Running High on BlackBerry

Research in Motion has a premium valuation compared to peers. But its strong business model and performance make it a compelling stock, says S&P

Research in Motion (RIMM; ranked strong buy; recent price: $75), founded in 1984 and based in Canada, is best known for its BlackBerry wireless e-mail device. Introduced in 1999, BlackBerry has found popularity primarily in the enterprise market, or large corporations and government. Through the development of integrated hardware, software, and services that support multiple wireless-network standards, RIM provides e-mail, phone, SMS messaging, Internet, and intranet-based applications.

We at S&P believe RIM will benefit from the pent-up demand for BlackBerry units. With the NTP lawsuit settled for $612.5 million in cash, we believe the company can now focus 100% on the business of driving its BlackBerry service (see BW Online, 3/3/06, "BlackBerry Won't Get Squashed"). Recent product introductions from Motorola (MOT; ranked hold) and Nokia (NOK; ranked sell) may begin to gain share of the mobile e-mail and messaging market, in our opinion.

We believe RIM has an attractive business model, with its BlackBerry contributing to more than 30% sales growth and low net margins in fiscal year 2007. With $1.2 billion of net cash and investments, the company should, in our opinion, be able to meet its working-capital requirements and still achieve return-on-equity in the mid- to upper teens by fiscal year 2007 (February).

We believe RIM is well funded to address growing competition and its expansion plans. Applying a price-earnings multiple of 27.8 times our fiscal year 2008 earnings-per-share (EPS) estimate, slightly above peers, we arrive at our 12-month target price of $100. The stock carries Standard & Poor's highest investment recommendation of 5 STARS, or strong buy.


  Along with making the popular BlackBerry, RIM's technology also enables a broad array of third-party developers and manufacturers to enhance their products and services with wireless connectivity. Its portfolio of products, services, and embedded technologies is used by thousands of organizations around the world and includes the BlackBerry wireless platform, the RIM Wireless Handheld product line, software development tools, radio modems, and software/hardware licensing agreements.

In our view, the market for wireless solutions is still in the early stages compared to the broader wireless voice market. We also believe the market for mobile e-mail in the enterprise market is ready to take off. According to Nokia, there were more than 1.2 billion e-mail boxes worldwide at the end of 2005 and 650 million corporate e-mail boxes, but only 8 million mobile e-mail subscribers.

At the end of fiscal year 2006, RIM had 5 million BlackBerry subscribers. The company's BlackBerry service is tied to more than 55,000 enterprise servers that are linked to 250 wireless carriers. In the fourth quarter of fiscal year 2006, Europe performed well as the company's second-largest region after North America. RIM will soon launch BlackBerry in China with China Mobile (CHL; ranked hold) and expects to release it by the end of May. We believe the company plans to launch the 8700g handheld in China later in fiscal-year 2007.


  RIM's principal competitor has been Palm (PALM; ranked buy), with its Treo mobile smartphones, although the two largest mobile-device suppliers have recently launched e-mail phones. Motorola introduced the Moto Q, a streamlined device for e-mail, voice, and multimedia, and Nokia is rolling out its E-series phones. However, Nokia's enterprise unit was unprofitable in first-quarter 2006. In fiscal year 2007, RIM's BlackBerry series may realize a slight decline in average selling price, but we believe the company can still exceed 30% revenue growth in fiscal-year 2007 with its strong service capability.

We think both Motorola and Nokia are more concentrated on the broader wireless handset market than the advanced devices that are earmarked for the wireless enterprise market. In addition, neither Motorola nor Nokia offers an integrated service with its device. We think this will limit their appeal to enterprises and governments, which will likely prefer to deal with an integrated service provider like RIM that will try to resolve wireless-carrier network problems or other issues that may diminish BlackBerry service to customers.

We expect Motorola and Nokia to continue to have some presence in the addressable markets for RIM's BlackBerry service. In the past year, Nokia acquired Intellisync, which should boost its entry into the enterprise mobile market. Intellisync brings to Nokia a direct sales force, mobile enterprise applications, security and device management, and integrated messaging.


  Last Nov. 30, the U.S. District Court for the Eastern District of Virginia issued a ruling in the patent litigation between RIM and NTP. The court ruled that the term sheet entered between the parties in March, 2005, to settle the litigation was not an enforceable agreement. During court proceedings, the District Court was asked to decide a variety of matters relating to the litigation, including the impact of the federal circuit's reversal of infringement findings on issues of liability and damages.

In March, 2006, RIM and NTP signed a definitive licensing and settlement agreement whereby RIM paid NTP $612.5 million in full and final settlement of all claims against RIM, as well as for a perpetual, fully paid license going forward. This amount includes money already escrowed by RIM to date. NTP granted RIM an unfettered right to continue its business, including its BlackBerry-related business.

With the NTP lawsuit settled, we believe RIM can now focus 100% on the business of driving its BlackBerry service. The company has seen a recovery in subscriber additions and business momentum since RIM settled the patent litigation, according RIM Chief Financial Officer Dennis Kavelman.


  On May 1, RIM learned that Visto had filed patent complaints against several companies in the industry, including Microsoft (MSFT), Good Technology, Smartner, and Sproqit (see BW Online, 5/2/06, "RIM's Latest Patent Problem"). Visto filed its complaint against RIM immediately after a jury verdict in its litigation against Seven Networks.

Visto's patent claims as directed against Seven Networks refer to a different type of system than RIM's technology. Given the status of Visto's current litigation with other companies, we believe it is unlikely that any material court proceedings in this litigation could begin before the middle of calendar 2007. We believe the company can grow its business profitably despite the legal claims from Visto that will be brought to court.

Following 53% sales growth in fiscal year 2006, we expect revenues to increase 31% in fiscal-year 2007 and in the low 20% area in fiscal-year 2008. We believe demand for the company's BlackBerry wireless e-mail device will remain strong as RIM expands wireless-carrier relationships outside North America. We see new display models broadening the appeal of BlackBerry to small-business and consumer markets.


  After realizing 2.5 million net-subscriber additions in fiscal-year 2006, we project 2.9 million additions for fiscal-year 2007 and 3.4 million for fiscal-year 2008. The company expects BlackBerry's average selling price to remain steady, at $350, in the first quarter of fiscal year 2007 compared to the fourth quarter of fiscal year 2006.

We expect increased unit volumes and stable to slightly lower pricing to keep gross margins in the 54%-55% range in fiscal-year 2007 and fiscal-year 2008, vs. 55% in fiscal year 2006. After posting operating EPS of $2.51 in fiscal-year 2006, we estimate EPS of $3.05 in fiscal year 2007 and $3.60 in fiscal year 2008, which includes 13 cents in projected stock-option expense in each year.

There are a few notable developments for the company. In March, 2006, RIM announced the immediate delivery of the BlackBerry Enterprise Server (BES) v4.1 and the BES Small Business Edition v4.1 for Microsoft Exchange and IBM Lotus Domino. We believe these upgrades should enhance the BlackBerry experience for enterprise IT departments that want more control over their wireless deployments as they extend to mobility for their employees.


  In April, Yahoo! (YHOO; ranked buy), the most-used mobile Internet brand, and RIM expanded their strategic global alliance to bring Yahoo services to BlackBerry users around the world, including Yahoo Go for Mobile, Yahoo Search, Yahoo Mail, and Yahoo Messenger.

On May 3, RIM launched an offering aimed at small and medium-size businesses, branch offices, and companies new to the BlackBerry device. BlackBerry Enterprise Server Express provides the same enterprise-level security, reliability, features, and functionality of BlackBerry Enterprise Server v4.1 and is available as a free download from RIM via the Internet to any customer who purchases a new BlackBerry.

Based on our Standard & Poor's Core Earnings methodology, we believe that the quality of Research in Motion's earnings is in line with its peers. Employee stock-option expenses are included in our fiscal-year 2006 and 2007 operating EPS estimates, as new accounting standards now require all employee stock options to be expensed. We're assuming 13 cents per share of stock-option expense in each of these years.


  Based on our estimates for 2006, RIM trades at a price-earnings multiple of about 25 and an enterprise value/EBITDA multiple of 15, above the average for our communications-equipment peer group. With our view of RIM's superior growth outlook vs. its peers, we believe the shares should trade at a premium to its communications-equipment peer average. Using this methodology and a multiple of 27.8 times our fiscal-year 2007 EPS estimate, we have a 12-month target price of $100.

Based on our discounted cash-flow model, which assumes a 14.8% weighted average cost of capital, double-digit free cash-flow growth for the first 20 years, and a perpetuity growth rate of 6%, we arrive at an intrinsic value of $97.

We believe that RIM's corporate-governance practices are in line relative to other communications-equipment providers we follow. Among the characteristics we view favorably are that the CEO position is shared while there is only one chairman, and there are outside directors represented on the board of directors. The board presently consists of seven directors who are elected annually at the July shareholder meeting. Additionally, the company does not have a poison pill in place to stop takeover attempts by outsiders. Administered by the board of directors and the compensation committee, the stock-option plan provides for an aggregate maximum reserve of 5% of the company's issued and outstanding common shares for issuance to any one person.


  Risks to our opinion and target price, in our view, include a decline in acceptance of RIM's products with increased device competition, network disruption and insufficient levels of service, and dependence on network carrier partners that may elect to use alternative vendors for e-mail and multimedia messaging services.

We view RIM as a compelling communications-equipment stock in S&P's information-technology sector. We think the combination of high market-growth potential, new products, an expanding presence in emerging markets like China and India, and competitors that lack either RIM's focus, strong customer relationships, or resources to offer a full-service offering for wireless e-mail and Web-based applications, makes RIM highly attractive.

Additionally, we believe that RIM will continue to boost its subscriber activation of BlackBerry service, especially in the U.S. market after six months or more of legal distractions from the NTP court case and events leading to a final settlement. RIM has a premium valuation to its peers based on p-e and price-to-sales, but we believe it's growing faster than peers and has a strong business model.