The market sent a clear message of displeasure to Research In Motion (RIMM) after reporting earnings on Thursday afternoon, sending the stock sliding as much as 17% on Friday. Revenue for the third quarter fell short of expectations, as did forecasts for the fourth quarter sales guidance. Analysts had anticipated that sales would be about $3.92 billion in Q4, but management thinks that $3.6B to $3.85B is a reasonable expectation.
Much of the blame for the revenue disappointment lay on the falling prices for RIM’s Blackberry products. Analysts wanted to see an average selling price of $340 to $350, and RIM’s expectation of $340 was a disappointment. The news out of Research in Motion has many analysts falling all over themselves to downgrade the stock and lower price targets. We think investors would be better served to take a deep breath and try to understand that the fundamentals of this company remain strong.
First of all, while the company reported disappointing sales, they actually beat the Street’s expectations for profits. EPS came in at a healthy $1.03 per share which is 3% better than consensus analysts’ predictions. The only way to miss on the top line and beat on the bottom line is through improved margins. Product costs are falling faster than the average selling price that many analysts are so upset about. Maybe I am not thinking clearly, but profit seems to be the primary goal of any capitalist enterprise; sales are simply a means to create profit. Not to mention the fact that sales–although less than expected–were 37% better than a year ago. Subscriber additions were up 45% from a year ago. Which is nothing to scoff at, considering the US economy has shrunk for the last 22-months.
We are aware that there are headwinds facing Research in Motion, including growing competition in the smart phone market. There are new products being delivered to the market from such worthy and established competitors of Apple (AAPL), Palm (PALM), Motorola (MOT) and Nokia (NOK) to name a few. In addition, there are upstarts joining this hot industry all the time, which is yet another reason that we are not concerned by the falling prices of Blackberries. Co-CEO James Balsillie discussed his “land-grab” strategy on the companies conference call.
“So the wise person, I believe, sees this as a rapidly expanding market where the benefit of establishing and holding a lead position will accrue many, many, many years of benefit. We’re still in a rapid expansion mode and we’re still trying to invest into it, although we get a return on our current sales.” — RIMM CEO James Balsillie
Now, this strategy may make investors with a short time frame nervous because eventually the land grab will undoubtedly pressure margins. That was not a problem in the previous quarter because of falling costs, but we can see how it would make some apprehensive. That being said, Research in Motion is adapting to the current economic realities and we believe as does the CEO that retaining market leadership right now will pay dividends in the future.
At Ockham, we are reaffirming our Undervalued stance and believe that this stock only became more attractive amidst this decline. We would have expected a small sell-off after the revenue disappointment, but this was much more than we expected. From a value perspective, we think that there is still plenty to like about RIMM. For example, even with sales growth slowing we are still talking about a fundamentally strong company. In the past, the market was willing to pay a huge premium for RIM’s growth, but currently it is selling for less than 3x revenue per share. This is less than half of the historical average. As for P/E multiple, after Friday’s clobbering the stock is selling for a very reasonable 16.6x multiple for fiscal 2009 earnings. Clearly, we see a lot of value in this company that–despite what you may have heard–is still growing sales and earnings rather quickly.
