Whenever a stock drops 30%, it gets my attention -- and that's precisely what's happened to BlackBerry-maker Research In Motion (Nasdaq: RIMM ) over the past year. The carnage is even worse if you look back another year, with the stock down some 70% since its 2008 high.
Yet this is a company that continues to be No. 1 in the U.S. smartphone market, with near 40% market share, and No. 2 globally, with 18% market share. It's also sitting on $1.5 billion in cash and no debt, grew sales at a better than 27% clip over the past year, and generated nearly $3 billion in free cash flow over the past year, much of which the company used to repurchase shares. That sounds like an attractive profile for a stock trading for less than five times EBITDA.
Not without reason
The fear, of course, is that Google (Nasdaq: GOOG ) and Apple (Nasdaq: AAPL ) , which are rapidly gaining smartphone market share and have by most accounts superior phones, are about to drink Research In Motion's milkshake, turning the BlackBerry into an also-ran along the lines of Betamax. Remember that these tech giants are similarly cash-rich and have other operating businesses that can subsidize their battles in the smartphone space.
I, however, am open to the argument that fears of the BlackBerry's demise are overblown. Not only do the devices continue to have significant market share, but they are also entrenched in the hands of many corporate and government users. Further, remember that technologies never disappear overnight. Smartphones, for example, accounted for less than 15% of all mobile phone sales in 2009, meaning 75% of consumers are still buying basic mobile phone technology. And by 2013, smartphones are only expected to account for 27% of all mobile phone shipments.
In other words, a significant number of mobile phone users don't need smartphones and by extension, a significant number of smartphone users likely don't need all of the superior features offered by Android and the iPhone. These products are becoming solutions in search of problems, which means that anyone who isn't a tech geek or early adapter may not be willing to pay up for them.
That, of course, creates an opportunity for Research In Motion to defend its BlackBerry business.
And that's why I'm interested
What this means for Research In Motion is that it can move down-market and maintain market share by offering lower-cost, basic smartphones (embrace the oxymoron). In fact, Research In Motion CEO Jim Balsillie alluded to just such a strategy on the company's recent conference call. Asked about BlackBerry's design strategy going forward, he said "This is really a promising space and we can address lots of segments ... and efficiency and different price points ... because if you make these things so high-end that they're not adoptable to the market or they are so consumptive of the networks they can't scale, that's not what we originally designed our business for."
The BlackBerry, in other words, intends to be a basic solution for the basic smartphone user and therefore should be able to continue to grow revenues as the global smartphone market expands.
The problem with that
This was my hypothesis in taking a look at Research In Motion. My suspicion was that following a two-year 70% decline, the market was pricing in dramatically slower revenue growth. And in fact, that's true. According to my estimates, a $50 stock price is baking in 6% annual revenue growth over the next decade -- a number Research In Motion continues to best by a wide margin.
There is, however, a wild card here: profit margin. If Research In Motion decides to go down-market in order to defend its sales base, then it should start to look more and more like another global mobile phone market share leader: Nokia (NYSE: NOK ) . Although Nokia continues to boast better than 34% of all global phone market share, the company's stock has been in a freefall since late 2007 and its board recently opted to change CEOs. Perhaps most ominous for Research In Motion is that Nokia is also cash-rich, with almost $6 billion in net cash, cash-generative, with almost $4.5 billion of free cash flow over the past year, and committed to repurchasing shares. Its problem has been that it can't stop market share declines even as it cedes profit margin. Nokia's operating margin has dropped all the way from 15.6% in the second quarter of 2008 to just 6.6% in the second quarter of 2010 as its phones have become commoditized, with price their most compelling selling point.
Could the same plight befall Research In Motion?
A worrisome scenario
Although Research In Motion's operating profit margin is down from 2008, it's essentially stable at slightly more than 20%. If that number were to fall to 12%, however, as the company embraces a less premium sales strategy, then my model suggests that the company would have to achieve 15% annual revenue growth over the next decade to justify the current stock price. That's a tall order given that overall smartphone sales are expected to grow between 20% and 30% annually through 2015 and the quality of competition in this space. Further, remember that much of this growth is expected to take place in emerging markets, and particularly Asia, where Blackberry's brand is weakest and where consumers tend to be much more demanding of their technology.
All told, I'm interested in Research In Motion, but not at current prices. Yet market pessimism can be a destructive force. Should investors be given the opportunity to purchase shares when both lower growth and lower margins are priced in -- let's say $25 to $30 per share -- then I think we will have an intriguing contrarian play on our hands. Until then, I would be neither long nor short the shares.
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