assumes a 2-year replacement cycle, which I know is a huge generalization and depends on the market. If they can sell 40 million phones at an average price of $350, with 25% gross margin they should make $3.5 billion in gross profit. Tack on service & software revenues, assume some reasonable level of operating expenses, and you end up with a company that makes a lot of money.
The stock price would rocket higher.
But let's not get too excited here. The risks are immense. RIM loves to talk about its $2.3 billion in cash. But they seem to refuse to talk about what's happening to the $1 billion in quarterly service revenue. What if that revenue drops 50% in the next year, as BlackBerry 10 launches, and carriers renegotiate prices. That means a drop of $500 million in quarterly cash flow. Without a return to profitability in the hardware business, the company would be out of cash in 5 quarters.
RIM out of cash? Yeah, it could happen. Of course, just like Nokia, they'd probably go to market with a convertible bond deal or something else to keep them afloat. But I hope this explains why the market is still so skeptical on RIM's future.
Apple and Samsung make good money on hardware. Almost nobody else does. Kevin and I were talking yesterday about the possibility that Google threw LG a bone by giving them the Nexus 4. LG certainly isn't making money on Android (along with most other players), and what if they were considering backing out of the market altogether? That wouldn't look good on Google.
But if RIM can carve out a sustainable profit by owning its own platform, just like Apple, they do stand a realistic chance of success. And success at this point translates to a complete reversal of Wall Street's opinion of the stock, resulting in a massive revaluation. I firmly believe that RIM has more upside potential than Apple in the next 2 years. But that upside opportunity comes with more risk.
Can RIM resume its path as a profitable smartphone maker and mobile computing platform? Separately, can RIM leverage its carrier relationships, NOC, and QNX platform to emerge as a global machine-to-machine leader? They certainly have an opportunity in automotive. But what about other vertical markets in need of M2M solutions? Could this space be even more profitable than smartphones have been? It sure is an interesting set of questions to ponder.
So is it time to buy shares of RIM? It's up to you, as an investor, to make up your own mind. I'm not going to tell you what to do because it's such a personal decision to make. If you have a strong convinction one way or the other, be sure to share it in the comments.