RIMM: Investors expecting a premiere performance

Research in Motion, the company which provides a popular blackberry service, was initiated into the 2007 stock list for our group in late Nov. We are playing RIMM on the short side. At that time, I maintain that coupled with the favorable investment sentiment for the tech sector, the stock could continue to advance till early January. The stock is now trading at lofty $134 level and has more than doubled in last six months. The company is set to report the earning after the market close tomorrow.

RIMM has reported stellar earning results last Q. The results surpassed the investors' expectation and analyst community. Since then the stock has been on a tear. RIMM has recently introduced the new smart (email) phone called Pearl and the management team has pictured extremely rosy picture for the future business climate based on this product's success. Pearl is thought to be penetrating significant portion of the consumer smart phone market outside the traditional enterprise business for RIMM and will be the engine for next phase of the growth for the company.
No doubt that Pearl is selling extremely well. Lehman's research indicates that Pearl is generating 15K net sub adds in last 2.5 weeks of September. Lehman thinks T-mobile alone is able to generate 200K net sub-adds this Q. In addition, although not as strong as T-mobile, Cingular and Verizon will also contribute a fair number of sub adds for the company. However, it does appear that Sprint has been a bit slow for RIMM to generate robust sub adds to date. Because of the great sell-thru of Pearl, I believe RIMM will report very strong number, probably 4 to 5 cents ahead of the consensus estimate of 94 cents.

The question is how much of this great story for Pearl is built into the stock price. RIMM is currently trading at PE of 40 on a trailing basis and PE of near 30 based on a forward basis. This implies great premium for the company compared to its competitors such as Nokia, Motorola, and Samsung, which are typically trading with PE of somewhere between 15 to 17. By this type of valuation, the investors are assuming that RIMM is in the midst of the robust growth that will last for a foreseeable future. RIMM is valued to be in a secular growth mode, rather than in cyclical growth mode.

For RIMM to continue to get this type of PE multiple, the company is now pressured to show that this Q was outstanding and next Q will be as well. In my opinion, if the company delivers bottom-line number that is about 4 to 5 cents higher than the mean estimate, investors will be disappointed as they will be looking for blowout Q performance. In addition, net sub add will be extremely important key metrics to pay attention. Bears maintain that strong Pearl sale will not last more than Q or two if it is mainly driven by the upgrades of the hardware by the existing customers. As such, the company needs to show strong net sub add performance this Q, far above the consensus estimate number of roughly 820K. The company guides for around 800K for this Q number during the last earning call. In my opinion, investors may be disappointed for anything less than 850K. More significantly, RIMM needs to guide higher for next Q net sub add number. The expectation is heading higher above 925K and I believe this may turn out to be very challenging for the company.

Because Pearl story has a significant consumer market component, I believe that the company cannot sustain this type of premium multiple for too long. The consumer smart phone market is extremely crowded by several competitions mentioned above. The pricing pressure for the product is great and the consumers have very little royalty for the product. This often leads to great churn number for the subscriber base. I can give higher multiple of greater than 30 for the enterprise segment of RIMM business, assuming RIMM continues to generate healthy subscriber growth (but some bears are also doubtful of this point). However, the consumer segment multiple should be roughly in line with what the competitions are getting, which is 15 to 17 range. As a result, it would be difficult to assign multiple greater than 22 ~ 25 range for the company. If you take current aggressive estimate of 4.62 and apply higher range of PE of 25, the stock would be fairly valued around $115 in 07. Should there be any weakness in the sales forecast, this multiple may further shrink and the shares are vulnerable for substantial downside.

RIMM is a relatively new stock for FilthyRich group and I may need to study the company fundamentals further to gain deeper understanding of the company. However, my current opinion is the company is heading into high expectation with the fundamental that do not support for the current share price.

Short term, investors may continue to be dazzled by Pearl sales number and chase this stock higher. Should this happens, you should be increasing your short position on the stock. Ahead of earning, it may be worthwhile taking 30% of your short position. Should there be a further price appreciation, you can establish your remaining position