I know what people are thinking. It is the very thing that I thought about 6 months ago when I first ran into Research In Motion (RIMM). It was trading at about $18. I had the same mindset as everyone else it seems. Apple and Google are taking over the smart phone world. I figured it was a dead duck like everyone says.
Then I saw Prem Watsa's name attached to RIM, so I took a glance at the financials. I noticed that it has no debt, has a nice cash horde and is free cash flow positive (to the tune of about $2 billion a year).
While past results are not an indication of future outcomes, I felt compelled enough to read more. I started with articles as I usually do. I then went in search of the facts to support the opinions of these articles. Turns out, the more I read the more I realized that authors are being single minded and often ignoring facts or conveniently ignoring what does not fit with their argument. I even ran across the occasional lie. "Is RIM the biggest example of groupthink I have ever seen?" I thought to myself. Can everyone be wrong?
Groupthink is a psychological phenomenon that occurs within groups of people. It is the mode of thinking that happens when the desire for harmony in a decision-making group overrides a realistic appraisal of alternatives. Group members try to minimize conflict and reach a consensus decision without critical evaluation of alternative ideas or viewpoints. - Wikipedia
Well, think of yourself as a Wall Street analyst. You can go to your boss, tell them why they should buy Google or Apple. The end result is that if you were right, great, you still have a job. If not, well everyone was saying the same thing so everyone was wrong. No big deal, you keep your job. Now imagine going to your boss and saying to buy RIM. If you are not fired or laughed out of your boss' office, there are two outcomes. RIM survives, one. The investment pays off and you have a job. A job that probably doesn't reward you for the correct thesis. But in this case, if you are wrong, two, you might lose that high-paying job. So, who really goes to their boss saying to buy RIM when there is no risk in saying to buy Google or Apple?
The same could be said for journalists. Imagine telling your boss that you want to write a positive RIM story and present a bullish argument. A journalist might not have the courage to do that.
I will not rehash all the negative news and rebut the inaccuracies in order to keep this article short. I do provide one example later. Instead, I will attempt to focus on why I am bullish.
To get everyone up to speed, RIM is staking its future on BlackBerry 10 (BB10), an impressive operating system and new user experience based on what has been seen of it. The BB10 has what RIM calls the flow interface. RIM started at the bottom and came up with a user interface that strives to be able to quickly go from app to app on the BB10. This is not like Android's clone of the Apple experience. This is a new experience that will differentiate the BB10 from the competition. RIM CEO Throsten Heins said this about Flow:
“We want a user paradigm that is easy and fast. The flow is taken to a new level in Blackberry 10. Everything flows continuously, it never stops, and because of that you just flow through it.”
“Applications run in realtime in the background. This means that apps run all the time, and never shut down, you can just flow through them.”
Typical negative article
This example stands out in my mind.
There are 5,000 lay offs (or firings depending on what the latest headline says) going on at RIM. Sorry, this is not news. This was first announced many months ago. Recently, this became headline news in the mainstream media. The mainstream media managed to not know that there were reasons given for this months prior. RIM over the past 20 years has had a history of hiring people into new positions to fill needs. Over 20 years, there was a lot of bloat created due to this process. There is a lot of wasted time due to duplicated job duties and additional management related overhead. There are also conflicts that can occur due to duplicate job descriptions. RIM appears to be restructuring their enterprise to be a lean enterprise. Lean enterprise (more often known as lean manufacturing) is a production practice that considers the expenditure of resources for any goal other than the creation of value for the end customer to be wasteful, and thus a target for elimination. This should also result in a more streamlined engineering process as opposed to the crippled model RIM used over the past few years as they tried to get the Playbook and BB10 out. The BB10 is a year delayed from the originally intended release date. And the Playbook came out late and lacking common features that many would expect in a tablet.
Many of the Playbook issues are resolved in the latest Playbook operating system, however.
Brief History of time:
Modern day RIM is best known for introducing the BlackBerry in 1999. They were the dominant business phone platform until the iPhone was introduced in 2007 which eventually led to market erosion. RIM is currently staking its future on the Blackberry 10 smartphone which is expected to be released in January of 2013.
Short Term: Thinking about the numbers
I will simply talk about the numbers right now. Blackberry 10 (BB10) is due in six months so where the numbers go post BB10 is anyone's guess. I'll admit that up front. I will provide reasoning that argues that there is room for more than just Android (Google) and iOS (Apple) based phones. But everyone should admit that things could get better.
Currently, this is where RIM stands as of the recent quarter:
- Debt: $0
- Cash/equivalents: $1.94 billion
- Free Cash Flow (ttm): $1.77 billion
The point of these numbers is that RIM is not dieing any time soon. That's all that needs to be gleaned. BB10 is a huge catalyst that everyone seems to be ignoring. Extrapolation of current data is not a valid approach as it would be with something like JNJ that is a large conglomerate.
“Be fearful when others are greedy and greedy when others are fearful” – Warren Buffett
The amount of fear revolving around RIM right now is astounding. I'll just leave it at that.
Thinking about RIM
People are trying to figure out what RIM is worth if it is broken up. What are the patents worth? What are the buildings worth? People are fixated on this. Figuring out how long RIM will take to die because of its “cash burn.” I put cash burn in quotes since this dieing company tends to grow its cash horde, even last quarter it did by about $200 million.
But let's face facts. RIM is putting its future on Blackberry 10 (BB10). RIM is quick to point out that nothing has changed in the iPhone experience since the iTouch was released five years ago. The GUI has not changed. The way you change between apps has not changed. BB10 is a new operating system and smart phone ecosystem intended to go head to head with the iPhone initially before lower end models come out down the road. BB7 will carry the mid-low end tier for RIM until those products start rolling out. Keep in mind that internationally, not all places have G3 service for mobile devices. In those places, RIM is actually doing quite well. In a recent interview RIM's chief marketing officer, Frank Boulben, pointed out the following:
Then when I look at the company, the brand (Blackberry) is still extremely strong globally. We have a weakness in the US right now, but when I look at it globally, we are #1 in South America, we are #1 in South Africa, in Nigeria, in the Middle East and some Asian countries. We are still in a solid position in Europe, so overall the brand is in a very good position, and it's an iconic brand. We have growth everywhere in volume, except in North America, so there is still a lot of attraction for the brand and the products (source: http://crackberry.com/12-questions-blackberrys-new-chief-marketing-officer-frank-boulben).
So, how long till RIM burns through all its cash? To this I think two question really need to be asked in conjunction.
1) Is it knowable?First, is this knowable? Maybe. Perhaps with continued market erosion, RIM will find its event horizon in 12 months. Perhaps 24. There are many so-called experts out there trying to figure this out. So maybe it's knowable. I don't know the answer and have no idea where one would even start to figure this out.
2) Is it important?
Second, is this important? No. RIM will either survive or die based on one thing: the success of BB10. This will not take 12 months to determine. Investing in RIM now becomes a qualitative issue only, not a quantitative one.
There will be some cash burn when BB10 launches. Apple currently has an advertising cost of $500 million per year. If RIM spends that much for the BB10 launch, they will still have about $1.5 billion in cash left. But that will be a chunk of cash that is gone. $500 million is about $1 per share. Advertising could reach $1 billion over the course of a year depending upon aggressiveness, scale, scope and other things like currency exchange rates.
The BB10 delay is almost a good thing as they will now be able to advertise the touch and QWERTY models together. QWERTY refers to a phone with a physical keyboard. These models will now be launched just weeks apart instead of two to three months apart. This will provide cost efficiencies in advertising. Also, launching BB10 at about the same time as the iPhone 5 may have caused the BB10 release to be muted in the media since the releases were rumored to be launched just weeks apart prior to the BB10 delay to January of 2013.
Q: Will RIM regain market share in the U.S.?
I feel as though this section requires its own little subsection. Who cares? That is the answer. Anyone preoccupied with this question (most of the media it seems) is ignoring the elephant in the room. And that's the global marketplace. This article will focus on India since it is a wonderful example of the state of the world as it relates to smartphones.
India, with a population three times the size of the U.S., is just starting to get mobile broad band rolled out. RIM sees this largely as their future. They need to be an equal competitor to Google and Apple in India. RIM has a strong focus on India right now. They have expanded Blackberry stores to about 80 stores in India and have plans to grow to 250 in one year's time. And RIM's plan seems to be working. Numbers are hard to come by but I did stumble across this nugget. It's a one-time event so take it with a grain of salt. But RIM has grown its market share in India from 13% last year to 15% in March of 2012.
RIM has point blank stated that a primary goal is capturing as much market share in India as possible. They are opening stores which is evidence of strategy implementation and they seem to be growing market share which is proof that their execution of the strategy is working. All that remains is tripling the Blackberry store count.
It is better to be approximately right than precisely wrong. Take these numbers with a grain of salt. Some numbers are out of date (by up to six months). Some are numbers derived from other numbers. But let's focus on being approximately right.
In the U.S., there are approximately 330 million subscriptions to mobile phones. The U.S. population is 310 million. So, there is about one subscription per person in the U.S. Of the subscribers, about 33% have smart phones. This is an adoption rate of 106% of the population. The number to focus on is 100,000,000. That's the approximate number of smartphones in the U.S.
India's Numbers are a bit hard to come by. In India, there are about 1 billion mobile phone subscriptions. Of that only 80 million are currently smart phone users. That is 8% of all cell phones. India's population is about 1.25 billion which represents an adoption rate of 80% versus the U.S. rate of 106%.
If India can grow its smart phone adoption to 33% of all subscriptions, one can see why there is interest by RIM, Apple, Samsung and others in India. The smart phone market there is largely untapped in a country three times the size of the U.S. If India grows its smartphone market to the adoption rate in the U.S., that represents about 415 million total smart phones. Subtract 415 from 80 and there is a potential market of 315 million NEW smartphone users that do not exist today. In India, the 3G infrastructure is just now going up which gives RIM some extra time to release the BB10.
- U.S. smart phone customers: 100,000,000It is interesting to see that the untapped pool of potential customers in India is about equals to the population in the U.S.
- Current India smart phone customers: 80,000,000
- Potential new India smart phone customers: up to 315,000,000
If the lessons from the India example above translate to the developing world markets then RIM has plenty of room for growth. Even if RIMM is literally playing third fiddle, that is a fairly big fiddle when considering the world as the stage.
There has been a big shake up at RIM over the past five months. The co-CEOs are gone and a single CEO, Thorsten Heins, is in. RIM has a new chief marketing officer in Frank Boulben.
Over the past few months, RIM has become more friendly towards journalists. During BB10 developer conferences, RIM has started inviting journalists and providing Q&A sessions. This is a change from the past where RIM ignored this important activity of emitting a positive light for journalists to write about. The CEO and CMO have even started doing interviews for both print and on-air media outlets.
Things are changing for the better in many ways. But one of Thorsten Heins' only (if not the only) short-term promises has been broken already. One of his primary objectives was to get BB10 out this year and that simply is not going to happen. His longer term goals mainly rest on getting back some market share in the Frank Boulben. He does provide reasoning though, as already hinted at in this article, such as the separation from the iPhone 5 release date.
While Thorsten Heins is running the show, it is also conceivable that Prem Watsa is providing some valuable insight as a 9.9% shareholder and board member. He is originally from India so has some knowledge of those markets. And without a doubt, he is capable of providing valuable advice to Thorsten Heins and others given his proven track record.
Regarding the Farifax increase in position, Fairfax spokesman Paul Rivett said, "We strongly believe that Thorsten Heins is singularly focused on the success of RIM and its BB10, and we firmly support him and the entire BlackBerry team working tirelessly to bring this exciting new platform to market."
Investing in RIM
Maybe I just don't see what everyone else does. RIM appears to be far from dead and making a lot of the proper strategic moves.
This is where the value investor in me thinks of risk and reward. If you buy $1,000 in stock it could go up to $5,000 if BB10 succeeds. But it could also go to $0. So, what investment vehicle is to be used? Stock? Perhaps. But I cannot drool over those long dated call options. January 2014 calls at the 35 strike are currently trading for about 10 cents. The January 2014 calls at the 22 strike are trading for about 20 cents. Even if BB10 is only a moderate success, the death watch will end. And people will start looking at the debt load (let's assume it is still $0). But that $2 billion in annual free cash flows will be noticed instead of ignored. With a 10x multiple, the market cap should be in excess of $20 billion under this scenario. With 524 million shares outstanding, that's a fair value of about $38 per share. I think BB10 success on a global scale will bring FCF beyond $2 billion by quite a bit though. So that $38 is conservative in my eyes. What if it gets to $45? Those January 2014 calls at the $35 strike would be worth north of $10 each under this scenario. It's not every day that an opportunity presents itself to turn 10 cents into $10.
So, this stock could easily approach $38 per share as it closed on Tuesday at $6.93 per share. This stock is grossly undervalued.
RIM can hit $30 per share or more if they simply execute their plan in India. Once investors see rebounding Free Cash Flows or even stabilized free cash flows with an expectation for FCF growth, the stock could sky rocket because it will no longer be getting priced with a sum of all parts methods.
RIM does not need to be the No. 1 or 2 player in the world market. As much as I would like that, there is still Google and Apple to deal with. However, the world market is huge. The world population is 7 billion. RIM does not need 50% of the smart phone market. Even 10% of the market in a sample set that size would be sufficient and represent amazing growth prospects for RIMM going forward. Perhaps this is why Prem Watsa has stated that this investment is a three to five-year investment.
Recent Prem Watsa Buy:
I wrote most of this article prior to Prem Watsa doubling his stake in RIM. I couldn't help but wonder why he has not bought more. He sits on the board of directors and knows the previous and current CEOs. If any investor knows what is going on at RIM it is Prem Watsa. His investing silence was both irritating and frightening. In the past week, we learned he has not sat idly by. In the past quarter, he has doubled his position to 9.9% of all RIM shares outstanding. This is something that investors should not be ignoring.
I currently own RIMM stock along with long-dated call options. In the next 48 hours I may add to my position.