The point of maximum pessimism.
When legendary investor Prem Watsa, sometimes referred to as “the Warren Buffett of the North” decided, recently, to double his stake in struggling BlackBerry-maker Research in Motion, he cited the man Money magazine once said was “arguably the greatest global stock picker of the century”, John Templeton, who was the originator of the famous contrarian advice.
Since last November, when Research in Motion fell below its book value for the first time, many have been asking Templeton’s famous question. Has RIM reached the point of maximum pessimism? With its shares barely scraping past $7 of late, the answer to that question, much to the chagrin of value investors such as Donald Yacktman, Laszlo Birinyi, Leon Cooperman and Joel Greenblatt, who all took a stab on timing, has been a decided “No”.
But sometime soon, presumably, someone will nail the precise moment of maximum pessimism on RIM. Cantech Letter’s resident expert on all things value, Saj Karsan, had the question come up on his excellent value blog, Barel Karsan recently. Two Barel Karsan readers, Mike and Phil Kazmaier, who describe themselves as “individual value investors and RIM shareholders” attended RIM’s Annual General Meeting in Waterloo July 10th. They say that with a long wait for new products RIM is a moving target, and that its eroding core business is blurring the line between qualitative and quantitative analysis.
As RIM shareholders since 2010 we had the opportunity to venture to Waterloo Ontario on Tuesday to participate in the annual general meeting. We had high hopes that the meeting would shed some light on the prospects of RIM and enable us to make that ‘oh-so-difficult’ value investing decision of whether this is a good investment idea that just keeps getting better (as the price falls) or a bad investment idea that just keeps getting worse (as the company slowly goes out of business).
Much of management’s presentation was geared towards the strategic initiatives RIM is pursuing. One such initiative is their CORE (cost reduction) program which includes finding 1 billion dollars in savings through restructuring, labour reductions and a streamlined product portfolio over the next year. The rest was dedicated to touting BB10 as the savior of the company.
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But the biggest concern facing shareholders was whether the ongoing business decline, as evidenced by the $500-million dollar operating loss last quarter alone, would burn through all the assets of the company before the BB10 savior arrived. And happily for us, another concerned shareholder bravely approached the microphone and asked this very question:
Shareholder: “I was wondering if you can provide a more detailed understanding of what will happen to the cash and cash flow situation between now and when the Blackberry 10 is on the market?”
RIM CFO Brian Bidulka: “Thanks for the question. Management is obviously focusing our attention on this issue. As Thorsten pointed out we exited the quarter with 2.2 Billion in cash and no debt. The CORE program is focused on working capital and our management capital expenditure review. We continue to look at our financial liquidity as the business evolves and based on our financial projections and our operating cash flow generating activities we believe we have the financial capacity to see us through to the launch of Blackberry 10 in the first quarter 2013.”
It appears clear that RIM is expecting to see some cash flow losses in coming quarters but that they feel confident they can make it to 2013. What isn’t mentioned in the response is the assumption that RIM will be back to normal once Blackberry 10 is available for sale. We believe that is a significant leap for which there is little historical evidence to support. There is likely some pent up demand for the new BlackBerry devices but the market environment will likely be more competitive than it is now.
Value investing is supposed to be all about the numbers. You analyze stocks based on the fundamentals and arrive and a fair value for the company. The problem we face now is that the margin of safety is being threatened by prospective future losses. With no real products to sell until 2013, the reasons to stay appear more qualitative in nature and may not be predictable.
RIM’s earnings, and potentially its assets, may be changing so quickly that it is really difficult to make a good judgement about what the actual value of the company will be over the next two quarters. They could see another collapse in sales and a loss of $500 million. How much will be cash, how will the asset base be affected? RIM is also cutting costs, how quickly will expenses fall? When will we see the benefits of this exercise? They are also expending on R & D for the BB10 phones and gearing up for production, so we know that they can’t completely eliminate capital and R&D expenses because their future depends on it. It’s just too hard to tell what the numbers are right now and determine a margin of safety.
So all we have to go on is that RIM claims their new phone is coming out Q1, 2013 and our fervent hope that earnings should normalize after that point. Qualitative assumption.
On the plus side:
– Making a new phone is RIM’s core competency, it’s not like they are trying to start a division in a totally different industry. This is what they know.
– The smart phone industry is growing fast and even if their market share is small it should grow proportionally. The rising tide lifts all boats.
– There could be some pent up demand for their product since many people who want a new BlackBerry may be waiting for BB10 to arrive. But that is purely supposition at this point.
In our opinion, at the end of the day RIM is more a qualitative judgement call or a gamble than a quantitative analysis and investment.