Why RIMM Will Comeback and How to Profit

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The market is finally showing some signs of life after a brutal month and a half of declines. Investors have been spooked by weak growth in the United States and the fear that Greece will default and start a domino effect that takes down the next weak link – Spain — and potentially unravels the entire experiment in European political and monetary integration.

The funny thing is that I could have just as easily written the paragraph above last June.

It is truly remarkable how little anything has changed in the past year. The U.S. housing market — the root cause of the lingering crisis — has failed to improve and prices appear to be taking another leg down. As a result, banks look as vulnerable as ever.

In the meantime, I continue to see value in this market. Investors, both retail and professional, are bearish (which is an excellent contrarian sign). And with bonds yielding practically nothing and commodity prices looking vulnerable, investors have few places to go outside of equities.

We should never take a cavalier attitude towards risk. At current prices, junk bonds, emerging market bonds and currencies, and most commodities should be avoided, as should the recent social media IPOs. We should invest only where we have that all-important margin of safety. We want companies with strong cash positions and recession-resistant demand. And where possible, we want maximum exposure to emerging market consumers rather than their cash-strapped counterparts in the United States and Europe.

With that said, let’s take a look at Research In Motion (NASDAQ: RIMM).

Last month I wrote that “Research In Motion is one of the most attractively priced stocks in the world at current valuations.” But I also wrote “You can be ‘right’ about an investment and still lose a lot of money if your timing is bad.”

Those words unfortunately proved to be prophetic; RIMM released a disappointing earnings report that sent the stock down more than 21% — and this was after the stock had already fallen by more than half in less than a year. Ouch.

The market consensus is that the BlackBerry is dead. The Android of Google (NASDAQ: GOOG) and the iPhone of Apple (NASDAQ: AAPL) killed it, and Research In Motion can now look forward to a rapid descent towards obsolescence like the erstwhile PDA leader Palm.

I disagree. The bearish consensus on RIMM would appear to me to be far too extreme, and I believe that the company is far from finished. The company is no longer the leader in the smart phone market (or at least the consumer market), and it most likely will never lead again. But there is still a lot to like here.

Please visit page 2 of “Why RIMM Will Comeback.”

Yes, the iPhone and Android-based phones are absorbing most of the new growth in the smart phone segment. A recent report by the technology consulting firm comScore revealed that the BlackBerry’s market share had shrunk from 30.4% to 25.7% in the first quarter of 2011 alone, with Android benefiting the most.

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Research In Motion

These numbers are somewhat misleading, however. RIMM is taking a smaller piece of the smart phone pie, but the pie itself is growing rapidly. Furthermore, the BlackBerry, while still popular among consumers (if less so than before), is primarily an enterprise product.

If you work for a large corporation or a government agency, chances are good that your company phone is a BlackBerry. Try asking your IT technician to configure an iPhone to work on the company’s enterprise system, and watch the steam come out of his ears.

I do not doubt for a minute that the iPhone and the Android phones will continue to grow at a faster rate than the BlackBerry. Frankly, they are more impressive pieces of technology that appeal to a wider base of consumers. I get that. But I also firmly believe that the BlackBerry will remain competitive in its niche professional market, and the lower price point on most BlackBerry models means that their retail consumer base will continue to grow as well, particularly in cost-sensitive emerging markets.

It should also be noted that BlackBerry devices hog less data bandwidth than the iPhone or Android phones, which matters greatly for those without unlimited data plans. In the most recent quarter — the one that sent the stock price down by 21% — RIMM’s revenues outside of the United States and Canada grew by an eye-popping 67%. Overall, the global smart phone market is growing fast enough to keep Apple, RIMM, and the Android phone makers in business for years to come.

RIMM’s financial are also quite strong, something the bears seem to be overlooking. I’ll address that in more depth but first let’s consider a way to profit from the near-term travails of RIMM.

Investors with experience trading options might consider selling out-of-the-money puts on RIMM. I would consider the RIMM August 20 and 22.50 Put contracts to be attractive. If the share price stays above those levels, you pocket the premium and earn a little income. Of course, if the share price falls below those levels, you will be obligated to buy shares of RIMM — which in my opinion would be just fine.

Selling puts is not an appropriate strategy for many retail investors, and I recommend you consult your broker or financial advisor before doing so. Make sure you understand the risks involved.

Please visit page 3 of “Why RIMM Will Comeback.”

RIMM PlayBook

Now, let’s look at the financials. RIMM is a debt-free company with terrific returns on equity of over 40%. It’s also shockingly cheap. Even after the revision to the company’s earnings estimates, it is trading for an almost pitiful five-times forward earnings. Yes, five. That’s one third the S&P 500’s valuation of 15 times earnings. It’s also considerably lower than the earnings multiple awarded to basket case Nokia (NYSE: NOK).

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This is not to say that I don’t take the company’s problems seriously. The rapid success of Android caught RIMM’s management with their pants down, and the current product line-up is looking rather old. Revenues, while still up year-over-year, were down slightly quarter-over-quarter, and the age of RIMM’s current product line is certainly a major factor in that decline. Perhaps more worrisome is that the company’s gross margins have shrunk as RIMM has had to lower prices to compete.

Furthermore, there is a reason why RIMM sports a lower valuation than Nokia even while Nokia is in far worse fundamental shape. The market hates surprises, and RIMM has had one after another of late. Nokia’s management has been far more candid with its investors.

RIMM’s management, in contrast, lost all credibility with investors earlier this year when they revised their earnings outlook just a month after offering guidance. It’s hard to recover from a reputational misstep like that.

Still, all of that said, at current prices RIMM would appear to be a bargain. RIMM is currently priced for destruction, and for the stock price to rise from here the company does not have to do well. It merely has to survive. And this it should do easily.

A new generation of BlackBerry phones and the new PlayBook tablet, designed to compete with Apple’s iPad, should help to end this year on a high note.  Still, I cannot in good faith recommend that retail investors buy right now given the volatility. While I believe the stock price could easily double or even triple in the next 12 — 24 months, RIMM is still a proverbial falling knife. Let’s give it a little more time before we try to catch it.

Charles Sizemore, CFA is a portfolio manager and financial journalist based in Dallas, Texas. His recommendations have been published in SFO Magazine, Investment International, and the Daily Reckoning, among others. Mr. Sizemore maintains the CFA charter and holds a master’s degree from the London School of Economics.


Article printed from InvestorPlace Media, https://investorplace.com/2011/06/rimm-research-in-motion-aapl-goog-nok-apple/.

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