Research In Motion: Don’t Look, Listen December 28, 2012Posted by Ishmael Chibvuri in Latest Articles!!!.
We’ve been here before. Research in Motion (RIMM) puts out good news, boosting the stock, only to see significant losses once CEO Thorsten Heins starts talking on a company conference call.
The first time came in January, when Heins was named to replace former co-CEOs Jim Balsillie and Mike Lazaridis. The stock jumped 5% in pre-market trading, less in anticipation of the little-known Heins than in relief that the struggling former leadership had been replaced. That jump on its own created nearly half a billion dollars in shareholder value. But as soon as Heins started talking on the introductory conference call, the stock began to fall. As TheStreet.com noted, the stock went from up 5% to down 2% by the time the call had wrapped; the stock would finish the day down 8.5%. From the time the call started to the end of the trading day, RIMM’s market capitalization fell by more than one billion dollars.
On Thursday, after RIM’s release of third quarter earnings, investors saw a similar pattern. The numbers — $2.7 billion in revenue and an adjusted loss of 22 cents — beat estimates, with gross margin also rising sharply year-over-year. The stock — which had already doubled from late September lows — rose as high as 9.8% in after-hours trading, after a 3.5% gain in the regular session.
But, once again, the conference call got in the way. As SA contributor Tufenk noted, the share price began to turn once Heins began discussing a new model for service revenue. Here is the relevant passage from the conference call:
Subscribers that require enhanced services, including advanced security, mobile device management and other services, are expected to continue to generate monthly service revenue. Other subscribers who do not utilize such services are expected to generate less or no service revenue. However, I want to be very clear on this. Service revenues are not going away, but our business model and service offerings is going to evolve. Our vision is to position BlackBerry as the clear leader in the enterprise mobility market. While the mix and level of service fees revenue will change going forward and will be under pressure over the next year during this transition, but we are targeting to grow service revenue in smartphones, tablets and embedded application to a new offering with new partners and across platforms other than BlackBerry 10.
This, of course, is big news. Service revenue accounts for one-third of RIM revenue, with higher margins than the company’s hardware segment. And that simple declaration sent RIMM into a tailspin. RIMM would reverse in after-hours trading, continue to fall Friday, and even drop another one percent after-hours Friday. All told, RIMM fell more than 30 percent from its after-hours high Thursday to its after-hours close Friday; over that span, its market value dropped by some 2.4 billion dollars.
The dramatic swings act as a metaphor for the RIMM thesis: the numbers often look good, but significant questions about the management and direction of the company remain. When I first wrote about RIM a nearly a year and a half ago, I noted the company’s tremendous fundamentals and strong cash balance. But I also called the company a "value trap." "This is not value investing — this is looking for a turnaround," I concluded.
The stock closed that day at $26, better than double Friday’s close of $10.91. Yet RIMM bulls — and RIM management — continue to persist in using trailing fundamentals to justify investing in a company whose future is in significant peril. On the post-earnings call, CEO Heins noted the company’s cash balance had grown to $2.9 billion, "demonstrating our financial strength." CFO Brian Bidulka noted the cash balance had grown $600 million, which "reflects strong cash from operations."
But the cash growth is, essentially, an illusion. Free cash flow for the first nine months was $1 billion, but $903 million of that cash came from working capital adjustments. Notably, inventory dropped by $570 million while accounts receivable fell by nearly $900 million. That is not cash generated by successful marketing and popular products; it is simply a short-term boost from admittedly improved management of working capital. And it will be reversed; as Bidulka noted later in the call, there will be a significant cash drain caused by WC adjustments in the fourth quarter, as the launch of BlackBerry 10 will create an increase in inventory and AR.
In a nutshell, this shows the problem with investors who continually value RIMM based on its fundamentals: its fundamentals are constantly eroding. Last summer, RIMM seemed a steal with a price-to-earnings ratio of 5 or 6; now its earnings are gone. Now, RIM bulls tout the company’s book value — which has declined over the last nine months — or its cash balance, which will be lower in just three months.
It all goes to show that what I wrote a year and a half — and 59 percent — ago still stands: Research In Motion is a turnaround play, not a value play. The company must execute on the BlackBerry 10 launch, and must prove that it can once again compete with the likes of Samsung (SSNGY.OB) and Apple (AAPL). That is what matters for RIMM stock: where the company is going, not where it is right now.
And while Heins has certainly made tougher decisions, and shown more awareness of the company’s position than his predecessors, it still appears that RIM has management issues. Indeed, look at last week’s drop. The announcement of a change in service pricing dropped the stock by over twenty percent. Yet neither Heins nor other executives thought to mention the pricing change in the press release, highlight the new policy away from the earnings release, or provide a detailed defense on the switch in the conference call’s prepared remarks. Analysts were clearly taken aback by the change; the first two questions in the Q&A directly related to service revenue pricing, with further questioning coming later in the call. Heins went on CNBC Friday to assuage investor concerns, an exercise in damage control that clearly did not work.
This is not to say that Heins’ primary focus should be the opinion of Wall Street analyst, but the company’s decision to casually mention a key change in its business model shows the same type of tone deafness that has characterized its treatment of not only investors, but customers, employees, and developers for the last few years and brought the stock down to its current level. Heins then added to the problem in the Q&A portion of the call by not being able to add more detail to the company’s plans, promising only to "provide more insight" as the launch nears.
Of course, that launch is barely a month away; given RIM’s past history of being seemingly unprepared for major releases, analysts are right to be worried about how exactly the new tiered pricing will be designed. The little specifics that Heins gave were largely negative, as he told an analyst that there would be a hit to the top line. "We’re trying and working hard to make this as easy as possible in terms of the financial impact. However, right now, it is too early to say how that will evolve really in concrete numbers," said the CEO. Heins closed by adding, "we are absolutely confident that we can manage that transition competently."
The problem is that investors have no reason to share that confidence. Yes, some of RIM’s numbers look good — but they looked good at $35, $25, and $15 per share. Don’t look at the numbers; listen to RIM management. Unfortunately, it doesn’t appear that much has changed.