Friday, November 12, 2010

Rule #1 Analysis Blitz #2: Research in Motion (RIMM)


A couple of years back, I bought a few copies of Rule #1 to give out to friends (yes, I liked the book that much!).  One of them was Matthew, my good friend, to whom I introduced my cousin, who he later married.  In return, he introduced my lovely wife, Renee, to me.  Not a bad deal!  So, anyway, I don't think he ever read the book until recently, when he fell ill for a few days and decided that it was time to crack it open.  I was actually quite impressed, because he churned out 8 Rule #1 analyses and sent them to me.  I now present one of them to you, and will also make some comments on the 4 "Ms".

The company in question is Research in Motion (RIM).  It's not a name that is exactly a household name, but its product definitely is.  Do you know which product I'm talking about?  It's none other than the ubiquitous Blackberry!  Not many people (outside Canada) know this, but RIM is a Canadian company, based in Waterloo, Ontario.

At this point, I must digress and tell a story.  It was the year 2001, my friend Archie, my cousin Kelvin, and I went to Europe for our grad trip.  We landed in the London Gatwick airport and the first 3 ads we saw after getting off the plane were of Nortel (now non-existent), Celine Dion, and Blackberry, all of which were products of Canada.  I felt so proud at that moment, and to this day, I still find it quite amusing.

Back to RIM...There has been quite a lot of murmuring going on about RIM.  As you know, Android (Google's smartphone OS) burst onto the scene a couple of years back and is now taking significant market share from RIM.  RIM's stock was recently downgraded by an analyst at Kaufman Brothers.  However, there are some good things happening with the company.  It recently came out with the Blackberry Torch, which sports a new version of its OS and was somewhat well received.  It also announced its PlayBook, its answer to Apple's iPad.  So, let's take a look at what Rule #1 tells us about RIM!

Moat
Before I start, you can download the completed spreadsheet here.

Let's go straight to the Big 5s!  What do we have here?...a sea of green!  That's usually a good sign.  9-year average of annual ROIC is 12.7%, annual sales growth a whopping 59.7%, and annual BVPS growth an impressive 24.4%.  The 9-year average annual EPS growth has a negative number.  Upon some investigation, it was found that 10 years ago, RIM had lost money, which resulted in a negative EPS.  So, the growth number became negative.  Looking at the annual numbers, EPS growth was very green for all years except one...excellent!  The last is free cash flow growth.  Data only extends to 5 years, so there is no 9-year average.  The 5-year average has an "Invalid Data" output.  This happens when something goes wrong with the math.  Checking the numbers, 5 years ago, there was a negative cash flow.  This negative number was the culprit.  So, looking at the individual numbers, cash flow increased from a negative $52 million to $1.6 billion in 5 years.  Awesome!  RIM also has 0 debt!  As far as Big 5 numbers go, RIM scores a perfect 10.

That was the quantitative part.  Now, let's talk qualitative!  As I mentioned above, Android is eating everyone's lunch, maybe with the exception of the iPhone.  RIM's stock has been punished for the last little while.  If you think back about 4 years (before the iPhone came out), when someone said the word, "smartphone", what would come to mind?  It would be a Blackberry...and maybe, just maybe a Palm Treo.  RIM had its moat back then.  There was no other phone that could do email even close to what Blackberries could.  Nowadays, when you think smartphone, you have a myriad of devices including the iPhone, the Droids, the HTCs, etc.  Blackberries have lost their appeal.  Its last stronghold is corporate email, and even that last leg is a little shaky.  Make no mistake, RIM has lost its moat.  It needs to get its mojo back!

RIM does have one thing on its side, and that is a megatrend!  Mobile internet is going to be huge and it will grow to be as large as the internet itself.  There is a fundamental shift from feature phones to smartphones happening right now.  What this means is that even though RIM may be losing market share, its sales (and profits) may continue to grow because more and more people are buying smartphones.  It is not a zero-sum game.

Quantitatively, RIM has all the ingredients for a great moat.  Qualitatively, that moat is already gone.  Given its consistent history, I will rate its moat a 7.

Moat Score: 7 / 10

Figure 1: Rule #1 Analysis of Research in Motion (RIMM)

Margin of Safety
At time of writing, RIM's stock was $58.00.  From Figure 1, we can see that the entry price is $38.23.  The stock is about 50% higher than we would like it to be.  The current PE is only about 12; I'm going to leave it as 15.6 for the analysis.  I think we can be a little more optimistic than the analysts and crank that number up to 17.5%.  That would give us a revised entry price of $50.39.  That's still below the current share price.  If you're going to buy this stock, it's going to be a little risky.

The payback time, however, is looking pretty good at 6.7 years.  This is a difficult one.  Margin of safety is not truly there, but payback time looks good.  It's not absolutely horrible, but not a home run either.  RIM gets a 7 for margin of safety.

Margin of Safety Score: 7 / 10

Management
Management is kind of a fun one here.  RIM has 2 co-CEOs: Jim Balsillie and Mike Lazaridis.  Jim Balsillie is the extravagant guy who busies himself with attempts to buy an NHL team and moving them to Hamilton, Ontario.  Click on the link above and you'll see that 80% of the information on Wikipedia is about his NHL dealings.  Sadly, this character graduated from the same university (University of Toronto) as I did...

Lazaridis is the founder of the company and is the guy who probably does all the work at RIM.  He is in less of the limelight than his partner, Balsillie.  He is quite philanthropic, having founded the Perimeter Institute for Theoretical Physics.  He also gave a big chunk of money to the University of Waterloo.  Anyway...if there's one thing about CEOs, it's that if they are the founder of the company, chances are he's good.  To name a couple of examples, Bill Gates (Microsoft) and Steve Jobs (Apple).  Why is that the case?  It's very simple.  The company is his/her baby and he/she has probably got a pretty big stake in it.

Insider trading information was not readily available on Yahoo Finance or MSN Money.  Not too sure why, but it being a Canadian company may have something to do with it.  So, can't comment on that too much.

Overall, I believe management is quite good, but there's no direct data to support it, except for the fact that the company has ruled the smartphone space for many years.  They are reacting well to competitors with the introduction of the Blackberry Torch and the PlayBook.  I think there's still some juice left in the company.

Management Score: 7 / 10

Meaning
RIM is an easy company to understand.  If you understand how Blackberries work, you already know 95% of what the company does.  You may want to investigate into its competitors, namely Android and iPhone, and how these two platforms are taking market share.  Also, keep you eyes on PlayBook as this could be a significant revenue driver or a significant flop.

As for the ethical aspect of RIM, I see it as fairly neutral.  There was an accounting issue a few years back.  Since then, Jim Basillie had resigned as chairman to be in line with best practices in corporate governance.  From that point on, not much has occurred to make this company suspicious of unethical activities.

The business itself is beneficial to our society.  Blackberries were designed to improve efficiency, even though some may argue that they have caused a whole slew of other problems, including tying employees down to work even on weekends and weeknights.  Business people like them and now, consumers like them too.  I think RIM is a company that contributes positively to society and, therefore, "investable" in this regard.

Meaning Score: 8 / 10

Summary
Moat Score: 7 / 10
Margin of Safety Score: 7 / 10
Management Score: 7 / 10
Meaning Score: 8 / 10
OVERALL (not an average): 7 / 10

All-in-all, RIM would be a good candidate if you're looking for a tech stock.  However, keep 2 things in mind: i) margin of safety - the stock is not overpriced, but it's not very underpriced either, and ii) competitors - watch out for Android.  If you start seeing companies allowing employees to use their Android phones or iPhones to access corporate email, RIM may be on its way to obsolescence.  Keep doing your homework!