Research In Motion (RIMM, Financial) is probably the fastest rags to Wall Street darling back to (near) rags again story in the history of Wall Street. In a 10-year period, it’s seen its stock price go from under $2 per share to over $140 as its flagship Blackberry brand seemed poised to take over the smart phone world, and then back to under $15 as growing competition from the iPhone and Android seem destined to wipe Blackberry off the face of the map. That’s what the market is projecting. But in the present, RIMM is throwing off some serious cash flows and some great numbers. Trailing twelve month EBITDA comes in around $5 billion, almost equivalent to today’s enterprise value under $6 billion. And they’ve earned that much with tangible invest capital of only $6.5 billion or so. In other words, in the present day, they’re generating world-beating returns on capital and trading at one of the cheapest valuations imaginable.
Currently, RIMM isn’t on the Magic Formula list. We only bring them up because RIMM, in its present form, is a great example of everything that is good and bad about the magic formula.
Let’s start with the bad, and then we’ll discuss the good.
The bad is RIMM shows the constraints of the magic formula. All of them.
The first bad is that RIMM isn’t even on the magic formula screen. If it was, it would likely be near the top of the screen in both valuation and returns on capital. Why isn’t it on there? Because, even though RIMM is publicly traded in the U.S. on the NASDAQ, it’s headquartered in Canada. And, for the most part, the magic formula doesn’t do companies headquartered in other countries. That’s just one example of one of the rules of the magic formula. Another is no stocks under $50 million market cap. That’s one of the rules that we take advantage of in GuruFocus’s own Micro Cap Magic Formula Newsletter.
The other bad thing about the magic formula RIMM shows is it seems obvious the future is going to look much, much worst for RIMM than the past. It looks cheap to the magic formula because the market is discounting the future, while the formula can only see the past. This is the same reason that you often see a bunch of biotech companies on the magic formula list. The biotech companies will look great on a trailing basis because they have cash-rich balance sheets and sold off a patent for a big gain recently. But on a forward basis, the biotech company will burn up tons of cash and post huge losses. It’s basically a lottery ticket.
However, RIMM also shows some of the best features of the magic formula.
First, it normally picks stocks with big competitive advantages. It’s tough to earn near-100% returns on capital without having some form of competitive advantage. Maybe RIMM’s is eroding, but there’s no doubt that it had a competitive advantage at some point. The magic formula helps you find and ferret those out.
Second, companies that make the magic formula are cheap. Remember, RIMM earned almost $5 billion in EBITDA, and that’s after expensing $1.4 billion in R&D. At this point, the market is pricing the company like they’re dying. They may even be priced below the value of their patents. If RIMM would just cut back on R&D and focus on repurchasing shares and returning cash to shareholders with all their cash, they could likely milk their business for much more cash flow than their current price. In other words, RIMM’s likely trading at a discount to their assets (patents) and a discount to their potential cash flows. That’s exactly the type of combination we look for in GuruFocus’s own Micro Cap Magic Formula Newsletter. Most of our picks trade for a discount to some of their assets, whether it’s their brand names, their patents, or the cash on their balance sheets. And on a normalized earnings basis, most of our picks, like RIMM, trade for a discount to what they would earn if they just wound the business down in an orderly fashion.
An investment in RIMM certainly has risks. If the co-CEOs don’t change their strategy, the company could be bankrupt in the next three or four years as they burn through all of their cash flows and massive cash balance. But if they manage it correctly, there’s huge upside to be had. That’s exactly the type of bet we’re looking to make in the MMF newsletter.
Currently, RIMM isn’t on the Magic Formula list. We only bring them up because RIMM, in its present form, is a great example of everything that is good and bad about the magic formula.
Let’s start with the bad, and then we’ll discuss the good.
The bad is RIMM shows the constraints of the magic formula. All of them.
The first bad is that RIMM isn’t even on the magic formula screen. If it was, it would likely be near the top of the screen in both valuation and returns on capital. Why isn’t it on there? Because, even though RIMM is publicly traded in the U.S. on the NASDAQ, it’s headquartered in Canada. And, for the most part, the magic formula doesn’t do companies headquartered in other countries. That’s just one example of one of the rules of the magic formula. Another is no stocks under $50 million market cap. That’s one of the rules that we take advantage of in GuruFocus’s own Micro Cap Magic Formula Newsletter.
The other bad thing about the magic formula RIMM shows is it seems obvious the future is going to look much, much worst for RIMM than the past. It looks cheap to the magic formula because the market is discounting the future, while the formula can only see the past. This is the same reason that you often see a bunch of biotech companies on the magic formula list. The biotech companies will look great on a trailing basis because they have cash-rich balance sheets and sold off a patent for a big gain recently. But on a forward basis, the biotech company will burn up tons of cash and post huge losses. It’s basically a lottery ticket.
However, RIMM also shows some of the best features of the magic formula.
First, it normally picks stocks with big competitive advantages. It’s tough to earn near-100% returns on capital without having some form of competitive advantage. Maybe RIMM’s is eroding, but there’s no doubt that it had a competitive advantage at some point. The magic formula helps you find and ferret those out.
Second, companies that make the magic formula are cheap. Remember, RIMM earned almost $5 billion in EBITDA, and that’s after expensing $1.4 billion in R&D. At this point, the market is pricing the company like they’re dying. They may even be priced below the value of their patents. If RIMM would just cut back on R&D and focus on repurchasing shares and returning cash to shareholders with all their cash, they could likely milk their business for much more cash flow than their current price. In other words, RIMM’s likely trading at a discount to their assets (patents) and a discount to their potential cash flows. That’s exactly the type of combination we look for in GuruFocus’s own Micro Cap Magic Formula Newsletter. Most of our picks trade for a discount to some of their assets, whether it’s their brand names, their patents, or the cash on their balance sheets. And on a normalized earnings basis, most of our picks, like RIMM, trade for a discount to what they would earn if they just wound the business down in an orderly fashion.
An investment in RIMM certainly has risks. If the co-CEOs don’t change their strategy, the company could be bankrupt in the next three or four years as they burn through all of their cash flows and massive cash balance. But if they manage it correctly, there’s huge upside to be had. That’s exactly the type of bet we’re looking to make in the MMF newsletter.
