Upon doubling down on his stake in Research In Motion Ltd., Prem Watsa cited the great investor John Templeton as saying "the best investments are made at the point of maximum pessimism."
For a value investor like Mr. Watsa, RIM's stock is attractive because expectations surrounding the company have sunk so low. It's easy to make the case that the iconic firm is trading below its liquidation value.
But for investors thinking about emulating Mr. Watsa, the problem is that RIM isn't liquidating. And that suggests an investment in the company could lose even more money over the course of the next few quarters.
Mr. Watsa, whose Fairfax Financial Holdings Ltd. now owns just short of 10 per cent of RIM, has already endured major losses on his investment in the smart phone maker. His average cost is about $19 per share, estimates analyst Kris Thompson of National Bank Financial.
RIM is now struggling to stay above the $7 mark – even though a "sum-of-the-parts" valuation suggests it should be worth more.
The math behind that estimate is relatively straightforward.
First, RIM has nearly $2 billion in cash and short-term investments. With 516 million shares outstanding, that works out to almost $4 per share.
The company values its patents at roughly $3.3-billion. An unreasonable number? Not at all, suggested the New York-based intellectual-property firm Envision IP Inc. in a recent piece on the Cantech Letter blog.
RIM says it has about 3,300 U.S. patents, which would mean each is worth about $1-million. The sale of Nortel Networks' patents yielded around that amount, while Google's deal to buy Motorola Mobility suggested a $735,000 per-patent price, Envision says.
Envision believes RIM's patent portfolio has an average remaining life of 13.5 years, versus 9.4 at Nortel and 8.1 at Motorola Mobility. "The additional four to five years on the life of its RIM's patent portfolio over the Nortel and Motorola Mobility patents is certainly valuable, as it gives RIM (or a potential acquirer) that many more years to obtain licensing revenues and possibly damage royalties through litigation," wrote Envision's Maulin Shah and and Farhan Mustafa (although they also hedge by citing cheaper per-patent amounts in other, smaller deals.)
If we use the $3.3-billion figure, that adds another $6.50 per share. Patents and cash alone, then, are arguably worth more than $10. And this places no value on RIM's network and corporate subscriber base.
The problem, however, is that this is the value as of June 2, the end of the company's fiscal first quarter, and the company is now running at an operating loss.
T. Michael Walkley of Canaccord Genuity, who has abandoned earnings-based valuation models because of the low likelihood of actual earnings at RIM, says he places zero value on RIM's cash because the company "will likely start burning cash." Any acquirer of RIM would likely exhaust the cash supply through severance payments, he believes.
Mr. Walkley assigns a value of $2.75-billion to RIM's enterprise subscriber base and network architecture and just $2.5-billion to the patents because roughly $800-million of them came from Nortel and are owned as part of a consortium, not outright, and would be difficult to sell. The consumer business is worth zero, he says, and any acquirer "would likely need to spend considerable cash" to shut it down. The result is a $10 target price.
That is optimistic compared to some of his peers. Peter Misek of Jefferies & Co., who drily notes "execution risks will continue as RIM plans to lay off 5,000 of its 16,500 employees by February while at the same time launching the most pivotal product in the company's history," has a $5 price target. If the Blackberry 10 rollout is pushed back much further, he sees cash per share falling to $3.50 — and that will also become the share price, he argues, as investors place no value on any elements of the business.
Who could save RIM? The team at Nomura Equity Research believes only a company that owns or controls a major operating system — Apple, Google or Microsoft — is a logical buyer.
But, they say, Microsoft is busy with Windows 8 and might not want to disrupt its relationship with Nokia. Apple "has shown no historic interest in major acquisitions." Google will do deals, particularly with patents involved, and could use RIM's applications to boost its Android offering to corporate customers. But, says Nomura, Google's deal for Motorola Mobility just closed, and its desire to double up is unclear.
The comment about maximum pessimism, then, has a solid underpinning. Investors who follow Mr. Watsa's lead and buy are indeed getting RIM for less than it's worth today. But the problem for RIM isn't today – it's tomorrow.