Last week’s powerball idea was Bank of America (BAC) warrants. This week we follow up with possibly the only stock that has fallen further this year and is more universally despised than BAC — RIMM.
The story is well known by basically anyone familiar with the financial markets. RIMM, the maker of the popular BlackBerry smart phones, was the darling of Wall Street until the iPhone came out. Now, sales and earnings are just beginning to drop off a cliff as the Android and iPhone cannibalize the market. Products are being delayed, management seems inept, and employees are getting drunk and restrained on planes.
However, at this point, it’s possible the stock is an incredible value candidate. The stock would likely be at the top of the magic formula list if it wasn’t for its Canadian headquarters. They’re almost definitively trading at a discount to what they could milk the business for if they cut R&D to the bone and treated themselves like a liquidation. They have some incredibly valuable patents. This is the most bearish valuation of their patents I can find, and it values the patents at $2.5 billion. And they’re so cheap that they are slowly but surely approaching net-net territory (note that most of their current assets are made up of pretty solid AR and cash plus investments, not inventory subject to high obsolescence risk).
Of course, value investors have been saying that since the high 50s. Check out the list of famed investors that have been burned by RIMM so far. The fact is, when a high-tech company falls, it falls fast. And it appears that a liquidation scenario and/or distressed sale may be all RIMM shareholders have left if management continues their current course.
However, all that territory has been covered. What I want to talk about is the similarities between RIMM today and AAPL 12 years ago, when Steve Jobs had just finished cutting the Newton project and settling in again as CEO, and the company qualified as an incredibly deep value stock. It traded for at about the value of its cash and seemed doomed to failure. It’s easy to forget now, but at the time Apple’s odds seemed insurmountable: No one in history had been able to withstand the Microsoft (MSFT) juggernaut, Microsoft had all the network effects in its favor, and Apple had needed a bailout from Microsoft just to continue operating (Microsoft, for its part, likely did the bailout to keep one competitor operating system alive and thus dodge anti-trust regulation). (P.S. I’m just starting Steve Jobs’ biography, so I’m sure I’m glossing over some of the details that it contains.)
So that brings us to 2000-ish, just before the iPod was released. You could basically buy Apple for the value of its securities. Check out this old VIC write up in December 2000. Even as late as 2003, you could buy the company for mainly the cash value – see this VIC write up from 2003.
However, looking back, the cash value wasn’t what turned Apple into such a great investment. In Bruce Greenwald’s book "Value Investing: From Graham to Buffett and Beyond" (which, by the way, is good but not anywhere close to his other book "Competition Demystified," one of my five favorite books of the year), he talks about three ways to value companies: on an asset basis (the cheapest), on an earnings power basis, and as a potential franchise (the most expensive).
What made Apple such a great investment was the cash balance protected the downside while their untapped franchise potential (spurred largely by the genius of Steve Jobs) gave near unlimited upside potential. In other words, it was valued lower than asset basis despite having franchise earning potential. Think of all the resources Apple had that weren’t on the balance sheet in terms of assets. It had Jobs, a man who had almost single-handedly created the PC era. It, along with Windows, had one of the two viable operating systems for computers. It had a tremendous brand name, even if the brand had been tarred by recent events, that could prove tremendously powerful if the company could get back on its feet.
Which brings us today to RIMM. Charlie Munger often speaks of having mental models and using them to recognize patterns when you see them. And just using the model we just developed for tech companies with turnaround potential, we can see RIMM has many of the same characteristics as Apple in 2000. It’s approaching trading for the value of its cash. It has plenty of incredibly valuable assets: Outside of its patents, it has its huge current user base, one of the three dominant operating platforms for smartphones, and a great (though possibly tarnished) brand name. Look at the news that’s coming out in the past 24 hours: AMZN interested in RIMM and MSFT and Nokia interested in RIMM. Clearly, companies are seeing potential value in RIMM’s assets and think they can pick them up for a bargain price.
But most importantly, RIMM is trading for a discount to its assets despite its franchise potential. Think about it: RIMM is certainly in better shape than Apple was in 2000: It doesn’t need a MSFT bailout and current earnings are very, very strong. And while the CEOs are widely mocked now, don’t forget that they built a dominant smartphone maker from basically nothing in about five years. They clearly are smart guys with potential. Do I think they’re the right people for the turnaround? No. But people said that about Jobs too.
Now think about the potential turnaround into reviving the franchise. Apple’s fate really changed with the introduction of the iPod, a device that truly changed the way music was listened to. That allowed them to begin to revive the franchise. How could RIMM do that? I don’t know. But no one could have seen the iPod coming either. And RIMM certainly has the engineering talent to figure out a new product to revive their brand.
Then think of management. If their CEOs could build the smartphone business from nothing within five years, wouldn’t they be the perfect pick for building whatever the “next great device” is from nothing for RIMM?
Now, I’m not saying any of this is likely. I’m just saying the similarities between the two companies are striking. I don’t have any position currently, but I think it’s well worth investigating. Maybe even the LEAPS would make sense. You could buy the January 2014 20 strike for approximately $2.10. If the company turns it around, you’d likely make 10x your money, maybe more. If they don’t, they probably get bought out on the cheap, but you still might double your money.
Of course, maybe the market’s right. Maybe the CEOs are dunces who blow the company’s cash hoard on fruitless R&D and the company goes bankrupt in three years. But at these prices, that’s why RIMM's a perfect powerball idea — huge upside potential, and downside could be limited by all of their assets.
Disclosure: No current position, though those options do look mighty tempting...
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