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RIMM (Nasdaq) RIM.TO (TSX) Date: December 17, 2012 Price: $13.93 (Nasdaq)
RIM is unusual among smartphone manufactures because it not only provides its own proprietary operating systems (similar to Apple) but also owns and operates its own network infrastructure. Many of RIM’s iconic services such as push email and BlackBerry Messenger (BBM), as well as the company’s security and encryption suite utilize this infrastructure, bypassing carrier networks. RIM receives royalty payments per BlackBerry user (subscriber) for use of these services. The company subdivides revenue into the following components: Devices – Sales of smartphones and tablets. Service – Payments made by carriers on behalf of BlackBerry users (subscribers) for use of RIM’s network assets. Software – IT software solutions provided by RIM to corporations for the management of their mobile workforces. Other – Accessories, non-warranty repairs, BB App World revenue and gains/losses on revenue hedge contracts. Revenue by segment for the most recent reported quarter (Q2FY13), filed on Sep 27, 2012:
Software 2% Service 35% Hardware 60% Other 3%
As total revenue has decline from 4,078mm in 4QFY10 to 2,873mm in 2QFY13, service revenue has increased from 641mm to 1,005mm in the same timeframe, representing a jump from 16% to 35% of total revenue. In other words, the service revenue category has increased in importance markedly:
40% 30% 20% 10% 0% Service Revenue as % of total revenue trend over last 11 quarters
As hardware margins are squeezed from increased competition, service revenue has become the main driver of profitability. Two things influence service revenue – total subscribers and Average Revenue Per Unit (ARPU), which is the average monthly fee RIM receives per subscriber. As the handset market increasingly becomes the domain of low cost commodity manufacturers, service revenue and consequently subscriber growth rate and ARPU become the single most important factors for RIM’s long term viability (more specifically, the viability of the company’s current business model).
Market Share Trends
Worldwide Share of Shipments Q107-Q312
In the last several years, we notice a trend of service revenue becoming a more important driver of both top line and bottom line performance. We first take a look at the absolute trends:
4000 2000 0 Hardware Service Total
The above chart is a reflection of the company’s falling aggregate device sales, coupled with the explosive growth of the Smartphone market. Note that tablet shipments are not taken into account, which would make the numbers starker still. The viability of any mobile ecosystem is subject to a feedback mechanism as market share deteriorates, it becomes increasingly difficult to attract developers to the platform, leading to increased sales pressure. The company’s challenge is to break this feedback mechanism.
We next direct your attention to the current state of the company’s market share in a number of choice markets:
50 45 40 35 30 25 20 15 10 5 0
Note the difference between the current share of sales and current market share data:
25 20 15 10 5 0
Share of Sales vs. Current Market Share
Mobile OS market share for 2012
Microsoft Windows Mobile
Share of sales
Share of current mobile users
We note that RIM maintains a foothold in most of these countries. In the UK, where RIM’s BBM service remains popular among users, the company commands a robust 23% market share. However, in what is now the largest smartphone market by volume, China, RIM is a nonfactor. Since current market share is lagging indicator, we turn to current share of sales in these same markets:
90 80 70 60 50 40 30 20 10 0
Mobile OS share of sales, Av of 12 weeks ending Oct 28, 2012
US share of sales has dropped to 1.6% compared to current US market share of 11%. In the UK, currently RIM’s strongest mature market, share of sales is at 7.9% compared to current market share of 23%. We predict this situation to only get worse in the January quarter, due to the announcement of BlackBerry 10 and the release of the iPhone 5. The fact that the January quarter is also the holiday quarter is further cause for concern. Emerging markets have become RIM’s last bastion of strength. The Southeast Asia region (especially Indonesia), and countries such as South Africa and Nigeria provide the bulk of new subscriber additions. Although the company does not disclose sales by geography in much detail, we can nonetheless infer the trend:
Revenue mix by region 100% 80% 60%
Microsoft Windows Mobile
40% 20% 0% FY10 Canada FY11 FY12 Q2FY13 Other United States United Kingdom
The current share of sales data paints a darker picture for the company. This metric is forward looking and offers a glimpse of where RIM’s market share is headed if things continue on their current path. Note that the above figures are more detailed but offer less scope than the worldwide share of shipments data on the previous page. The conclusion to draw is the same, however.
RIM’s filings in this regard simply offer confirmation of its shift away from developed markets.
Emerging markets are characterized by low Smartphone penetration rates. We look at penetration rates for Southeast Asia: Smartphone penetration
80% 60% 40% 20% 0%
Subscriber Growth Trends
We look at subscriber growth trends first:
With the world’s fourth largest population, and only 20% Smartphone penetration; Indonesia is a key market for Smartphone manufacturers. RIM is currently the number one selling Smartphone brand in the country, but as in most other emerging markets, low cost Android devices are making rapid headway:
100% 80% 60% 40% 20% 0% 2011 2012 Mobile OS market share in Indonesia
As illustrated, the company’s subscriber base has been somewhat resilient in the face of declining handset shipments. The nature of RIM’s largest customer base (enterprise/government) means that subscriber numbers are somewhat ‘sticky’. The company’s continued leadership in terms of security and reliability means that these security conscious clients tend to be more loyal to the BlackBerry brand, and less likely to defect. That being said, the Bring You Own Device (BYOD) trend has seen RIM lose significant enterprise and government customers over the last year, this trend is expected to continue, posing yet another challenge to RIM. New subscriber additions are a result of emerging market demand, where RIM’s network assets complement immature and low bandwidth local carrier networks. BBM and RIM’s email service are key differentiators in these markets, where many users lack even basic internet access. Though RIM is losing market share globally at an alarming rate, the exponential growth of the smartphone space in emerging markets means that it still sees a net addition of subscribers. In order to continue subscriber growth, RIM is selling handsets at negative gross margins. The company’s strategy is to maintain market share via incentives and lower prices while it prepares to release its new BB10 operating system.
Indonesia is currently RIM’s most successful market, where it enjoys its highest market share. The overall trend in Southeast Asia mirrors that of Indonesia, RIM is slowly starting to lose ground to Android manufacturers and to a lesser extent Apple. In India, which is the fastest growing Smartphone market in the world, RIM’s share of the Smartphone market is projected to decline to < 10% in 2012 from just over 13% a year ago. As Wi-Fi and 3G/4G networks gain ground in Asia-Pac and elsewhere, RIM is seeing its network advantages becoming less relevant. We are therefore witnessing a repeat of RIM’s fate in Europe and North America, this time taking place in emerging markets. The question is whether the company has the vision and resources to not only stop the impending assault it will face in emerging markets, but also to start clawing back share in mature markets.
Average Revenue per Unit (ARPU) Trends
Along with total subscribers, Average revenue per Unit (ARPU) is the second variable affecting RIM’s high gross margin service revenue segment. Carrier partners are continuing to pressure the company with regard to ARPU. Analysts estimate a continued decline in this metric:
Operating Performance and Profitability Trends
The combination of declining ARPU and ASP’s has lead to the erosion of gross margins and loss of profitability, even in the face of continued subscriber growth.
4,000 3,000 2,000
1,000 0 FY2014E FY2013E FY2012 FY2011 FY2010 FY2009 FY2008
$0.00 FY2011A FY2012A FY2013E FY2014E
The company has continued to generate operating cash flow over the last several quarters:
1,500 1,000 500 0 Q2FY12 Q1FY12 Q4FY11 Q3FY11 Q2FY11 -500
Maintaining ARPU is becoming increasingly difficult as competition intensifies and RIM’s carrier partners continue to invest in new and better infrastructure; this trend is going to continue for the foreseeable future. The company’s competitors do not charge carriers in the same manner.
Total cash from operations
Average Selling Price (ASP) Trends
In an effort to stem its decline in market share, RIM is attempting to grow the subscriber base via discounts and incentives. This has led to a steady decline in ASP’s. RIM’s revenue shift to emerging markets has exacerbated this trend:
400 300 200 100 0 FY2009A FY2010A FY2011A FY2012A FY2013E
Current cash balance is about $2.1 billion, representing just under 30% of market capitalization. Rim carries no debt on its balance sheet.
ASP RIM is attempting to maintain market share and grow its subscriber base at the cost of profitability. The company is seeing increased market share pressure in emerging markets, and continued rapid share decline in mature markets. Its traditional enterprise and government clients are increasingly adopting the BYOD trend, whereby consumers’ personal devices are also becoming their work devices. In addition to aggressive cost cutting, RIM must strive to: Increase revenue by increasing the rate of subscriber growth and handset sales growth. Maintain or retard declining ARPU. Widen gross margins and increase ASP’s of the handset business through product differentiation.
In line with the decline in ASP’s, RIM’s gross margin on handsets has declined and is now believed to be negative.
Two main factors have contributed to the near 100% run-up in RIM’s share price since late September. RIM 1 YR
As confirmed publicly by RIM, the first phone based on BB10 is an all touch-screen device. A physical keyboard offering is slated to follow in 1-3 months (some estimates peg the release date of the physical keyboard variant to be as late as May or June 2013). The new operating system has garnered mostly positive reviews for its ease of use and innovative new features. Several noted analyst upgrades and upside revisions have followed both the Q2 surprise and the BB10 announcement. The bullish sentiment around RIM stemming from its new BB10 operating system can be gleaned from several chosen research notes: Peter Misek of Jefferies & Co. “Preliminary results from our quarterly handset survey indicate developed market carriers have a much more positive view of BB10 than we expected. With greater carrier shelf space and marketing support, we now believe BB10 has a 20%-30% probability of success.” – 20 Nov, 2012. He moves PT to $10 from $5, upgrades to HOLD from UNDERPERFORM. Increases FY14 shipments and estimates. Kris Thompson, NB Financial: “We think there is MORE money to be made ahead of the C2013 launch of BB 10. The new management team is executing by maintaining the BlackBerry subscriber base, managing costs and cash, and seemingly readying a February 2013 BB10 global platform launch. Most analysts were expecting a March launch.” – 22 Nov, 2012. Maintains OUTPERFORM, increases PT to $15 from $12. Raises FY14 shipments and estimates. Gus Papageorgiou, Scotia Capital: “Upgrading to 2Sector Perform; the strong cash position and increasing subscriber base improves the company's odds of a successful BB 10 launch. We also believe the value of the underlying assets can justify the share price. Finally, stable to improving operations may increase the odds of a take-out bid.” – Sep 28, 2012. Upgrades from UNDERPERFORM to PERFORM, PT raised to $11.20 from $6. On Oct 15, 2012 releases note reiterating rating, sees strong EPS of $4.39 in Upside scenario. Simona Jankowski, Goldman Sachs: “We now assess a 30% chance of success for BB10 given positive early reviews, broad-based carrier support, attractive features, and interest by carriers and consumers in broadening the field beyond Android/iOS” – Nov 28, 2012. Upgrades to BUY, raises PT to $16 from $9.
1. A better than expected Q2
Revenue came in at 2.87bn, solidly above consensus of 2.51bn. EPS loss of ($0.27) was better than consensus of $(0.46). RIM sold 7.4mm phones, ahead of expectations of < 7mm. Addition of 2mm new subscribers vs. consensus of a slight loss/flat. ASP was up from $205 to $229 QoQ. Net cash position improved by $96mm. Cash from operations was a strong $424mm; vs. ($49mm) in Q2FY12.
RIM’s management has indicated that the drivers of a better than expected Q2 can be ascribed to core business strength in emerging markets; specifically: Indonesia, South Africa, the Philippines and the Southeast Asia region in general. As well as the CORE cost cutting program, initiated in March of 2012. The CORE program has so far realized about $350mm across the companies cost structure, offset by total restructuring charges of approximately $136mm since initiation.
2. Optimism regarding RIM’s upcoming Blackberry 10 operating system
During the week of November 12, 2012 RIM announced the January 30th launch date of its long awaited BlackBerry 10 operating system. The market expected a launch date of around March 2013. Products are expected to hit the market ‘shortly’ afterwards; with consensus being 2-6 weeks after launch date, depending on carriers. The first BB10 products are aimed at developed markets, where RIM intends to challenge traditional smart phone leaders.
However, the broad consensus among analysts following RIM remains neutral/moderate sell:
16% 13% 18% 53%
Buy 0 Outperform 6 Hold 24 Underperform 8 Sell 7
OPINION Turnaround is Unlikely
We believe that the likelihood of a successful turnaround is much less than the 20-30% probability that some analysts are maintaining. RIM’s business model is not viable for today’s environment. The company cannot continue to play in the unprofitable hardware market to support a diminishing service revenue stream. Even with aggressive restructuring, closing the cost gap with its lower cost competitors will be difficult. Gross margins on hardware are unlikely to improve in emerging markets, and RIM will struggle to regain share in developed markets. Falling ARPU is the new normal. This will continue even if BB10 is moderately successful.
In mature markets, the BYOD trend will continue to eat away at RIM’s last bastion of subscribers. The company has rolled out software suites aimed at corporate IT departments that can accommodate most types of smartphones; previously RIM only offered such functionality exclusively for its Blackberry corporate clients. This was done out of necessity, as companies like Microsoft and IBM are entering the corporate IT market with similar solutions that allow companies to better manage their communication environments, driven by the complexities inherent in BYOD. Once BYOD implementation becomes less cumbersome, we see the trend accelerating – eliminating the distinction between business and personal devices and targeting RIM’s weak spot. These trends are confirmed by IDC; which sees iOS as the top operating system in the enterprise among companies that deploy their own devices, and Android taking top spot where BYOD is prevalent – by the end of this year.
Low Probability of BB10 Success
Management believes that the current business model has merit, and is placing its hopes squarely on the shoulders of the upcoming BB10 operating system, which is slated for official unveiling on January 30, 2012. BB10 handsets are initially aimed at mature markets, where RIM believes it can gain back share and raise hardware ASP’s. We believe that BB10 will not differentiate itself sufficiently from Android, iOS and Windows Phone. RIM’s lack of a coherent ecosystem is a serious hindrance to BB10 acceptance. BB10 continues doing best what Blackberry has done best for years. Emphasising security and business friendliness has not stopped RIM from bleeding market share, doing more of the same is not likely to bring success. BB10 is innovative in some areas, but it will not stand out from the crowd for consumers who are increasingly becoming attached to established ecosystems.
The industry has changed more than meets the eye. The coming wave of low cost devices running on Android will further pressure margins and lead to increasing share loss in emerging markets. In these same markets, RIM’s innate network advantages are steadily disappearing leading to continued squeezing of ARPU. ARPU will continue to decline even if BB10 devices gain traction, as management has previously stated that BB10 will not be ARPU accretive, and will actually rely on RIM’s network to a lesser extent. RIM’s strategy in emerging markets is not fundamentally different from its failed attempts in developed markets of a few years ago. The company’s offerings are superior to the feature phones that dominate emerging markets, but as smartphone penetration increases, there is no precedent to believe that RIM’s current offerings will win out against the coming flood of cheap Android devices, the opposite is likely true. What the company’s current BB7 devices amount to are essentially a halfway point between a feature phone and a smartphone. The hardware business is rapidly becoming commoditized, with Chinese manufacturers about to enter full force into emerging markets, we see the mobile landscape in these markets being dominated by Android phones and companies that can both tolerate razor thin margins and have cost advantages. Neither of which characterizes RIM.
While it is likely that loyal Blackberry customers who have postponed upgrading will make the switch to BB10, clawing back market share from the smartphone leaders in our view is not realistic. A key weakness for the company is its lack of coherent ecosystem, similar to Google, Apple and Microsoft. All three of these companies have developed a robust support structure around their mobile operating systems. This includes desktop operating systems (Apple, Microsoft), cloud storage services (all three), a robust presence in tablets (Google, Apple, Microsoft in early stages), and services such as Xbox Music, iTunes, Siri, Google Now and other peripheral products with which customers associate a certain mobile platform. RIM has
attempted entering the tablet space via their Playbook tablet, with less than stellar results. The Playbook OS is similar to BB10 as both are based on the QNX architecture; it offers a smooth user experience, a quick browser and traditional BlackBerry services such as BBM – much of what RIM promises with its upcoming line of BB10 devices. Developer support is greater for BB10 than for the Playbook at launch, but ultimately developers follow consumers, and an OS must be sufficiently different and specifically appealing to entice consumers to switch from established ecosystems, where they are familiar with the apps, services and functionality specific to their preferred OS. We believe that BB10’s unique features, namely: an enhanced on screen keyboard, the ability to switch from business to personal functionality, BB Hub universal inbox and novel use of gestures will not be enough of an enticement for consumers to switch to what is essentially a me too operating system experience. The first device to launch after January 30th is an all touch screen model. This is somewhat perplexing as one of the main differentiators for RIM is its best of breed physical keyboards. This may slow the adoption rate of BB10 among existing clients, as they wait for the QWERTY version which will ship with a delay of about 1-3 months. RIM’s best selling phones in the US are its Curve line, which have physical keyboards. In addition to the lack of keyboard, the first device features absolutely no physical buttons, instead relying on gesture control for basic functionality, this learning curve may put off some existing BB users who retain their BlackBerry’s out of familiarity.
suggests a gradual acceptance of Windows Phone 8 devices, the most popular among which are Nokia’s Lumia line. Nokia’s devices have received generally positive reviews, with reviewers praising their best in class cameras, excellent build quality and unique design. The WP8 operating system itself is unique in form and function. In fact, Nokia shares have been rallying on rumored Lumia sales success: RIMM NOK
1 YR This provides a further challenge to RIM, in that consumers who are looking for something other than Android or iOS may be swayed by Microsoft’s increasing prominence. As was briefly mentioned, Microsoft will increasingly draw on its ecosystem to further along WP8, including releasing a version of its popular Office application suite for use with its mobile devices. RIM can also expect a challenge from Microsoft in the enterprise space, where it will leverage its existing software partnerships to penetrate the market for wireless enterprise solutions.
The Case for Microsoft Outmatching RIM Analysts believe that carriers seek to disrupt the
Android/iOS duopoly. This is absolutely correct in our view. Carriers will certainly give RIM a fair shot at gaining market share, through advertisements and promotions. This opportunity afforded to the company by carriers is no guarantee of success, as witnessed by Microsoft and its Windows Phone 7 rollout with Nokia. It is the product that will ultimately determine the company’s fate. As Microsoft and its partners iron out the kinks in Windows Phone 8 and its ecosystem, we expect Windows Phone to gradually gain market share, relying on Microsoft’s expertise in enterprise, security and productivity – including a likely roll out of Office Mobile in 2013. Ultimately, Microsoft possesses the assets and expertise required to become the third major mobile OS provider.
Implication for Share Price and Conclusion
The optimism that has propelled RIM’s stock in the last several months is grounded in over-optimistic forecasts regarding the success of BB10. The company is under assault in all of its key markets and is subject to a feedback loop of negative news. We believe RIM’s upcoming products will not help matters as they are not sufficiently differentiated; and it is difficult to ascertain which type of consumer these products are aimed at. We believe that the company does not deserve the benefit of the doubt. Management has consistently mismanaged new product launches and delayed key updates. RIM has value as a company, including a robust patent portfolio and excellent software IP. There are several possible outcomes for RIM if BB10 is not successful, but the current optimism surrounding its share is misplaced.
The partnership between Microsoft and Nokia has yet to bear much fruit, but there is anecdotal evidence that
There are several arguments put forth by bullish analysts regarding RIM: robust subscriber base, strong balance sheet, valuable IP, emerging market dominance, loyal enterprise customer base, cost cutting initiatives etc. The fact of the matter is that the recent run-up in RIM shares is the specific result of the optimism surrounding the new BB10 OS and not much else. All of the other positives were in place when shares were trading in the $6-7 dollar range; however these virtues were mentioned much less often at that time. RIM’s current business model is unlikely to survive, but that does not mean RIM as a company will not survive. Reorganization into enterprise/government services and software licensing is the most probable outcome that we see for the company. QNX, which is the architecture that BB10 is based on, is found in everything from cars to nuclear power plant control systems. It is a secure, scalable and robust operating system that is certainly valuable when deployed properly. However, reorganization into the IBM business model will be difficult for RIM, which will almost certainly leading to share price depreciation. We note that at the $6-7 dollar range, investors still had the possibility of BB10 success to look forward to down the line, if, as we predict, BB10 will not be successful - a retracement of those price levels is not out of the question. A buyout is also a possibility, but likely at a lower price level than we have today. We expect RIM’s shares to remain volatile going into the January 30th launch date of BB10:
120 100 80 60 40 20 0 2/29/2012 5/31/2012 8/31/2012 11/30/2012
The swift run up in the price of the stock in the face of increasing short interest suggests the buying is mostly speculative and short term in nature. Volatility should be expected on both good and bad news.
Any good news may trigger a short squeeze as shares sold short now account for over 22% of shares outstanding. We note that the buying pressure has actually been stronger than would appear by looking at the price action alone. Such a large increase in shares sold short over the last several months has certainly dampened upward momentum.
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