I am putting a lot of my eggs into the Research in Motion basket. Here is why:
http://stanleybing.blogs.fortune.cnn.com/2011/10/19/blackberry-work-iphone/. A good post touting the essence of Blackberry’s value. This blog is excellent by the way.
When you talk about the demand curve, supplying the client’s wishes, there are two ways to look at it:
1. Is it what the client wants?
2. In the long run, does it help the client?
Right now, number one is squarely on the Android and iPhone’s side of the court. Those guys have all the hype, at least in the U.S. The advantages of the Android and iPhone are the ease of use, the app world, internet browsing, and the social perception of owning the devices.
Number two, more up for grabs in my opinion. RIMM has the secure servers, wireless sync of contacts, mail and calendar with Blackberry Enterprise, the keypad for more accurate typing, ability to edit MS Office, better phone call signal. Here’s a youtube review to support my point:
I am not going to try to analyze the technology because that is not my forte. But I think a few things argue for RIMM’s value at its current trading range around $15:
1. Many core U.S. subscribers will not switch
2. Strong international growth
3. High margin for error, with price at only a couple times trailing Cash Flow
Here you go
1. Core subscribers:
Once a customer has used a phone for years, there are switching costs to learning a new phone’s interface. The reality is that there are many corporate guys who have been using Blackberries for 10 years are not going to want to switch over to the iPhone. The first time “Let’s have a meeting in 10 minutes” is changed to “Let’s have a merang in 19 mimosa,” they are going express dissatisfaction.
2. Strong international growth:
Here is a news report of Indonesian customers rioting over a shortage of Blackberries in a black Friday deal.
Blackberry Messenger and prepaid service are very popular overseas. International sales were 61% of Blackberry’s revenue in the most recent quarter, and growing. The international Blackberry business alone is worth more than RIMM’s $8 billion market cap.
3. High margin for error
You don’t need Blackberry to grow to make money on an investment. In fact, if the RIMM can maintain its 2012 results for three years, the investment will be a resounding success. Considering the international growth of the company, I think that is achievable.
Let’s break down RIMM’s income statement from the first nine months of Fiscal year 2012 (through November 2011):
Revenue $14 billion
COGS $9 billion
Gross Margin: $5 billion (36%)
R&D $1 billion
SG&A $2 billion
Amortization $0.5 billion
Net Income: $1.5 billion
Proj. FY2012 Net income: $2 billion
That includes the PlayBook $500 million inventory charge. So margins are sitting pretty at 36%, not likely to go down a lot unless RIMM dramatically lowers its phone prices. Amortization will rise in the coming years. But there’s no reason to think there will be a huge decrease in revenue or increase in COGS (remember that RIMM is still selling a lot of phones at the $300 level; although hardware sales are flat they are not tanking. Plus subscriptions fees are approaching $4 billion per year, and those are higher margin, and are not going to decrease because the number of Blackberry subscribers is increasing). Income statement looks good.
Now the balance sheet:
Cash $1 billion
Other current assets and investments $1 billion
Receivables $4 billion
Inventory $1 billion
PPE $2.5 billion
Intangible assets $2.5 billion*
Liabilities $3.8 billion
*Includes patents valued by analysts around $5 billion, but held at cost on the balance sheet
Equity $10 billion
That is a very strong balance sheet for a company with an $8 billion market cap. I like to organize the items as above, and evaluate their certainty so to speak, with cash always certain and the rest evaluated on a case-by-case basis. Inventory, we know, should be realistically priced after that enormous Playbook charge. Accounts receivable is the only red flag - $4 billion is pretty large. Here is what I found in RIMM’s annual report about this:
At the end of fiscal 2011, accounts receivable was approximately $4.0 billion, an increase of $1.4 billion from the end of fiscal 2010. The increase is primarily due to increased revenues and the increasing international mix of business where payment terms tend to be longer as well as the timing of shipments in the quarter. Days sales outstanding increased to 65 days in the fourth quarter of fiscal 2011 from 58 days at the end of fiscal 2010.
Credit and Customer Concentration
The Company has historically been dependent on an increasing number of significant telecommunication carriers and distribution partners and on larger more complex contracts with respect to sales of the majority of its products and services. The Company continues to experience significant sales growth, resulting in the growth in its carrier customer base in terms of numbers, sales and account receivables volumes, and in some instances, new or significantly increased credit limits. The Company, in the normal course of business, monitors the financial condition of its customers and reviews the credit history of each new customer. The Company establishes an allowance for doubtful accounts that corresponds to the specific credit risk of its customers, historical trends, and economic circumstances. The allowance as at February 26, 2011 is $2 million (February 27, 2010 —$2 million). The Company also places insurance coverage for a portion of its accounts receivable balances. While the Company sells to a variety of customers, one customer comprised 15% of accounts receivable as at February 26, 2011 (February 27, 2010 —one customer comprised 14%). Additionally, two customers comprised 11% each of the Company’s fiscal 2011 revenue (fiscal 2010 revenue — three customers comprised 20%, 13% and 10%).
So it looks like their receivables are from large telecom companies. The international companies are receiving Blackberry phone shipments, and perhaps not paying for them until they sell them? As an investor, to be honest, I wish RIMM would go in there and bust some kneecaps and get some money faster. But RIMM claims the money is good. In any case, this is a minor concern compared to the big picture.
What is the big picture? Look at the margin of error. So many things have to go wrong for RIMM to end up selling itself for less than $8 billion dollars. Receivables have to vanish, profit margins have to disappear, and subscribers have to stop paying monthly fees. It’s an improbable scenario.
I think the market is suffering from some recency bias here – investors saw the Palm result and are freaking out, but RIMM is a different company than Palm was. Also, Palm still commanded $1.2 billion from HP even in its decline. Palm was hovering just above a billion in revenue and was losing money. Blackberry is sitting on $20 billion in revenue, and is profitable. Blackberry’s $7 billion market cap is below the bottom of the barrel.
At 75 million subscibers, RIMM is trading at about $100 per subscriber right now. I have been unable to get my hands on decently comparable statistics, in part because only Apple and RIMM combine the smartphones with the OS. But common sense tells you that is low.
A quick note on:
Tablets – You see the three tablets that are selling well: Kindle and Nook (sold at or below cost), and Apple (social value – owning a device with the big Apple on it is a trend now). Like the RIMM CEOs said in their latest conference call, the tablet market is still in its infancy, and there is a lot to play out.
Apps – Apps are important. Blackberry has to step it up in this department. But I think they can do it with incentives for developers.
Service Outage – A one-time blip will be forgotten. Let’s hope it doesn’t happen repeatedly, but I think that’s unlikely.
A good exercise is to look at the investment of the guys on the other side of your trade. The investment thesis goes like this:
Blackberry has no advantage over the iPhone and Android market. The phones are behind technology-wise, and the user experience is not as good. There are fewer apps. So the phone is pretty much a dead fish in the water. Sure they are more secure, but that’s not going to save them. The company will have to choke down on margins and will not make any profits starting in mid-2012. We should put “0s” in our model for all future profits, and value the company at the present value of all of its assets, no higher.
I don’t see it. Sure, the delay of the new operating system is a bump in the road. But there will still be a market for Blackberries in two years. Gross margins are not going from 38% to zero year over year.
Part of why RIMM is suffering is it got burned by share buybacks in the last two years. So the company is not going to buy back shares today, although that would be the right move in this case. That has caused shares to plummet, with no floor in the immediate future.
I think the Bold is a nice phone. RIMM is seeing strong international demand. I believe some of the weak U.S. demand is because of the sort of social coolness factor of owning an all-touchscreen phone right now. But in the long run, trends change. BBM is popular overseas, especially among teens.
The part I like most about this trade is that most people seem convinced that RIMM is going to fail. Message board posters, bloggers, and analysts are talking about no future profits, the potential for bankruptcy, etc. Writers who were playing the value card at $25 are now so tired of looking bad that they just flip their positions. People who were short the whole time are convinced that they were right and push harder with their reasoning.
Investing in RIMM could be viewed as a prop bet: Can the company maintain profitability for three years? If it can, then RIMM is probably a good investment based on its balance sheet. I think the odds are greater than 50% on yes.
Disclosure: I own RIMM shares.
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