RIM Turn-around Appears Extremely Unlikely Based On History

RIM surged on Friday by 13.65 percent, to close at $11.66 (on the NASDAQ). The troubled smartphone maker, has seen its share price increase by approximately 85% in the past 60 days alone. Investors seem to be thinking that the company’s do or die strategy with Blackberry 10 will pay off. However, Research In Motion Limited (NASDAQ:RIMM) (TSE:RIM) still operates in arguably the most competitive industry in the world. RIM will need to convince both former and new users that Research In Motion Limited (NASDAQ:RIMM) (TSE:RIM) products are just as good as Apple’s or Google’s. How hard will this be? The answer seems to be very.

Below are some of the key points to consider:

In a global smartphone market where analysts expect 880 million to be sold in calendar 2013, selling 18 million new smartphones into this market would seem like a very doable task. However, recent experience suggests this is quite difficult. Nokia Corporation (BIT:NOK1V) (NYSE:NOK) (HEL:NOK1V) has sold only about 10 million Lumias in its first year since its Windows Phone launch, and this is with massive marketing help from Microsoft Corporation (NASDAQ:MSFT) and the willingness to sell at effectively flat-to-negative gross margins.

Most Android vendors outside of Samsung Electronics Co., Ltd. (LON:BC94) are selling ~30 million Android smartphones/year, but at far lower price points than what many analysts have assumed for Blackberry 10, and none are generating sustainable profitability.

How hard is that? Consider the following factoid: before the onset of Android, nearly every smartphone OS launched was at least modestly successful, and created a profitable ecosystem (Symbian, Windows Mobile, Palm, Blackberry, iOS). After Android,
not a single new OS has been successful (WebOS, Meego, Bada, and Windows Phone so far). Free OS has changed the economics of the industry forever.

Below is a table of annualized 3Q12 revenues, smartphone sales and EBIT margin of competitive smartphone vendors in the market today.

As shown above, most are not profitable, and in HTC Corp (TPE:2498)’s case, it is unclear if its profitability in 3Q is sustainable. Essentially, Apple Inc. (NASDAQ:AAPL) and Samsung Electronics Co., Ltd. (LON:BC94) have developed massive scale economics in smartphones, and this is leading to out sized operating margins for these two vendors.

However, none of the other competitors have reached that level. It appears that one needs to sell well over 30 mln smartphones annually in order to reach sustainable profitability.

Because RIM owns its own OS, perhaps it does not quite require the 30 million or so smartphone sales to reach profitability that Android partners appear to require, but even getting to 18 millioin no easy task.  They would have to sell 18 million at very good economics; once the likely price discounting takes hold, it is likely that the level of sales needed to reach break-even will climb.

To put the challenge ahead for Research In Motion Limited (NASDAQ:RIMM) (TSE:RIM) in perspective, Nokia Corporation (BIT:NOK1V) (NYSE:NOK) (HEL:NOK1V) has tried to help launch a new OS to the world, and in the first year it has sold roughly 10 million devices, at an average ASP that many analysts expect is well below $300 and at gross margins that are flattish at best.

This has included substantial marketing support from carriers and from Microsoft Corporation (NASDAQ:MSFT), and although RIM can probably count on marketing support, it does not have a deep-pocketed OS partner to lean on.

Black Berry 10 Commercialization may be more about strategy than profits – The most strategically interesting thing about RIM is the fact that it has its own OS, and is thus vertically integrated, giving it the ability to differentiate in a way that Android and Windows Phone hardware partners cannot.

Although the ability for RIM to return to meaningful profitability will be an uphill battle, a somewhat successful BB10 launch could pique the interest of other players wanting to differentiate their smartphone offerings or enter the smartphone market without having to resell someone else’s OS.

Perhaps what is most important for RIM shareholders is that simply commercializing a new OS, and showing some modicum of success, may incent some other handset players or players from outside the industry to partner or look more strategically at RIM. It is clear that birthing a new OS since the birth of Android has become nearly impossible, but it is also true that using Android as a platform has only been a success for one hardware vendor to date.

Summary: RIM is attempting to successfully do something that has not been done since late 2008 with Android, and that is to launch a successful new OS into the smartphone world. Palm’s WebOS failed, Nokia/Meego failed, Samsung/Bada failed, even Microsoft Corporation (NASDAQ:MSFT) Windows Phone has failed to date.

Before Android, nearly every smartphone OS launch was successful to some degree and supported a profitable ecosystem (Symbian, Windows Mobile, Blackberry, Palm, iOS).

Since Android, not a single one has succeeded as Android has obliterated the economics of the business by making the OS layer free. RIMM’s task appears to be daunting.