Research in Motion (RIM): A value trap?

Is RIM a value trap? More importantly, did I fall into this trap? Looking at the constant consistent fall of the stock price of this business I can't help but question where I went wrong.

NCAV or bust!

Reflection

The following advice from late Walter Schloss comes to mind-- emphasis added:

Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.

The corollary is that a lot less has to go right when relying on balance sheet.

That is very sound advice and when looking at my investment in RIM from this perspective it is very obvious to me that I got trapped into a classic value trap. My original thesis was that the balance sheet is very strong with a large cash position and no debt. Furthermore, looking at the income side of the story, the free cash flow was strong and gross margin above 40%. My expectation was that earnings may slow down but RIM will not swing to operating losses. I suspected that the market was being more pessimistic than the reality warranted.

It would be obvious to anyone who has been following the RIM story that Market was quite right in this case. In this case Mr. Market created his own reality. RIM got caught in a vicious cycle of bad press, stock sell off, bad press, and so on. Even though their devices are still very capable and the only sensible choice available to an enterprise user, the bad stigma attached to the blackberry created a self-reinforcing loop that eventually started to scare away business from RIM.

While this has been going on, the balance sheet is still sound and forms a solid foundation under the, what seems at times, an ever-sinking stock. The book value is still around US$19/shr, in spite of the recent goodwill impairment. The tangible book has been quite stable as well.

Going back to Schloss' advice, I made the mistake of placing too much importance on the income statement. The margin of safety that I demanded from RIM was not high enough. I focused too much on the upside and didn't demand enough protection of the downside. Mea culpa.

This is an earnings based investment idea that has reverted to the balance sheet for support.

Is RIM a value trap?

From the perspective of my average cost price of $20, yes. RIM is a value trap and I am trapped in it. But is it a value trap today? I don't think so. Here are the latest numbers from the balance sheet.

- Shares outstanding: 524.1M
- Book: 9.6B or 18.32/shr
- Tangible Book: 6.23B or 11.88/shr
- NCAV: 3.2B or 6.1/shr
- Cash/liquid assets on balance sheet: 2.2B or 4.2/shr
- Market Value: 3.81B or 7.39/shr (USD)

The above numbers are shown below in a graphical form that provides some perspective.

That's right-- RIM is officially selling below two-third of tangible book (which ignores the huge patent wealth), forming a sizable margin of safety. If RIM just decides to go private and split up, it would most definitely sell for at least tangible book, which is 50% above today's market price.

The big risk is that the management will continue to invest into blackberry 10 and whittle away the margin of safety. This is exactly what the market is discounting when it sells this multi-billion dollar business under tangible book value.

As Schloss would say, very little has to go right for this stock to turn around at current prices.

Full Disclosure: I am an owner of RIM at the time of this writing.