Five Reasons RIMM Will Continue to Fall

by: Matt Stewart October 02, 2008 | about stocks: AAPL / NOK / RIMM / VZ    

Matt Stewart

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Research in Motion, Ltd. (RIMM) has fallen significantly from its all-time high of around $150 per share. As of Tuesday's close it was valued at $68 per share or roughly 4x this year's revenue or $39 billion.

Hate to tell you folks, but I believe RIMM's stock price still has further to fall. Can't say when, can't say where…but can say it is not if, but when. Here are the reasons for this argument. There are five things I can promise you about RIMM's devices and those of their competitors in the future:

1) The average selling price will continue to fall for smartphones. Just like they have for cellphones, plasma TVs, Personal computers, digital cameras, and most other hardware devices that can be copied and mass produced for less and less money every year.

2) The average gross margin for these devices will also continue to collapse. How far will they fall? I took a look at Nokia's (NOK) gross margins as a reasonable proxy for where RIMM's margins are heading.Try 35% v. RIMM's recently reported 50%.

3) At some point, these devices will "commoditize" in terms of features and innovations. It seems logical to me that consumers will ultimately be offered a cross-section of "me too" devices, trustworthy brand names, and compelling pricing. RIMM's hardware and software will also get commoditized if not out-innovated in the future.

4) Enterprises will migrate to completely open e-mail architecture to allow their users to be "device agnostic". Many enterprise accounts that only support RIMM for their users today will ultimately open up the range of hardware options for their users and put pressure on RIMM's device share in this segment.

5) Carriers will increasingly apply pressure to handset vendors either by way of bargaining for better pricing or by continuing to produce their own private label handsets in order to capture more of the vertical value chain that exists in this space. As hardware continues to be innovated, carriers have been ceding bargaining power to hardware manufacturers. But as the innovation curve flattens, the bargaining power will tilt back towards the firm closest to the customer. eg. Verizon (VZ) v. Apple (AAPL).

If you think of RIMM's market capitalization as a giant pair of shoes that the company has to grow into, follow this set of assumptions to its conclusion and tell me what you think of the exercise.

Assume that:

A. Pricing pressure reduces RIMM's average selling price to $250 per unit

B. Gross margins fall to match Nokia at 35%

C. RIMM's Price to Sales Ratio (P/S) falls to 1.5x Sales or if you like 1.5x Nokia's P/S of close to 1x Sales

Q: How many handsets does RIMM have to sell in an annual cycle to support these assumptions?

A: $39 billion Cap @ 1.5x sales = Implied Revenues of $26 billion

B: $26 billion/ $250 = 104 million handsets sold per year (RIMM shipped 11 million in the first half of this year)

Now, pick a point in time in the future when you think RIMM will hit this set of business results/handset volumes and trade at these simple valuation metrics. Then take the current share price and discount it by 10% (reasonable return) for every year out you pick.

e.g. I think it might take RIMM 7 years to sell 100 million handsets per year and that average selling prices will have to fall to $250 for these volumes to materialize.

$69 per share (Tuesday's price)/ 1.10^7 = $35 Present Value for the Stock

Monkey around with some of the assumptions and see what you come up with. My approach to this exercise asks you to think about the following question. When a market reaches maturity, should the participants in that industry/market trade at similar valuation metrics?

Should the industry leader typically command the highest premium? When it all shakes out, is it reasonable to conclude that RIMM will trade at similar valuation metrics to Nokia which currently enjoys 40% share of the global handset market and trades at a Price/Sales ratio less than 1?

I happen to think so, which is why I think the stock will trade lower over time and remains decidedly overvalued. For fun, try to guess how many handsets RIMM will sell ten years from now, pick a price per unit, multiply it out at 1x sales and discount back ten years at 10% to see what share price you get for RIMM.

Here's an example. 150 million handsets x $150 - sounds like a hum-dinger of a business to me. At 1x sales the Present Value of the Stock is $15 per share. Not to worry – if you own RIMM @ $68, it would only have to sell 600 million plus handsets by 2018 for your investment to break even on this set of assumptions.

Disclosure: None

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This article has 36 comments:

  •  
    Oct 02 05:37 AM
    Always suspected that analysts blindly pumped RIMM because they used BB's and were in love with the technology.

    Well, the chickens have come home to roost, haven't they?
    Reply | Link to Comment
  •  
    Oct 02 06:37 AM
    Agree Rimm's price trend is shaky on a technical chart basis as well as fundamentally as its moat of safety may not that solid.
    Reply | Link to Comment
  •  
    Oct 02 07:02 AM
    NOK, why not use Motorola. Sure the smartphones will mature someday, but it's still a bit early to do this comparision. NOK is suffering because they didn't keep up with Rimm and Apple.
    Reply | Link to Comment
  •  
    Oct 02 07:08 AM
    Somebody check out this guy to see if he is short RIMM.
    RIMM is "best of breed" and will come back as the market bottoms out. Dramatically, no, it will become more of a growth stock story.
    Reply | Link to Comment
  •  
    Oct 02 09:06 AM
    Very good and informative article. I absolutely agree with the conclusions. I think RIMM is going to have a very difficult year to year and a half. The close architecture (email) and the premium on the device is going to disappear in the next 18 months for sure. They have not innovated at all on the software front. Although, I will say that they have a good hardware, but it is very easy to do better by Nokia. Apple with iPhone and Android based devices will kill the RIMM leadership in this space. The killer issue will be the close-net email control that people/businesses have to sign-up for which is just not done nowadays and these other vendors providing open application support will take a lead. Granted that all these open architecture will also be a negative disruption as stupid applications will hamper the controlled setup of the phone and these vendors (including Google, Nokia) will have to learn how to provide a better controlled system. Apple already has a controlled approach with the Appstore (reminds me a lot of one of the company i used work for called Novell where we had to controll, test and certify any applications that went into our Network Operating System and we all know where that approach took us then), Apple will also learn its lesson after a couple of more launches with Android.

    SG
    Reply | Link to Comment
  •  
    Oct 02 09:19 AM
    RIMM's weakness was obvious the day the iPhone went into production. I have been telling people is was a short term play since then.
    Reply | Link to Comment
  •  
    Oct 02 09:22 AM
    "reminds me a lot of one of the company i used work for called Novell where we had to controll, test and certify any applications"

    I don't think that policy was the source of Novell's problems. There biggest problem was trying exist at all during a period when MSFT had a death grip on the whole computer industry and, particularly, on Enterprise.
    Reply | Link to Comment
  •  
    Oct 02 10:19 AM
    Well, pure brilliance. Why don`t we apply this logic to leaders in all sectors. Assume their valuations will eventually fall to the same level of the old leaders from which the new leaders are taking market share from. And do this at recessionary market levels during a financial crisis. Maybe we should just take this one step further. Since old leaders or most companies eventually cease to exist in the very long run, we can safely assume that Rimm will also cease to exist. I mean who in their right mind would want to own any stock? Give me my treasuries now.
    Reply | Link to Comment
  •  
    Oct 02 10:24 AM
    This article will be proven to be DEAD wrong. I would suggest reading the last two conference calls for obvious clues why.

    You are missing a HUGE point that the service revenue, which carries 80% margins, is currently at an annual run rate of $1.3B, and that number is increasing as they sell more devices. Even if I buy your ridiculous assumptions, you haven't included a nickel of valuation for that high margin, recurring revenue stream.

    The carrier argument is simply wrong. Carriers love Blackberry. Why? Value added subs. And the best part is that you don't have to step up to the full blown unlimited data package with the BB if the carrier offers a cheap (or pre-paid) email plan. There is huge demand elasticity in data as carriers seek to get more out of existing subs and RIM is uniquely positioned to drive this. Please look at economic incentive schemes before posting this dribble. Did I mention that RIM compresses all the data as well - yet another incentive for carriers to have BBs on their network. Just ask ATT about the $1B they have to spend because iPhones are using so much capacity (because they are such great internet devices).

    This article is poorly though out using the wrong valuation assumptions. How can you simply ignore the service fees. At least tell us they are going away. Weak. Just weak.
    Reply | Link to Comment
  •  
    Oct 02 10:50 AM
    I just want to comment on #4 as I'm not interested in how much the stock goes up or down.

    There will be no "open" email platform .. do you realize almost every company on the planet if either using Microsoft Exchange or Lotus Notes? These infrastructures require millions of dollars to function as email is critical application #1. Most large companies also have a slew of regulation / compliance they have to apply to email so the whole "bring your own device" theory is not anywhere close to being reality in enterprise. If anything it is being pulled back to support 1 or 2 preferred vendors.

    IF there was a way to manage and enforce policy across other device (which is pathetic with iPhone and non exsistent on Android) then I'd say this could happen but reality is Apple just wants to feed the iTunes ecosystem and doesn't have any chance of offering something similar to BES, Microsoft has the pieces but it's cost is at least double that of RIM's BES solution. In the next 2-3 years costs will be the biggest driver and while you can boo-hoo over the gross margin reduction it's a matter of technology maturing and being made cheaper.

    RIM will be fine until someone can compete with the BES head to head.
    Reply | Link to Comment
  •  
    Oct 02 12:09 PM
    Apple has been making iMacs for how long, and they seem to be on the uptick now because the commodity product is not as easy, "not as secure", even though Apple charges a premium.

    Blackberry needs to continue to innovate and has a number of new products coming out, hopefully they've improved their SW on the multimedia side, and browsing speed as well.
    Reply | Link to Comment
  •  
    Oct 02 01:12 PM
    If you are talking about just the lowly folkphones or even the heady heights of schmartphonedom, I might agree with scenarios that allow a fair future for RIMM. It's a good phone. But it is just a phone after all by modern metrics or by market expectations.
    I don't know what kind of ambitious vision the Googlers have for the gPhone. It could be much more than just a phone, but they have only a partial ecosystem at present with Cloud computing and Search. Just possibly they will have an Apps channel too, but it all depends on the quality of what they offer in their (as yet) non-existent store. Open may be fine in computing but risky in telephony, without quarantining measures in place.
    Apple otoh has a broadening ecosystem, and a very rich business franchise that goes well beyond telephony alone. They have a super-sophisticated, feature-rich, rapidly evolving, ultimately stable and demonstrably scalable OS. They have total hardware/software optimisation. And ITMS. The best mobile web. A real and immediately successful Apps store. A whole family of independently successful products. The best software in areas where it competes etc etc. And who knows what else is to come? A mobile teleporter perhaps to hammer transportation and commuting costs and (finally) render the car obsolete? I am waiting. The next iPhone killer app perhaps.
    But perhaps most importantly, it has two more truly winning attributes. Firstly, since 1997 Apple has a corporate vision to add to its legendary marketing imagination. Secondly, it is the only company that I know of in the fields of computing, mobile entertainment and telephony that thinks about its users wants and satisfactions as its first, middle and final priorities. Apple has learned from its many many cringe-making corporate stewardship and marketing mistakes, pre 1997.
    As for its competitors, in telephony or in computing, ask yourself this question. What are the unintended consequences of a lack of vision and imagination and the absence of a user-centric focus in a savvy marketplace with high expectations? Mediocrity, declining results and likely failure, no? Complacency and a tendency to favour the same-old same-old approach to business offerings and to customers. In a word ... WYUTIWYG or what you're used to is what you get.
    Whether or not it succeeds as well as it deserves to, Apple has given every player in its many markets a well-deserved rude shock of awakening. The music industry will never be the same exploitative biz it has always been, selling mostly crap tracks to powerless fans and groupies - each CD containing a little wheat and a hell of a lot of chaff. I'll admit there are very very few but notable exceptions to this. But this is down to the rare but talented performers who never put crap music out there. It is not due to music companies who will sell any cruddy (wheat and mostly chaff) mix to fools willing to pay for it.
    Smell familiar? Reminiscent perhaps of many bad mortgages and a few good ones being pulped into a CDO mix and then touted as good stuff and sold to the dummies in the financial sector who think they know a good deal when they see one? he he. Really, r$ally schmarrrrttttt! CD ... CDO... Hmm.
    In the telephony market, I think the Apple effect will serve to wrest market control from the grasping telcos and unimaginative (same old same old) phone makers and place it fully in the hands of the customer where it belongs. I mean if you're a customer, don't you want to call at least some of the shots? What are we? Willing doormats? I don't think so. Come on now you Applephobes, exactly what would be so bad a deal about getting great phones and fair mileage plans? Just wait and see. You'll love it.
    Finally, it's the same, but even more so, with the computing marketplace - I mean who else makes a computer that runs its maker's proprietary OS (OSX) but also provides the very best hardware platform for its chief rival's OS (Windoze)? Name me just one other PC maker. Come on now all you Apple doubters and naysayers. Just one name is all I want. And just what is so bad a deal about getting a dual platform computer for the price of a dreary, low quality, arthritic one trick pony .... errr .... I mean donkey?
    And if you can't find that name (he he), then do the brave but ssshcary thing, step up to the plate and ask the logical next question. If no one but Apple can offer this, a true USP after all, why would anyone buy anything but a Mac? Duh!! I mean what is the average IQ in America?
    At it's leisure and with the usual perfect timing, all Apple has to do is to sell some new, slightly under-specified, Macs (let's call them Schmacks say) at prices that no PC maker can match, quality standard for quality standard of course ie wheat for chaff. And by 'under-specified' I mean by Mac standards. By PC standards, they just have to slightly better the very low specs of any PC format they choose to compete with. Where would be the objection from PC die-hards? I mean, Apple's Schmack offerings would easily (also) be the best of breed in each class of PC format they choose to challenge.
    Also, what is the likelihood that, in the markets it operates in, an Apple product could ever be described as having succumbed to commoditisation?
    Short Apple whydontcha? I am buying.
    Apologies for the length of this post. I guess I'm just a Daniel Eran Dilger wannabe after all. Hmmm. Sob sob.
    Reply | Link to Comment
  •  
    Oct 02 03:03 PM
    This article is not necessarily true. And Motorola is a better comparison. They had an awesome product, "at the time", but was not able to keep innovating. There is a lot of pressure when you are at the top like RIM and Apple to keep people willing to pay the extra money for their top end phones. If RIM and Apple do fall into the trap mentioned in this article, then someone else will come along and have that next "must have no matter the cost" phone. Apple and RIM both have the cash to keep innovating through this crisis, even though sales may "not accelerate as fast" for a bit.
    Reply | Link to Comment
  •  
    Oct 02 04:13 PM
    there are parts of this article i think are exaggerations, but the fact that RIMM's products are becoming more commonplace is at least a little true. Blackberry's just really aren't that expensive anymore. RIMM definitely needs to create a new "must have" phone. I think RIMM is gonna see some some red, even though sentiment for this company is surprisingly bullish
    Reply | Link to Comment
  •  
    Oct 02 05:05 PM
    RIM have been totally, outclassed, eclipsed even, by iPhone. That won't change, it will just take some people several years to realize it.
    Reply | Link to Comment
  •  
    Oct 02 11:40 PM
    Just another "writer" writing after the fact... If RIM's numbers or forecasts would have "pleased" all the investors/traders, it would have shot up to the usual 115-120. Now that the hype and b/s hit it, the traders and wusses will drive it down until they are ready to run it up again.. And don't forget the sitution of the market anyway.. But then again, thats investing. This will just be another good traders story in the future... RIM peeps want to make money with their phones, and iPhone just want to listen to music or watch movies on that giant screen. Then again, that's the beauty of options, it doesn't matter which way the stock goes. JUST SET YOUR STOPS. LATER
    Reply | Link to Comment
  •  
    Oct 03 04:39 AM
    good article. RIMM's a decent outfit, but the stock is overvalued. has been for a long time. I hope most of you got out at 140 as I did, then went short to monetize the flip side! anyone still holding on, I'd either liquidate now, or if you have the stomach, wait for the next suckers bounce and then get out. all the Canadian bank analysts were convinced the stock would go to 200, but they've been, and will be, proved both wrong and biased in their analysis.
    Reply | Link to Comment
  •  
    Oct 03 09:30 AM
    Sounds like a lot of guess work to me. You say enterprises will, going forward replace their RIMM email architecture with ‘open’ e-mail systems. This is a pricey venture for any corporation, and I think that is where your argument is flawed. Also, you can definitely set up say, A Microsoft Exchange server and still get your e-mail pushed to you. Many Corporations, including my previous employer, take this route as it leaves options open. Even though they leave the door open they still continue to buy RIMM products, why?
    Apple, Motorola, and other Smart phone manufactures have attempted to compete with RIMM’s line of product and have on every occasion failed epically. Starting with the iPhone, not many business people would be dumb enough to even consider buying this for business use. The on screen keyboard is annoying, and not easy to use. The fact that it is all touch screen poses another user interface issue, which would be navigation. Yes the interface is easy, however there aren’t any options, you must use the touch screen. Another down fall for many people is it is made by Apple… And realistically it simply doesn’t do what a Black Berry does. Onto Motorola, as if the Windows Mobile platform didn’t suck enough, you have Motorola who doesn’t want you to lay your hands on a full version of windows mobile. So they hack it all up to crap, leaving you with nothing good, and nothing very functional.

    The only real opponent I can see of RIMM’s for business phones is HTC, but HTC also has a few problems. The HTC Touch was a failure, its screen often failed, it would freeze a lot, and does not have push e-mail. The HTC P4000 (I have this pone  ) is an ok phone, but that is for personal use. Once again no push e-mails system like the Black Berry’s. Once again running windows mobile, which has its pros and cons, the con being that my P4000 seems to freeze up on me like it’s a new religion.

    What I’m getting to is RIMM has competitors, but are they even in the same race? When it comes to Business solutions, I would think that no other company can offer a product even half as good as RIMM’s. The operating system is stable, the phones are nice and even becoming stylish, true push e-mail system, use java so software is widely available, and EVERYONE has one. I work in sales, in a retail environment and young people are constantly looking at Black Berry’s. I think RIMMS stock is just showing that the economy is slowing down.
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  •  
    Oct 03 09:50 AM
    That's what happens when you play musical chairs with stocks, expecting bigger fools to pay more than you did. Rimm was obviously overvalued. And when the "momentum investors" pull out, they all pull out, don't they? Wasn't Jim Cramer advocating this stock a few days ago? And he also said that it's good to buy overvalued companies, well here you go.
    Reply | Link to Comment
  •  
    Oct 03 11:59 AM
    If the so-called 'business users' need more than email, they will need more than RIM can produce. How much tech do you really need to sell things? Not much, apparently.

    I find it easier to type on the iPhone than the BB, and the iPhone fits in my pocket much better, and is about one million times more useful.
    Reply | Link to Comment
  •  
    Oct 03 12:30 PM
    The same logic can be applied to why doesn't enterprise allow users to bring their own laptop/pc. There is always something "better". iPhone in its current state, no matter how cool the GUI and internet is cannot compete in the security / management that enterprise need. Every year some new slick device comes out that is email capable - that is not all that is required for mobility.

    What we are seeing is the growing use of mobile devices and the cross over with personal usage and business usage. It will take some time for companies to understand what they need, how to manage it and how to apply current compliance / usage rules against WHATEVER device they deploy. At the moment Blackberry has the lowest TCO and tools to do these things via BES.

    Apple has itunes and the Appstore.
    Reply | Link to Comment
  •  
    Oct 03 01:39 PM
    Any iPhone user will defend it to death. There is no reason involved. So of course iPhone will be in every single person's pocket in the world and no other mobile phone will ever be sold again. Why try to reason an iPhonatic? It's a fool's errand. Anyone with half a brain knows the end market for these devices is huge and growing so anyone who brings value to the table will sell tons of devices.
    Reply | Link to Comment
  •  
    Oct 03 01:44 PM
    I re-read this article and it strikes me how DUMB this it is. Uses faulty valuation metrics. Never looks at earnings. Doesn't once mention how to value the service revenue. Doesn't look at carrier incentives. Pretty much doesn't add any real value to this site. Thanks for a nothing article Matt. You will be proven wrong in the next 12 months.
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  •  
    Oct 03 01:59 PM
    Questions:
    1. Why is Price to Sales the only metric you care about? Do earnings matter?
    2. When you calculate price to sales, why do you ONLY include handsets and not SERVICE REVENUE?

    Answers:
    1. YES
    2. Because your total lack of understanding limits you. So you say that RIM (not RIMM, that's the ticker, not the name of the company) could sell 100 million handsets in a few years. If that was the case, assuming the usual 50/50 split between upgrades and new subs, then 50 million new subs would be added. At ARPU of just half current ARPU of $7 (from service fees, Matt) or $3.5 per month, per sub, equals $2.1B annual revenue from JUST service fees at 80% margins, 30% taxes, that alone equals over $1 billion after tax profits, which you could easily place a 20 multiple on. And the user base would have grown dramatically if they got to those number. So you would have to add device sales PLUS service fees for existing customers and OBVIOUSLY the value of this enterprise will be far greater than your ridiculously inane target value.
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  •  
    Oct 03 08:02 PM
    Where were you when RIMM was trading in the 140's? It's easy to jump on the bandwagon when its unidirectional. Articles like this are good contrarian tools.
    Reply | Link to Comment
  •  
    Oct 03 10:27 PM
    The only difference is RIMM makes Service money monthly!
    With large margins to boot.
    it's not like Nokia, LG,Samsung,and Motorola that just make
    a profit only once when they sell the handset to the operator.
    RIMM sells the device once, then runs the Blackberry service portion
    and garners huge margins that way...

    -Your math is wrong.

    -I hold no shares, but they are unlike any other handset manufacturer.
    Reply | Link to Comment
  •  
    Oct 03 10:27 PM
    The only difference is RIMM makes Service money monthly!With large margins to boot.
    it's not like Nokia, LG,Samsung,and Motorola that just make a profit only once when they sell the handset to the operator.RIMM sells the device once, then runs the Blackberry service portionand garners huge margins that way...

    -Your math is wrong.

    -I hold no shares, but they are unlike any other handset manufacturer.
    Reply | Link to Comment
  •  
    Oct 03 11:35 PM
    Lol......I agree......Where were you when the stock was at $140........But I do agree that RIM has quite a bit more to fall. But I have no idea what he is talking about!!
    Reply | Link to Comment
  •  
    Oct 04 08:51 AM
    i definitely hold this analyst credible, a "former" rbc vp, gee i wonder why from some college i never even heard of, who cant even add. u better do your homework next time you decide to post... this just shows how easy it is for any fool to write an article
    Reply | Link to Comment
  •  
    Oct 04 10:54 AM
    You have some valid points in your 5-point argument, but some other ones that are way off base.

    I agree that there will be some margin compression. However, your argument doesn't factor in that RIM doesn't play in the low-end commodity handsets that are selling large in Emerging markets. This is the cause of much of Nokia's lower margins. RIM also has a significant high margin revenue from the Carriers as a "Royalty" for using their BES service. This is huge margin.....

    As well, I have heard this open Architecture argument for years. I used to be a Carrier Sales Manager, and we were concerned years ago that RIM was taking up too much of this market, almost a Monopoly status. We tried to push other technologies (Visto, Good, Microsoft Exchange, etc). While they all had some functionality, none of them could match the slickness, security and reliability of the BES/BlackBerry combination. Even when companies tried to use the RIM software on their devices, such as Palm and CE, it never proved to be as reliable.

    I am long on RIM, having just bought some this week. Are you sure that you are not Short?
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