Research in Motion (RIMM), the maker of Blackberry devices, has been on a tear since its March 2006 patent infringement lawsuit settlement with NTP - the same firm which is now suing four of America’s largest wireless carriers in what is largely of an extension of its previous shakedown, uh, lawsuit… but I digress.

RIMM shares have doubled year-to-date and have tripled since the start of 2006. The last time I did any serious analysis of RIMM was back in December 2005, when I thought that shutdown fears were overblown and the stock was significantly undervalued. I tried (to little effect) to talk my mother into purchasing shares, but she dislikes the Blackberry due to the fact that the device stole my father.

Yes, RIMM shares have been riding huge momentum to big gains, but it’s worth considering how the stock price now relates to intrinsic value. By just about any metric you use, RIMM looks expensive, but with a projected growth going forward at 31% annually and RIMM having beaten quarterly earnings estimates by 4% on average in the last year, does the growth justify paying up? Or, to put it even better, is Research in Motion going to be able to meet or beat those lofty expectations?

It is difficult to compare the valuation on RIMM to that of a Nokia (NOK) or the whipping boy of handset makers, Motorola (MOT), because Research in Motion’s fat 26% operating margins are double that of Nokia, and… don’t even bother with Motorola. Still, paying up multiples in excess of 31x forward earnings and 17x book value isn’t something that should be taken lightly. Is Research in Motion’s torrid growth going to be sustained?
Almost every analysis I see of RIMM talks about the enormous opportunity the company has as it expands its product line away from the business enterprise and starts to go after the consumer handset market. Opportunity doesn’t count for anything though; is such a push going to be profitable enough for the company that it will result in a continued rise in the stock? I wouldn’t count on it. I think there is too much enthusiasm here for devices that are going to be limited in their appeal due to price. As I’ve pointed out before, the economics of the handset industry are moving against the premium-priced competitors as average selling prices (ASPs) continue to decline. All of the companies know it - Nokia, Motorola, and Research in Motion all clearly state in their filings that they continue to see a decline in realized ASPs. Research in Motion has seen sequential declines in ASPs of 7% from 2005-2006 and 2.6% from 2006-2007. That represents a move from an ASP of over $380 to $345 in a little more than two years.
Material? I would think so. When Apple (AAPL) came out and cut the iPhone price, that should have been a huge signal to everyone that there are significant headwinds in even the top-end of the handset market.

The secondary part of the pricing concerns I have about RIMM is what goes beyond the device: the service plan. Both Verizon (VZ) and AT&T (T) say that their average monthly revenue per customer for wireless is $49-50/month; having looked at buying a Blackberry on Friday, I know the lowest-priced contract at Verizon is $80/month; the “recommended” plan is a $110/month base. This might be the most overlooked point about the ability of RIMM to penetrate the consumer marketplace: the upfront cost of their device represents only a fraction of the true cost. Although Wall Street analysts might view the Blackberry as a birthright subsidized by their company, I think that many consumers might not have the same view given that such a device will cost several hundred dollars to purchase in addition to the several hundred dollars in extra service charges that will be incurred over the life of usage.

Thinking like this isn’t going to arrive at much of a conclusion about valuation though, so how about some hard numbers for what Research in Motion is expected to pull off? I’m going to use 30% as the annualized expected earnings growth rate, and make a (generous) tradeoff assumption that ASP erosion is offset by leveraging of SG&A expenses so that there is no net change in operating margin. Device revenue as a percentage of total comprised 73% of revenues in 2007, and I’ll assume that holds steady even though that percentage rose year-over-year. Total devices sold in 2007? 6.4 million.

The main point of concern is 30% growth estimates. Compounded out over 5 years, that represents a net change of 3.7x, meaning that implied sales equates to 23.8 million Blackberry devices sold in 2012. In reality, with annual ASP declines of 3% over that period, the target for Blackberry sales would be 26.7 million units. In fact, for each annual 100-basis-point decline in ASPs, add 620k to the terminal sales figure. Given that a large part of Research in Motion’s strategy is targeting larger market share with lower cost devices, I see the actual target ending up around 28.75 million units. Is this impossible? No, but I do think it is improbable, and even if it was to occur, I think the stock has already priced in success. Consider the following:
Taking EPS of $1.27 (ttm) and assuming the company hits its 30% annualized 5-year target gives an exit EPS of $4.71, at a 20x multiple shares would be valued at $94 - just an 8% premium to the current price. Worth a bet from that perspective? No.
Revenues in the out year would be $11.27 billion under the current assumptions. We know that NOK is valued at 2x sales; but with RIMM’s superior margins (currently twice Nokia’s) you could justifiably price RIMM at 4x or even 5x sales. Using that estimated revenue figure at a 4.5x multiple gives an enterprise value of $50.7 billion. RIMM’s current enterprise value is $47.5 billion, so that estimate gives a 6.75% premium to the current price. Again, I don’t see that as a discrepancy worth being enthusiastic about.

RIMM has had a great run as a stock, and while I think the company has much to offer, I don’t see the stock as being a great investment; expectations already look too high given the inflated multiples the stock is selling for. The downside risk significantly outweighs the upside potential in my opinion, and for that reason I think it is time to sell RIMM.

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