RIM: Downgrade is Too Late

“I thought the downgrade should have been made 20 points ago. You’ve got a 14 times earnings stock in the 50s. I’m not going to back away from it at this level. I’d rather buy it than sell it. It’s really down a lot.” — CNBC’s Mad Money 11/2/2009

Not much has been going right for Research in Motion (RIMM) investors recently with the stock about 33% in just under 6 weeks time. The most recent sell-off was sparked by a downgrade to “Sell” from Citigroup (C) analyst Jim Suva related to stiffening competition particularly from smart phones running on Google’s (GOOG) Android operating system. The stock was down about 6% on Monday mainly due to this downgrade news.

We have to agree with Cramer’s assessment above that the downgrade is probably too late as the stock has fallen hard already on concerns over increased competition. Research in Motion has dropped considerable even as earnings have continued to increase significantly over the last few quarters. So, relative to a market that has seen substantial P/E expansion, RIMM has seen its multiple contract. This is an interesting phenomenon especially considering RIM operates in a particularly hot sector of smart phones where most other stocks have enjoyed a very nice run over the past few months. For example, over the last six months Research in Motion has fallen 21%, whereas competitors like Apple (AAPL) has increased 48% and Motorola (MOT) is up 64%. Even Palm (PALM) which is expected to make a profit until fiscal 2011 is just about even over the past half year.

This seems to us to be a perfect example that has fallen deep out of favor with the market, and in most cases we see that as an opportunity to value investors. The stock has continued to drop as the fundamentals have strengthened; a fact that we believe the market will eventually take into account. Not surprisingly, we have RIMM rated Undervalued and if the price falls any further it may be an upgrade to Greatly Undervalued in next week’s rating review. For an example of just how undervalued Research in Motion is, we looked at the past eight years of price-to-sales for RIMM and it has normally traded within the wide range of 3.7x to 12.1x revenue per share. That metric now sits at only 2.04x, which is incredible for a company that is expected to grow revenue at 34% this fiscal year and 23% in the next.

Cramer is correct that this is a stock that investors should more readily buy than sell. The Citi downgrade was piling on with the bad news and the resultant drop should be viewed as an opportunity.

Research in Motion: Downgrade is Too Late

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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