RIM Looks Oversold but Here’s How to Justify it

Research in Motion (NASDAQ:RIMM) stock has taken a pounding in the past few months sliding more than 50% since the beginning of the year from $58 to around $27 today. It touched a high of $70 in February before the free-fall. We have a $43 price estimate for RIM stock implying a more than 50% premium to the market price. This view is predicated on the assumption that RIM will turnaround its BlackBerry fortunes and regain some market share in the smartphone segment from competitors Apple’s (NASDAQ:AAPL), Nokia (NYSE:NOK), Motorola Mobility (NYSE:MMI) and Samsung, which would help boost margins. Nonetheless given the current trend we look at what drivers would cut our estimates in half and justify the market’s pessimism for RIM.

Here we will highlight 3 downside scenarios to some of the most important drivers:

1.  RIM’s mobile phone market share: We expect RIM’s market share of total mobile phones sold to stabilize going forward and reach 3.6% by the end of our forecast period from from 3.2% in 2010.

2.  RIM’s BlackBerry phones gross margins: We expect BlackBerry phones gross margins to decline from 37% in 2010 to around 27% by the end of Trefis forecast period.

3.  SG&A % of gross profits: We expect RIM’s SG&A expenses to increase dramatically in 2011 when compared with the gross profit growth. However, we expect the company to control expenses and for this to flatten our going going forward.

How $28 Trefis price estimate for RIM stock

1.  Mobile Phone Market Share Slips Further (-20%):

RIM is expected to transition from using BlackBerry operating system to QNX operating system for its smartphones by next year. QNX OS performance is considered much better than BlackBerry OS, and hence we believe this transition could bring some life into its smartphone suite and help regain some market share. However, the market seems to have throw in the towel, and due to a lack of new products in the near future and continuous delays in implementations, confidence has dropped considerable in the past few months.

In a scenario where RIM’s market share continues to decline to about 2.5% in the long term instead of leveling off as we forecast, there could be downside of 20% to our price estimate for RIM stock.

2.  Gross Margins (-10%):

We expect gross margins to decline sharply in 2011 and then steadily drop thereafter. We believe the competitive edge that RIM had with features like BlackBerry Messenger (BBM), corporate security and push email have all been lost as other smartphones have evened the playing field. The recent announcement from Apple to come up with its iMessage service is a direct assault at RIM’s BBM service, which has been quite popular with consumers. The downside of BlackBerry phones becoming more commoditized is that it will need to compete on price to maintain sales and thus compromise on its gross margins.

However, the market seems is pricing in a faster decline in gross margins on top of the 4 percentage point drop expected in 2011. In the scenario where BlackBerry’s gross margins decline at a faster rate to reach 20% in the long term, there could be additional 10% downside to our RIM value.

3.  SG&A to Gross Profits Stays High (-15%):

We expect the company’s SG&A expenses as % of gross profits to increase dramatically in 2011 before steadying in the medium term. We believe that the company will be able to manage its expenses going forward through job cuts and carefully choosing its product portfolio. During the recent earnings release, the company announced job cuts to streamline its operations by removing the redundancies. ^[1]

In another recent development, RIM might have stopped the development of its 10-inch PlayBook 2 tablet to avoid direct competition with Apple iPad. (See: Why RIM Would Throw in the Towel on Playbook) This goes to show that the company has started to carefully chose its product portfolio to save on SG&A and R&D costs associated with product development.

However, markets seems to be taking a short-term view and seems to be punishing RIM’s stock for its inability to manage expenses. In the scenario where RIM’s SG&A expenses as % of gross profits increase continuously to reach 40%, there could be downside of about 15% to our estimate for RIM’s stock.

See our complete analysis for RIM stock here

1. RIM FY Q1 2012 earnings press release, June 16th 2011 [↩]