Will RIMM's impressive surge end badly?
The maker of the BlackBerry smartphone is unveiling the fruit of a crucial and long-overdue makeover. How should investors play it?
Since bottoming out at $6.22 a share in September, Research In Motion (RIMM) surged to briefly surpass $18 within the last week. The rally seemingly came out of nowhere; many investors simply assumed the maker of BlackBerry smartphones was bound for the technology sector's graveyard.
In hindsight, it's clear most investors were overlooking the ample cash on the company's balance sheet, a still-impressive user base of more than 75 million people and a likely appeal for potential buyers at such distressed levels.
Yet many factors point to a possible imminent pullback reversal for RIMM, perhaps by a significant amount. In fact, some suspect that Wednesday may be when shares start to lose steam. That's when Research In Motion will release the much-anticipated version 10 of its operating system.
A fresh start
The newly-revamped software is expected to yield greater functionality, finally enabling the company to truly compete with the more dominant platforms from Apple (AAPL) and Google (GOOG). These two companies control 90% of the smartphone market, so if RIM can pick up lost market share, this may prove to be one of the greatest turnaround plays of the current era.
But short-sellers have a different take.
They have been boosting their positions in RIMM at a steadily rising pace, even as the company has started to see bullish interest from long-oriented investors. RIMM is now the fourth-most-heavily-shorted stock on the Nasdaq, after Sirius XM Radio (SIRI), Intel (INTC) and Frontier Communications (FTR).
Why do short sellers doubt that Research In Motion's resurgence is for real?
First, many short-sellers remain unconvinced that even with a refreshed product line and software, the company can compete with Apple and Google. They note that Microsoft (MSFT) is working feverishly to build market share in the smartphone space, so in their view, it's impossible for RIM to garner double-digit gains, which would represent growth at twice the current level. (Microsoft publishes MSN Money.) Market research firm IDS predicts that Research In Motion will control just 4% of the smartphone market by 2016.
Second, short-sellers say that the company's decision to eliminate monthly service fees for consumers will deeply damage the income statement. These monthly fees, which average $4 per user, carry very high margins, offsetting the fairly low-margin profile of the hardware business.
In recent years, service revenue has accounted for roughly one-third of sales, though that looks set to decline in coming years.
RIM will still impose fees on enterprises that demand greater security, and other bells and whistles. The company notes that more than 60 companies in the Fortune 500 are testing its new software, but it's unclear how many of them will commit to sticking with the BlackBerry platform. After all, many employees now have smartphones that run on Apple or Google's software, and are not necessarily inclined to give them up.
Also, companies will take their time before making major moves. "Our own checks suggest enterprises will take at least four to six months to test the new BB10 OS," predict analysts at Citigroup.
Third, RIM's impressive growth in emerging economies may be at risk. Markets such as India and Indonesia have become a key source of growth, but a number of Chinese and Korean vendors have revealed new models that will be priced far lower than RIMM's current offerings.
Fourth, short-sellers have been looking at what happened when Palm released a new phone in 2009, which was expected to sharply boost the company's flagging fortunes. Shares ran up in anticipation of the release, but subsequently tanked after the phone was released and as sales came in well below forecasts.
The bull case
There are good reasons why another camp of investors has become bullish. These investors note that wireless service providers such as Verizon Communications (VZ) are likely to throw considerable marketing support behind the new BlackBerry phones. These companies know they will be able to reduce the subsidies provided to the major hardware players like Apple if there is greater competition.
And unlike Palm, RIM has nearly $3 billion in cash and has the staying power to wait as market share rebounds. Indeed, even with hefty spending associated with the launch, RIM will still likely have more than $2 billion in cash a year from now. RIM's burn rate should be tolerable as marketing spending rises, in large part because management has already taken roughly $1 billion in overhead out of the business. To boost cash, management has even hinted it may look to sell off the hardware business.
Lastly, bulls note that if the BlackBerry is able to stay even moderately relevant among enterprise users, the company might become a solid acquisition target for a company like Microsoft. To be sure, this argument was a lot more valid when shares were trading in single digits.
Wall Street's view
A few analysts who follow RIMM have become increasingly bullish as well. RBC Capital, for example, raised its price target to $19 from $11, though this represents only about 10% upside. Jefferies also upgraded the stock, to "buy" from "hold," with a $19 price target. The analyst say RIM's decision to allow the BlackBerry email service to run on Apple and Google's smartphones is a wise one.
But most firms take a dim view. Here's a quick sample:
- "We consider the recent gyrations in RIMM's stock to reflect trading momentum with no fundamental change in RIMM's outlook yet. We are retaining our stop price target of $9.50," note analysts at UBS.
- Merrill Lynch sees shares falling to just $7. "In our view, RIMM's long-term outlook seems unlikely to improve and its strategic options are diminishing."
- Analysts at Citigroup are perhaps the most bearish, with a target price of just $6 a share. They predict that RIM's profit margins will slump badly as service revenues start to diminish.
- Goldman Sachs' analysts have a binary view of the stock. If the company can indeed regain its footing and boost sales in coming years (which is 30% likely), then shares are likely worth $30. But if RIM's steady downward spiral in revenues continues (which they believe has a 70% chance), then shares are worth just $11.
Action to take
Though shares have performed remarkably well, they could keep rallying yet higher if the new lineup of BlackBerrys gets off to a strong start. But considerable headwinds remain in place, and official launch could mark the end of the recent period of euphoria.
Short-sellers are betting that Research In Motion has lost valuable ground to Apple and Google that it will never make up.
If you've owned this stock all the way up from the September lows, it may be a wise to take profits.
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