Analysts have been chided quite a bit on this site for their poor predictions and focus on the short-term. So when they get it right, they deserve some credit.
As recently as two months ago, management of Research In Motion (RIMM) re-iterated that it expected earnings per share for the company’s fiscal year of $7.50/share. Analyst estimates, on the other hand, clocked in significantly below this level. The difference in expectations between analysts and company executives is even larger in light of the fact that we were already 1/4 through the fiscal year in which these estimates were based!
Two weeks ago, we found out which of these groups would be correct in their assertions; it was not management. RIM shares tanked on the news; the stock now trades almost 60% lower than it did four months ago.
In high-tech industries where product life-cycles are short and disruptive technologies are the norm rather than the exception, company fortunes can turn very quickly. In this case, the sluggish pace at which RIM is bringing new products to market is causing it big problems. But the company’s position doesn’t appear as dire as market sentiment would suggest.
First, management appears to finally recognize that there is a problem. As of two weeks ago, the company is aiming to streamline its operations to become more nimble and efficient. Headcount reductions (in areas management believes to be non-vital to the company’s strategy) have already taken place, and the company’s acquisition and capex spree is likely to slow significantly. This should allow the company to generate more free cash flow, and focus management resources on existing assets.
It is also worth examining the main reason for the recent lull in new devices: the company is transitioning to a new platform. As RIM moves its new devices to Blackberry 7, it has been slowed up by delays in the certification process with carriers. The new devices carry more functionality (e.g. HD video) in a smaller package (e.g. the Bold 9900 will be only 0.4 inches thick). Problems have been experienced at the certification stage which have delayed all the new products; but as certification for the initial Blackberry 7 products is now almost complete, the rest of the products under the new platform should experience quicker carrier acceptance.
Despite the fact that the company has been slow to market and has an aged product portfolio which is arguably inferior to that of competitors, RIM is still very profitable as a result of some competitive advantages that have kept it in the game. First, it remains the preference of corporate customers where security is the number one priority. Second, its enormously popular messaging application likely has network effects. The company’s commitment to an open platform (for example, RIM’s playbook can run Flash, connect via USB and HDMI, and will soon support Android apps, none of which the iPad can do) could also become an advantage in the long-term.
Lost in the competitive shuffle, however, is the fact that this is a growth industry. The market for tablets, smart-phones and other devices and services these companies are working on is relatively nascent. As such, each of these companies will experience tailwinds just from being in an industry that is growing at incredible rates.
Finally, from a price vs fundamental point of view, RIM’s stock price appears extremely cheap. Based on the midpoint of the new earnings estimate for the year, RIM trades at a P/E of just 5. After subtracting out the company’s $3 billion in cash equivalents (against no debt) from the company’s market cap, RIM’s P/E becomes just 4.
Nevertheless, risks remain. Management may not be able to execute on its plan to speed up the pace at which it is able to bring new products to market. On this point, once again management appears to sound overly confident that it is doing everything right, as on the latest call both co-CEOs seem to think they have done nothing wrong despite the fact that the company is no longer the market leader. Considering these guys have built the company from scratch and continue to generate very strong returns on capital despite the lowered estimates, however, perhaps they deserve a little more credit than they have been receiving.
Furthermore, even if management does execute and deliver much-improved products to the market, the competition is not standing still either. Both Apple and Android-based competitors are constantly innovating, with Microsoft also looming as Nokia will soon enter the market with Windows phones. This industry is characterized by fast changes, which remains the biggest risk to this company for value investors.
With the lowered share price, profit potential for shareholders is remarkably high. But downside risks remain if the company’s competitive situation continues to deteriorate.
Disclosure: Author has a long position in shares of RIMM
