research in motion cash model

Research In Motion Limited (USA) (NASDAQ:RIMM) (TSE:RIM) has had a nice run lately for shareholders. Most analysts are still bearish on the stock, but one boutique sell side firm thinks Research In Motion Limited (USA) (NASDAQ:RIMM) (TSE:RIM) has a bright future. The report is interesting and uses a value balanced sheet approach, which may explain why value investors, such as Prem Watsa and Donald Yacktman like the stock.

Richard Tse, CA, CFA, of Cormark Securities,explains in a new report why Research In Motion Limited (USA) (NASDAQ:RIMM) (TSE:RIM) is a buy.  Ahead of RIM’s Q3/F13 results on December 20, he is reiterating his buy rating on the company and increasing the target price from $12.00 to $16.00 on the back of an improving outlook. The revised $16.00 target is based on the midpoint of RIM’s NAV calculated using its reported balance sheet and Cormarks’ version of the value based on a markdown in the company’s assets.

The report from Cormark can be summarized in three separate sections, we detail them below:

1) The power of the product cycle.

A primary driver of valuation for technology names, particularly those with a hardware focus, is the product cycle and Tse believes that product cycles can drive equities even when the immediate financials are absent provided there is strength in those products. In the case of Palm, while its mobile operating system WebOS failed in the end, the product cycle propelled the stock from nearly $4 to $18.

In the case of BB10, Richard believes that RIM’s new mobile OS has many elements of Palm in that BB10 looks to be a meaningful improvement to BB7 – catching the Company up with its main competitors.

2) Cash is king.

Going back to Palm, as good as webOS was, Tse believes that the lack of cash for a strong and continued push into the market contributed to its failure. This is why cash is so important for RIM. A cash balance of just over $2.3 BB last quarter was positive and is one of the factors for the upgrade.

This is largely because the cost of rolling out a new operating system and related hardware products is pricey. This price tag comes from many perspectives beyond the obvious ones like R&D but extends into carrier seeding programs, marketing campaigns, and in RIM’s case, payments to developers. As a benchmark, blockbuster launches like the Motorola Droid and Nokia Lumia were well over $100 MM from a marketing campaign perspective.

Going back to Palm, while its mobile operating system webOS received rave reviews, its lack of carrier support and likely related money to push into those channels led to its downfall. Tse notes that Palm had a negative NAV per share prior to Hewlett-Packard Company (NYSE:HPQ) acquiring it.

Last quarter, Research In Motion Limited (USA) (NASDAQ:RIMM) (TSE:RIM) had the cash it needed to get BB10 off the ground and this improved the odds that it would at least have a viable shot of getting BB10 products to market without a cash constraint. Tse believes that cash will continue to be a critical data point in the upcoming Q3/F13 results. A cash balance of around $2 BB will be positive in supporting this thesis.

3) Valuation is still low.

Tse does not use a conventional earnings model, but rather a metric which many value investors will be familiar with.  Tse still sees upside particularly as an improving outlook derisks his view on this value. Tse believes that it provides a substantial fundamental base for RIM.

He believes that there are just  many variables for even the company to call the eventual success and whether those numbers, including his own, will ever pan out, so a better measure is based on a more defined metric – the balance sheet.

Apart from the subjectivity and uncertainty of whether a buyer would ever surface for such assets, it is still a firmer measure. Below is the NAV valuation analysis. The methodology has the base value of RIM at ~$14 per share including cash and ~$9 per share if cash is excluded. The NAV per share as of Q2/F13 (as reported) was actually closer to ~$18 per share.

Research in motion valuation based on NAV and book value model
Via Cormark Securities

Disclosure: No position in any securities mentioned.