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(Jason Scott)
(Jason Scott)

Vox

RIM's best days are behind it Add to ...

Fabrice Taylor is a chartered financial analyst. He can be reached at ftaylor@globeandmail.com

Someone is very, very wrong about Research In Motion Ltd.

In one corner, the analysts are predicting - fingers crossed no doubt - profit of $4.17 (U.S.) a share for the current fiscal year ending in February and $4.89 for fiscal 2011. The growth rate from 2009? An astonishing 19 per cent compounded annually.

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In the other corner, though, is "the market." Investors love growth and pay dearly for it. Collectively, investors are pretty smart. The market is rarely wrong, though it can be. It's telling us that those estimates are hopelessly optimistic.

How do we know? Because RIM is changing hands for a paltry 13 times estimated earnings. Bell Canada, ye olde telecom shoppe, trades for 11 times and its earnings are only growing at 5 per cent.

As even one bullish RIM analyst put it, the company should be trading at 20 times earnings. So who's right? As a scarred veteran of the contrarian wars - aka betting against the tape - my money is with the market.

RIM's glory days are behind it. Best-case scenario is that it keeps growing in terms of business and deteriorating in terms of returns to investors. The worst case is that it ends up on the technological slag heap like so many once-profitable and successful firms.

It's not a complicated story. RIM is facing intense and growing competition. Even if it stickhandles its way through it flawlessly, its business will be hurt by it. There's the iPhone, of course. Personally, I prefer the BlackBerry, but Apple is gaining market share.

But while the iPhone gets all the press, other players are quietly sneaking into the market. Earlier this month, Verizon Communications announced a new partnership with Google Inc. to start selling smart phones that use the search giant's Android operating system. Verizon, for the record, is RIM's biggest customer.

Furthermore, the CEOs of both companies attended the conference call to announce the partnership. That means they see it as a huge opportunity and priority.

Verizon's CEO was diplomatic when he said the new relationship wasn't necessarily bad news for other smart phone makers since the market, which he said was growing briskly, is not a zero-sum game.

But, come on. Google, if successful in smart phone technology - it doesn't make handsets, just software and applications - will take a lot of market share at the expense of other players.

Other optimists point to Asia as a huge growth opportunity for RIM. They point out that 70 per cent of the company's revenue comes from North America so tapping the fast-growing Asian market could light the stock on fire.

The problem is that Asia isn't North America. They don't pay hundreds of dollars for a handset in India or China. In fact, the way handsets are sold in Asia is very different. They tend to be supplied by retailers as opposed to carriers. RIM likes to sell BlackBerrys to relatively affluent people. This is not the high-end market, and it's not a market RIM has experience in.

Nokia Corp. does, and so does Sony Ericsson. Both are massively accelerating their smart phone offerings, and they'll be competitors in North America too, at least to a certain degree. So will Palm Inc. and all the others. There's just too much money to be made.

So that spells trouble for RIM, and might explain why the market won't pay for what the analysts claim are the company's growth prospects.

You can, in fact, already see the beginnings of decline in RIM's numbers. The company missed estimates in the latest quarter by a country mile. And, as the accompanying table shows, while unit sales and revenue are up sharply, so are the costs, meaning profit is down, relatively speaking (that is, profit margins). Sure, selling, marketing, and research and development, taken together, are about flat as a percentage of revenue. But you'd like to see some economies of scale there; the profits of companies with true competitive advantages balloon as revenues rise. And the company, like any tech concern with little in the way of a competitive moat around it, is plowing all of its profit back into the business.

It's getting more expensive to drive revenue. I'll bet you that trend accelerates even if RIM executes perfectly.

But will it do that? The company doesn't seem like the innovator it used to be. It's reacting to competitors rather than leaving them in the dust (why does my indispensable BlackBerry not adjust to a change in time zones, the way a dumb phone can?). One of its CEOs runs around picking fights with government (politicians are remarkably vindictive) and chasing hockey teams, while Google and Apple are rolling up their sleeves behind his back and some telecom providers are cutting subsidies for handsets.

If you agree with my assessment, you have to wonder what even flawless execution means. I think the stock is unattractive, even under that scenario. And that might be wishful thinking.

****

Number Crunching BlackBerrys

Looking at RIM's expenses and profits as a percentage of revenue shows that profitability (if not absolute profit) is falling as R&D and selling costs rise.

6 months 2010

6 months 2009

Revenues (millions)

$6,949.2

$4,819.9

Cost of sales

56.2%

49.3%

Gross profit

43.8%

50.7%

R&D

6.6%

6.4%

Selling, marketing and administration

13.6%

14.7%

Amortization

2.0%

1.7%

Litigation

2.4%

n/a

Operating profit

19.6%

28.7%

Taxes

3.5%

8.4%

Net income

16.1%

20.3%

Cash from operations

$1,195.8

$599.1

Investments

$919.3

$674.6

Free cash flow

$276.5

-$75.5

 

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