Investoid

Last week I talked about what makes a good technology growth stock investment. Not all technology stocks fit into this category nowadays, as the several areas of the technology sector have matured (eg. operating systems, networking gear, database software, etc.) and are no longer going to have the growth to justify high P/E valuations.

Research in Motion (TSX: RIM, Nasdaq: RIMM) is a company that can still be seen as a growth stock (or at least has to be given its Price /Earnings ratio). RIM one of the darling stocks on the TSX. It enjoys high institutional investment, strong growth in the past 7 years, and a killer product known around the world (how many companies get their product affectionately entitled a drug by their users). Nonetheless, from a valuation perspective I don’t think RIM is a good investment.

Company Analysis

• RIM is run by co-CEOs Jim Balsillie and Mike Lazaridis. While this is an unusual setup for a large company, is has worked extremely well for RIM. I’ve listened to Jim speak at the Banff Venture Forum and he is a very down to earth person with little ego. I believe that management is quite solid and has a solid performance record with this company.
• Luckily (from a business perspective), Balsillie was ousted as the Pittsburgh Penguins owner, meaning he can focus on the business full time.
• About 75% of RIM’s revenue is generated by its BlackBerry device sales, with most of the remainder from service agreements with carriers and large businesses and a small amount in software sales.
• Gross profit has been increasing steadily, from 39% in 2002 to 57% last year.
• The company has been profitable for over three years and has been growing earnings per share by nearly over 200% in that time.
• The company places a high value on R&D, spending over $150M last year. As a percentage of revenues, R&D spending has decreased from 12% in 2002 to 7% last year.
• The BlackBerry is the undisputed leader in corporate e-mail devices. Most major companies have invested in RIM back-end hardware and software to facilitate push-email technology.
• RIM has a strong intellectual property war chest for its proprietary hardware and software. Nonetheless, it is at continual risk of litigation given the complexity and vast popularity of its offerings, and the company has had to pay large settlement fees in the past (most notably to NTP).
• The company has been attempting to make inroads in the growing consumer market for hybrid phone/e-mail devices. The BlackBerry Pearl is the company’s current mainstream offering.

Competitive Landscape

• Previously, the company’s main business competition was the Treo line of products made by Palm. However, today there is a growing number of smartphone manufacturers coveting both the business and consumer markets.
• Some major manufacturers include HTC, HP, Samsung, Nokia, and Motorola.
• While RIM has its own Java-based operating system, most other manufacturers (except Nokia and to a certain extent Palm) have opted to use the Microsoft Mobile platform.
• This increased competition is likely to squeeze profit margins as manufacturers attempt to gain market share through aggressive pricing and heavy marketing.
• RIM has not had an unqualified success in terms of Pearl sales, as RIM is discovering that the consumer market is looking for additional and different features than what the business market is accustomed to.

Personal anecdote: I have looked at getting the BlackBerry 8800, since RIM’s products have a solid reputation for quality. While the 8800 had most of the features its predecessors lacked and that I was looking for, I couldn’t believe they still didn’t have Wi-Fi available. To me this was a deal-breaker, since so many GSM smartphones like the HTC TyTN have this and more.

RIM seems to be serially 18-24 months behind in terms of features. When Jim was asked about this in late 2005, he indicated that they saw it as a tradeoff in dependability versus getting hot features out quickly.

I see parallels between RIM and Nortel in Canada (not necessarily because of some impending collapse on RIM’s part). Everyone knows RIM’s story and as a result I think there’s a disproportionately high amount of individual and institutional investment in this stock, which is part of the reason for its high PEG valuation relative to its peers.

Given RIM’s volatility, I would be foolish to say that people can’t make good money by investing in (or trading) this stock. And management may easily prove me wrong – they’ve been counted out before and have merely produced extremely high growth fairly consistently. Nonetheless, I believe the company will underperform the market over the medium term.