Earlier this month, Byron Capital analyst Tom Astle openly questioned his own sanity when he initiated coverage of Research in Motion (TSX:RIM) with a BUY rating and $12 target.
Today, Astle wonders whether he has descended into full-blown madness. In a research update to clients this morning, the Byron Capital Head of Research raised his target on RIM to $14.
Astle says his original premise was that RIM was trading at a significant discount to tangible book value and that sentiment would improve and close this gap before the launch of the BlackBerry 10 platform. He says now that this has happened, RIM will need to find earnings support.
To justify a share price of $14, says Astle, RIM will need to generate earnings of at least $1.50 a share in fiscal 2015, this would imply a P/E ratio of less than 10x.
He says his key assumption here is that RIM will sell 31 million BlackBerry 10 devices at an average price of $450 with a 20% gross margin. Astle isn’t factoring any earnings from BlackBerry 7 devices, and is predicting a slow, steady decline in services revenue.
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The important variable, says Astle, is margins. If BlackBerry 10 margins come in at 15% instead of 20%, RIM earnings will fall to just $.48 a share. If services revenue falls faster than expected, say to $1.8-billion instead of the $2.8-billion he predicts for fiscal 2015, the company will earn just $.25 a share.
But Astle cautions that margin sensitivity works both ways. What if RIM can command something closer to its traditional margin of 35%, say 30%? Then things get interesting, with earnings of $3.59 a share, which would more than double Astle’s current estimate.
Where might these sales come from?
Astle says the larger picture on RIM is that the company now has relatively little exposure to the U.S. where the company, he says, has “significant branding hurdles and competitive issues”. Just 22% of the BlackBerry subscriber base is now located in the U.S., while RIM is strong in places like the U.K. (11%), Saudi Arabia (7%), Indonesia (7%) and The Philippines, Brazil and Canada, with 4% of the total subscriber base each.
The bottom line, says Astle, is that $1.50 in earnings for RIM’s fiscal 2015 seem to him to be the most plausible scenario, and is one that has a downside that is protected by tangible book value and the value of its patents, which he pegs at about $12 share.