RIMM: Why it's not over yet

September 16, 2010: 3:00 AM ET

Research in Motion is Wall Street's latest whipping boy. But reports of the BlackBerry-maker's imminent death may be premature. Here's why.

by Andy M. Zaky, contributor

According to word on the Street, Research in Motion's (RIMM) best days are behind it. Many contend that Apple (AAPL) and Google (GOOG) are stealing a critical amount of the smartphone market share from the company, and that the once dominant BlackBerry maker can barely keep its head over water. CNBC's Fast Money recently likened the company to the tragic story of Palm, which, after suffering from considerable selling pressure, was bought out by Hewlett Packard (HPQ) at a rock bottom price earlier this year. Goldman Sachs analysts not only dropped RIM off their conviction buy list, but they maintain a sell rating on the stock – a rarity for Wall Street.

It seems that every morning yet another analyst dishes out a downgrade. Earlier this week, Jeff Fidacaro from Susquehanna Financial downgraded his rating to "negative" with a $37.50 price target on the stock. While the market has rallied almost 80% off its bear market lows, the Blackberry maker is down nearly 70% from its all-time highs. It currently sits just a chip-shot away from its lows set during the financial crisis.

So as the company gets ready to report fiscal second quarter results later today, we can't help but ask: Is all of this bearishness really justified or have recent reports of RIM's demise been greatly exaggerated?

While no one can speak for the future of the company in any certain terms, one thing is clear: Research in Motion's financial performance is alive and well. In fact, with every quarter, RIM sets a new record in Blackberry unit sales and revenue. While Wall Street has now priced in a future collapse in sales, nothing in RIM's financials so far suggests such an event will come to pass. The chart below demonstrates just how explosive that revenue growth has been.

RIM Revenue

click to enlarge

Ever since Apple released its revolutionary iPhone in 2007, technology watchers have been touting the death of the BlackBerry. This, despite overwhelming evidence suggesting that both Apple and RIM have been able to successfully co-exist within the space. A case can even be made that the iPhone has only helped RIM's business by pushing smart phones into the mainstream.

In fact, RIM's best years only began with the release of the iPhone. Nearly five times as many BlackBerry devices are sold today than before the iPhone existed. Even more interesting -- BlackBerry sales continue to outpace that of the iPhone. When the iPhone was first released in June 2007, Research in Motion was selling between 1.8 and 2 million handsets a quarter. Today, it sells well over 10 million units a quarter -- a feat Apple has yet to achieve in even its strongest 3-month period.

The two charts below illuminate three key concepts in analyzing the Rim story.  First, that despite the widely accepted perception that Research in Motion is struggling to sell handsets, BlackBerry sales are up nearly 43.3% from the same quarter last year -- which were up 44.8% from the previous year.

Secondly, these charts demonstrate RIM's ability to successfully overcome mounting competition from the likes of Nokia (NOK), Google and Apple. The data also suggests that much of the bearish sentiment in the name is far overdone, and is more speculative than based on hard facts.

Thirdly, and most importantly, the smartphone market is clearly large enough to accommodate the success of more than one name. There is this big misconception on Wall Street that only one company can do well in the smartphone space -- that it's a small pie and that for Apple to do well, RIM has to do poorly. This is an ideological mistake. As anyone can see from these two charts, both Research in Motion and Apple have performed very well over the past three years. Though I'm firmly in the camp that believes Apple will soon surpass Research in Motion in quarterly unit sales, that doesn't mean that Research in Motion can't continue to put out explosive growth.

Blackberry sales

So what if Wall Street is wrong? What if technology analysts are wrong? What if, instead of collapsing, Research in Motion continues to perform well within the sector? Is the name undervalued and does it present a good buying opportunity to investors? When compared to other names in the sector, RIM does appear to be severely undervalued.

According to analysts polled by Thomson Reuters, the company is expected to earn roughly $5.55 in earnings per share on approximately $18.7 billion in revenue during fiscal 2011. This compares to the $4.38 in EPS on $14.95 billion in revenue the company earned last year. That's about 26.7% in earnings growth and 25.1% in revenue growth.

Moreover, analysts are conservatively modeling for 16% earnings growth over the next five years. Yet, the company's stock only trades at 7.5 times next year's earnings, has an enterprise value of $21.98 billion, and currently trades at one times its expected 2012 sales. For a company flush with $2 billion in cash and no debt, this makes RIM at the very least an extraordinary buyout target for a firm like Microsoft (MSFT).

The stock trades at a .51 PE to growth ratio, which suggests that the stock is undervalued by at least 50%. RIM should probably be trading at closer to $90 a share, twice what the market current values it. This indicates that Wall Street has priced-in a future collapse in BlackBerry sales to the tune of 50% of the stock's inherent value. If RIM proves that it can continue to compete within the sector, the stock can go on a huge tear. If the market bottoms, employment improves and enterprise spending gets an uptick over the next several years, RIM could be worth upwards of $100 a share.

Yet, on the other hand, any weakness in earnings could send the stock spiraling. If the company begins to underperform -- as many believe it has with its recent models, including the poorly received Blackberry Torch -- it will only justify Wall Street's bloated concerns. A highly volatile and uncertain stock like RIMM is not for the faint of heart.

Andy Zaky is a graduate from the UCLA School of Law, and editor of Bullish Cross. His main area of emphasis is in global macro-economics, fundamental analysis and technical analysis. Andy also regularly follows and conducts financial statement analysis and quarterly earnings projections for Apple and other high profile tech stocks.

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