How to assess RIM’s turnaround
Special to The Globe and Mail
Published Monday, Feb. 04 2013, 8:15 PM EST
Last updated Monday, Feb. 04 2013, 8:15 PM EST
Chris Umiastowski is the growth investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.
Research In Motion has a new name and a new product line. Now it’s enjoying something equally novel – positive reviews.
Shares in the smartphone maker jumped 15 per cent on Monday after Bernstein Research upgraded the stock to “outperform” following last week’s unveiling of the company’s new BlackBerry 10 phones.
As I write this I’ve been using my new BlackBerry Z10 non-stop for five days and I’m impressed. The new BB 10 operating system is stunning, fast, and powerful.
But does all of this make the company a good investment? The company, which is in the process of changing its legal name to BlackBerry, has turned an important corner, but I’m not convinced it will return to heady days of double-digit growth any time soon.
The manufacturer’s biggest problem is the need to win over the armies of buyers who have flocked to Apple and Samsung. In the three months to last November, BlackBerry accounted for a mere 7.3 per cent of smartphone subscribers in the United States, according to ComScore.
Until last week, BlackBerry had been bleeding market share and its sales and profitability were nosediving. Kantar Worldpanel ComTech, a market research firm, estimates that the company accounted for a mere 1.4 per cent of U.S. smartphone sales in the 12 weeks ended Nov. 25. That was down from 7 per cent a year earlier – quite the collapse.
The Z10 may help to turn the tide. Sales of the new device are off to a strong start in the U.K. and Canada, the two countries where it debuted first. Analysts are reporting several British stores had lineups for the product and many stores have no stock left. In Canada, preorders have been reported as being very strong, with about half of all orders coming from non-BlackBerry customers.
The question is whether BlackBerry will be able to translate hardware sales into profits. My guess is these new devices can eventually generate a 30 per cent gross margin – the difference between the price at which BlackBerry will sell the units and its cost to make the devices. However, it will take some time for volumes to scale high enough to generate that level of profit.
While that’s happening, the company will face threats to other parts of its business model. Right now, BlackBerry brings in roughly $4-billion (U.S.) per year in revenue from service fees it charges the phone companies that carry its products. That service business has historically delivered very high margins – a reflection of the fact that many of the carrier deals were negotiated back when Research In Motion was the only smartphone game in town.
Those lush profits could soon be a thing of the past. Rival handset manufacturers, like Apple and Samsung, don’t charge phone carriers a similar service fee, so phone companies are well positioned to drive a much harder bargain with BlackBerry as the transition to BB 10 takes place. If BlackBerry wants carriers to stock its new devices, it will have to settle for lower fees.
If the service fees were to drop by half, that would knock about $3 per share off BlackBerry’s earnings per share. But if BlackBerry can replace 20 million of the older devices it currently sells at break-even prices with an equivalent number of the Z10 units at 30 per cent gross margin, it would gain about $5 per share in earnings.
If everything works out according to my calculations, BlackBerry stands to gain a substantial amount from its shift to the new devices. For investors, the problem is that the two driving forces – increasing hardware margins and decreasing BlackBerry service fees – will proceed at different paces. The boost from higher hardware margins will happen very quickly while the drag from lower service fees will play out over a longer period.
How that all works out is difficult to predict. I’ve owned shares in the company since 1999 and I’m considering adding to my position, but if anyone is considering doing the same, I would counsel them on the need for patience. BlackBerry is a much better company than it used to be but this turnaround is still a work in progress.